Saud Masud, a Dubai-based UBS analyst, posed some interesting questions in a note published on Thursday.
Amid speculation as to who has the most exposure to Dubai — be these exposures individual, institutional or even econo-political — Masud laid out an even-worse case scenario:
Perhaps Dubai’s financial problems are much bigger than have been assumed so far. Perhaps Dubai’s debt includes sizeable off-balance sheet liabilities that imply a total debt burden well above the US$80-90bn in debt that the markets have estimated so far. This could imply that the debt issued by Dubai in recent weeks (see above) is indeed insufficient so meet upcoming redemptions. The government may have concluded that increasing delinquencies and defaults would pose an ongoing threat to many banking and property companies and that just addressing near term balance sheet debt would mean tackling just the tip of the iceberg. The repercussions of this scenario may reverberate beyond Dubai and into other Gulf regions.
The possibility that the shockwaves in Dubai might lead to tsunamis elsewhere in the world was also raised by analysts of Bank of America Merrill Lynch on Friday (emphasis ours):
Short-term contagion risks were going to be inevitable, given the size and the surprise factor that characterized the Dubai World call for a debt standstill. What happens next is the real question, however. In a best-case scenario, this will remain limited to a Dubai corporate sector problem, with either some bailout from UAE authorities or a market-friendly debt restructuring. In this instance, the short-term contagion would pave the way for a rebound in emerging markets, with attractive levels to re-establish bullish views that would have emerged.
At the other end of the spectrum, one cannot rule out—as a tail risk—a case where this would escalate into a major sovereign default problem, which would then resonate across global emerging markets in the same way that Argentina did in the early 2000s or Russia in the late 1990s. We think this would clearly be a very serious outcome—which again remains only a tail risk at this stage—but the implications would be indeed quite severe in our view. These would include a sudden stop of capital flows into EM, more fragility for foreign banks exposed to the Middle East, possible contagion into global developed markets, and eventually a major step back in the path to recovery out of the global financial crisis.
On the other hand, Andrew Garthwaite at Credit Suisse is much more optimistic:
The potential for economic contagion is very low with the UAE accounting for just 0.3% of global GDP.
We side with the bears on this one, however: the potential for contagion is very real, and at this point, unquantifiable.
What’s happening in Dubai is a not-so-small reminder that swans of all colours abound.
Related links:
Abu Dubai? Pah! – FT Alphaville
Polite suggestion to the Dubai sovereign that creditors of Dubai World not be bailed out – Willem Buiter / FT
The morning after the sandstorm before… – FT Alphaville