Dubai’s $59 billion default sends tremor through global financial system

28 November 2009,   Dubai’s announcement on Wednesday that it would be delaying by “at east” six months the maturity date of $59 billion in bonds issued by the city-state’s largest state-owned company, Dubai World, has sent global shares tumbling. The market reaction to Dubai’s massive debt default is partly explained by the exposure of European and Asian banks to DP World and its tourism subsidiary, Nakheel.

The real reason for the falls, however, is that Dubai’s apparent insolvency confirms that default by hyper-indebted government borrowers is now a real risk right across the globe, especially in the Middle East and Eastern Europe. Such a default would not only mean an immediate worsening of the already brutal post-crash conditions suffered by millions of workers in defaulting countries, but would usher in a second, and probably worse, phase in the global financial crisis.

A note published by Bank of America strategists warned of the possibility of a major sovereign default. “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,” the note
said.

An editorial in today’s Financial Times noted that while markets were not expected to return to the panic of September 2008, because the financial sector had state backstops, “fearful investors have started to worry about how safe sovereign debt is,” citing Ireland and Greece as two examples.

The Dubai meltdown represents only a small sum in terms of total global indebtedness. Nevertheless it indicates that despite talk of global economic recovery, the world remains on a knife-edge. Attempts at reassurance by British prime minister Gordon Brown indicate that financial and government elites are already fearful. Brown this morning acknowledged the risk that Dubai posed to the global economy but, with careful understatement, told reporters “I think we will find this is not on the scale of the previous problems we have dealt with.”