Next week financial markets will be looking for some pretty speedy answers from Dubai after the sudden decision to suspend payments on the debt of Dubai World.
If the intension is to ring-fence a particular part of state assets then creditors will need to know what they are facing. Just what does Dubai World have as assets? How much are they worth? What can be realized? And how much is available?
There are always two sides to a debt crisis. The lenders are partly culpable. Why did they lend so much to an entity that now can not pay up? What happened to their due diligence and credit assessment? Did they not see the soaring debt levels?
$60bn debt mountain
But going forward lenders will have to realize that having invested in Dubai World they are reliant on the company and its advisers for a solution to their $60 billion debt mountain. It will always be better to reach a solution than no solution for creditors. A disorderly liquidation really would be a nightmare with everybody a loser.
That said the Dubai Government is also going to have to face up to the inconvenient truth that markets do not selectively apply government guarantees. If a sovereign gives its word on one entity’s debt and then goes back on it, then all its sovereign guarantees are open to question.
Actually it is more basic than that: if an entity is a part of the government then the liability of the government is surely unlimited? Well, to argue the reverse would be difficult, unless it is explicitly stated in the reams of documentation.
This is just a fact of life in global markets, not an interpretation of reality. That means it is impossible to contain a credit crisis that involves a sovereign guarantee within the boundaries of one government entity.
The global market response to this news has surely demonstrated this fact. An announcement about the debts of a Dubai Government company brought share prices down as far away as Japan, and even impacted the value of the US dollar.
New credit crunch
In the UAE the impact is going to be similar to the credit crisis last autumn, unless the federal government intervenes very decisively. The cost of money will go up to reflect the greater risk of it not being repaid, and banks will presumably be even less willing to lend money to the private sector, or to the public sector entities with sovereign guarantees.
Actually this situation is by no means unique to the UAE. The $22 billion Algosaibi banking scandal in Saudi Arabia has had a similar impact on the availability of credit to small and medium sized enterprises across the Kingdom.
Yet arguably facing up to a day of reckoning is exactly how a financial crisis should be dealt with. There is a very good argument that the rest of the world is only putting off its ultimate crisis by borrowing even more heavily to bail out global financial markets, and that its final crisis will just be bigger.
Clearing up the debts
Could Dubai just be doing what everybody else ought to be doing? You can certainly argue that by clearing up its books now Dubai will be in a position to recover more strongly later.
But this will be painful and come at a high price for those who lose their jobs and investments in this fall-out. It might be the right commercial response to a difficult position. But then this position should never have been reached in the first place, and for that bankers must also share a part of the blame.
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