Following the flight to safety and sell off in the risk assets on Thursday and Friday of last week, markets today showed a return to stability with equity markets closing up in Asia and marginally down in Europe. Abu Dhabi and Dubai, whose markets opened today for the first time since the news of Dubai World’s warning on debt repayment, witnessed a record drop in their indices; falling 8.3% and 7.3% respectively. Fears that the delay in debt repayments by Dubai World may signal new strain of systemic risk have largely abated. The United Arab Emirates central bank’s announcement that it would stand behind domestic and foreign banks has reassured investors and has stemmed a potentially larger capital flight. Nevertheless, the news from Dubai is a sharp reminder that the financial crisis that began two years ago and almost destroyed the global economy a year ago is still with us. Pimco’s Mohamed El-Erian believes Dubai is a reminder that we still need to deal with the repercussions of massive credit expansion to unjustifiable projects earlier this decade.
Despite the emirate’s astonishing level of self-aggrandisement, Dubai’s debt is not enough to rock financial world. Of the $123bn of UAE foreign obligations, US banks account for $10.6bn, Japanese banks for $9bn and EU banks $40bn. The UK appears to be uniquely vulnerable to a potential Dubai default as British banks account for $50bn of the debt. The Foreign Exchange markets have reflected this, with Sterling being the only currency to fall against the USD at the start of the trading week. The US Dollar had strengthened significantly against all currencies, bar the CHF and JPY. The resumption of a weakness reflects a modest return to risk. However, the news from Dubai has had a broader impact on sentiment towards sovereign debt. Given the sharp increase in debt to GDP over the last two years, no end in sight for emergency monetary policy and, unlike Euro area countries such as Greece and Ireland, an ability to put off difficult political decisions by devaluation, Sterling may be the biggest loser from the Dubai debacle.
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