The crisis in Dubai is "no Lehman event", although investors should expect risk assets to underperform during the remaining weeks of 2009.
Last Thursday, state-owned property company Dubai World made a surprise announcement that it was seeking to restructure its debt and delay some repayments. Dubai property developer Nakheel then asked for some of its Islamic bonds to be suspended.
The news saw Dubai’s Financial Markets Index tumble 7.3% in the first hour of trading on Monday, after the four-day break for the Eid holiday. Shares on the Abu Dhabi Securities Exchange index plummeted 8.3%.
However the central bank of the United Arab Emirates said on Sunday it would provide banks with extra liquidity, raising hopes that the Dubai debt crisis will not spread to other markets.
"The Dubai World announcement is an extreme example of the collapse in the financing model that has been unwinding since July 2007," says Chris Iggo, chief investment officer of fixed income at Axa Investment Managers. "But it is not something that can derail the fragile global economic recovery. This is no Lehman event."
Iggo calls the Dubai World announcement a "delayed echo" from the same forces that blew up the sub-prime mortgage market.
While he believes there is enough money locally to help out Dubai - for example from Abu Dhabi’s sovereign wealth fund worth up to $500 billion - Iggo warns that the situation should not be downplayed. "There will be significant losses and for the banks involved this will be a depressing set-back to their capital rebuilding plans. Property valuations in Dubai will collapse I imagine."
According to Ghadir abu Leil-Cooper, head of EMEA equities at Baring Asset Management, Dubai’s problems are a reality check for investors. "They have served to remind investors that an equity rally and a large dose of monetary and fiscal stimulus from emerging and developed governments alike have not eradicated debt-service difficulties."
Iggo predicts that December will be a month of risk assets underperforming as we see a flight to quality. "Investors are likely to reduce their levels of risk until the new year or at least until there is some clarity on the Dubai situation and its impact on the rest of the financial world."