- Dubai World: Ripple Effects and Market Volatility

A hallmark of today's global economy is that capital can flow freely around the world to a wide variety of investment destinations. Investors can seek exposure on a vast playing field and realize optimum profits from international sources. But a crisis in one region can have a ripple effect that increases volatility in markets on the other side of the globe.

Launched as a holding company on July 2, 2006, Dubai World is an investment company that manages and supervises a portfolio of businesses and projects for the government of Dubai, one of the seven emirates of the United Arab Emirates. Projects range across a wide range of industry segments and seek to promote Dubai as a hub for commerce and finance. But its activities are not isolated to the UAE; with more than 50,000 employees in over 100 cities around the globe, Dubai World holds extensive real estate investments in the United States, the United Kingdom, and South Africa.

6-Month correlation of major US equity indexes to the Dow Jones UAE index generated using the RiskAPI Add-In.

Dubai and its related companies have about $90 billion of debt. On November 26, 2009, Dubai World asked for six months delay in payment on $26 billion of debt on its property units Limitless World and Nakheel. DP World, the profitable port operator, quickly assured creditors that it was not subject to the proposed standstill. A $10 billion infusion from Abu Dhabi helped forestall default on Nakheel's $4.1 billion Islamic bond and provided enough funds to service debt until April. But these funds are conditional upon a standstill agreement being secured.

On the day of the announcement, the proposed standstill shook world markets and caused many indices to drop. The Dow Jones industrial average lost about 155 points, or 1.5 percent, in an abbreviated Good Friday trading day. The London Stock Exchange lost 1.86 percent in late morning trade before being suspended due to a technical issue. Frankfurt, Paris, Beijing, Tokyo, and Hong Kong all posted losses. Oil prices fell as much as seven percent before later in the day making a recovery. Moody's Investors Service and Standard & Poor's cut the ratings on several Dubai state companies, saying that the standstill plan may in fact be a default.

On December 1, investors and creditors who anticipated a Dubai government bailout were not encouraged when Abdulrahman al-Saleh, director general of Dubai's Department of Finance, said, "Creditors... think Dubai World is part of the government, which is not correct."

90-day correlation-over-time of SP500 to the Dow Jones UAE index generated using the RiskAPI Add-In.

After suffering huge losses in the 2008 market collapse, until the Dubai debt announcement most Gulf bourses were on track to show strong gains. At the close of 2009 the two United Arab Emirates bourses of Dubai and Abu Dhabi made only modest increases over the beginning of the year, after seeing most of their gains evaporate in the last six weeks of the year on Dubai debt problems.

The problems haven't stopped. In January, a consortium of four Japanese companies and one Turkish company announced that they would suspend construction of the Dubai Metro due to a delay in payment from the Dubai government.

The future depends on how the big banks that have lent to Dubai and its various entities now respond to an anticipated formal standstill request, which will propose a debt restructuring and rescheduling. If they demand payment on outstanding debt and withdraw credit lines, the massively leveraged structure could collapse. For Dubai, both lower economic sentiment and credit growth for 2010 is a certainty. By blurring the boundaries between an ordinary corporate and a government-backed entity, Dubai will now find it harder to repair the damage from a high-profile failure, and international investors will seek exposure in less volatile markets.

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