Global financial markets swooned Thursday, with London seeing its most precipitous drop in nearly nine months, a day after Dubai stunned investors with the news that it was asking banks to allow its main investment vehicle, Dubai World, to suspend its debt repayments for six months.
The announcement - the global high finance equivalent of a homeowner asking the bank to allow six months of skipped mortgage payments, presumably because the homeowner was out of cash - sowed fear of a contagion of instability that could roil markets that are only now recovering from the near cataclysm of the last year.
That possibility sent markets in London, Frankfurt and Paris spiraling downward, even as analysts struggled to explain which fears of contagion were legitimate and which were overwrought.
Some market experts noted, for instance, that while banks that have lent money to Dubai World could suffer significant losses if the company were to default on all or part of its billion debt, worries about the sovereign debt of Middle Eastern countries swimming in oil reserves were unfounded.
"This is another wave of the credit crunch," said Christopher Davidson, an expert in Gulf politics at Durham University in Britain.
"Dubai was fairly much the worst example of overextension. It had the worst debt per capita in the world by far. I would like to put it down as a really enormous white elephant that doesn't have much in common with the regular economy of a regular state."
Still, in the mentality of the market, guilt by association can be a powerful force. Referring to the unexpected weakness at Dubai World, Mr. Davidson said, "It will tarnish the reputation of the Gulf region a bit, and it will certainly make investors more bearish again about emerging markets."
Like many Western consumers during the good times, Dubai gorged on debt and borrowed too much to finance a building boom that has gone bust in the downturn. When credit markets froze last year, Dubai, like Iceland, found itself overextended. But Dubai, which has no oil, was backed by its Arab emirate neighbors. At least that is what investors had assumed.
The shocking announcement on Wednesday upended the assumption that Dubai would stand behind Dubai World and that other emirates, especially Abu Dhabi, would stand behind Dubai.
On Thursday, the first full trading day in Europe since Dubai's announcement, the FTSE 100 index in London lost 3.18 percent, to close down 170.68 points. The DAX index in Germany fell 3.25 percent and the CAC-40 index in France lost 3.41 percent. In Tokyo, the benchmark Nikkei 225 stock average, was less affected, falling about 0.62 percent. Markets in the United States were closed for Thanksgiving.
In separate moves that could portend longer-term instability, Standard & Poor's downgraded Dubai-based banks with heavy exposure to Dubai World, and the Saudi-backed Gulf International Bank postponed a bond auction that was scheduled to be priced this week.
The cost of insuring Dubai's debt against default quadrupled Thursday.
No one could be certain how destabilizing a default by Dubai World would be - banks have not disclosed their exposure to Dubai World's debt. But concern in global markets ran high. The dollar fell below 85 yen. The dollar also fell against the Swiss franc, a traditional safe haven, until the Swiss National Bank intervened in the market to bolster the American currency.
"Investors have gone from getting cozy to a sense of serious concern," said Saud Masud, head of research at UBS in Dubai.
Mr. Masud said negotiators would feel pressure to reach some kind of deal to present to the markets before trading in the region resumes next week after the Eid holiday, because otherwise markets there might fall precipitously too.
Dubai, one of the seven members of the United Arab Emirates, said Wednesday that it intended to ask all lenders to Dubai World, the government's main investment vehicle, and Nakheel, the conglomerate's property development unit, to sign on to a so-called standstill agreement and extend repayment deadlines until at least the end of May.
Foremost on the minds of bondholders was the .5 billion sukuk, or Islamic bond, that Dubai World had been expected to redeem in December, one of the largest such financial instruments ever issued. Islamic law prohibits the payment of interest.
In Europe, banking stocks fell amid concern that the value of loans to the emirate would have to be written sharply lower. The financial sector declined about 3 percent over all. In London, HSBC Holdings fell 4.3 percent, Royal Bank of Scotland declined 4.2 percent and Barclays fell 3.9 percent. Deutsche Bank lost 4.2 percent in Frankfurt. ING Group fell 5.3 percent in Amsterdam.
EADS, the maker of Airbus planes, which has counted Middle Eastern customers among its most resilient, also declined, as did the French luxury goods conglomerate LVMH Moët Hennessy, Daimler and BMW, all of which have substantial sales in the region.
Shares of companies in which Gulf investors own big stakes, including the London Stock Exchange, the grocer J Sainsbury and the German carmaker Porsche, also fell sharply on concerns the holdings would be cut to meet obligations at home.
Booming services and real estate sectors, a gleaming new airport and a pro-business climate had for years lured businesses, as well as prominent investors, including the soccer star David Beckham.
The Dubai government's total debt is estimated at about billion, of which, Mr. Masud estimated, about two-thirds is held by local investors.
Real estate developments for which market values have tumbled have accounted for much of the company's problems, he said, though "the biggest liabilities for these companies isn't just the stuff on the balance sheets. It's the cost of completing the half-finished projects on which the investors have bailed out."
The company did not respond to requests for comment.
Source: Agencies
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