Dubai struggled to ease fears of debt default after its move to delay repayments at two flagship firms shook confidence in the Middle East as a centre for investment and a source of capital.
Dubai's debt problems, a hangover from a property boom that produced the world's tallest building, have shaken trust among Western investors who turned to the oil-exporting Gulf region for help during the global financial crisis.
The emirate said on Wednesday it would ask creditors of Dubai World, the conglomerate behind its rapid expansion, and Nakheel, builder of its palm-shaped islands, to agree to a standstill on billions of dollars of debt as a first step towards restructuring.
Dubai tried to revive confidence by saying on Thursday its profitable DP World, which runs 49 ports around the world, would not be involved in the restructuring. DP World, which has $US3.25 billion ($NZ4.60b) outstanding bonds, is majority owned by Dubai World but has shares listed on NASDAQDubai.
"It might be a move to distinguish the solvent from less solvent companies in an attempt to shift the weight away from the less exposed entities," said John Sfakianakis, chief economist at Saudi Fransi bank.
European bank shares, which had recovered in recent months on hopes that the worst of a global crisis was over, fell to lows not seen since May on Dubai's debt delay.
There was no immediate sign that US banks were exposed, but it was difficult to ascertain, given Thursday's Thanksgiving holiday.
"It is not so much that Dubai did what they did, but how they did it ... with no notice," said Andrew Brenner, head of emerging markets at Guggenheim Securities. "Spreads on a lot of fixed income products have gotten to very rich levels and the Dubai default will force risk to get repriced downward. Either way, look for a flight to quality scenario tomorrow on a holiday-shortened day."
Shares in companies in which Gulf investors own big stakes - including the London Stock Exchange, UK grocer J Sainsbury and German carmakers Porsche and Daimler - also fell sharply on concerns the holdings would be cut to meet obligations at home.
Britain's FTSE 100 stock index dropped 3.2 percent to its lowest close since Nov. 6, pressured by hefty falls in the banking sector due to concerns about Dubai's ability to pay debts.
Exposure to Dubai World could be as high as $US12 billion in syndicated and bilateral loans, including existing loans for Nakheel and Istithmar, an investment arm of Dubai's government, banking sources told Thomson Reuters LPC.
International banks are seeking to clarify their position as they formulate their response to the standstill request and are assessing the implications for lending to Dubai and the Gulf.
"This is very serious and will have implications across the region," a senior banker said..
The Dubai news ricocheted through emerging markets. Stock markets around the world sank, with weakness extending to Latin America, where the Mexican peso was knocked off a 1-year high and Brazilian assets sank.
BONDS EXTEND LOSSES
In one of the first signs that Dubai's problems could hurt global fund-raising efforts for its neighbours, Saudi-backed Gulf International Bank pulled a bond sale due to priced this week.
Dubai's move will likely lead to a reassessment of the riskiness of debt issued by the region's sovereign-linked firms.
Ratings agency Standard & Poor's said on Thursday it had placed the ratings of four Dubai-based banks on negative outlook due to their exposure to Dubai World.
S&P's and Moody's Investors Service severely downgraded several government-related entities on Wednesday.
Wednesday's announcement also sent the cost of insuring Dubai's debt against default soaring and bond prices tumbling.
Dubai World, whose slogan is "The sun never sets on Dubai World," has $US59 billion of liabilities, a large proportion of Dubai's total debt of $US80 billion.
Dubai's credit default swaps are being quoted as high as 500-550 basis points, some traders said, while the cost of insuring Qatari, Abu Dhabi and Bahrain debt also surged.
Analysts downplayed the fallout for the wider region, however, pointing out that Dubai funded its growth through loans, whereas its neighbours are mostly major oil and gas exporters.
"I would not rush into talking about contagion. Anything from Abu Dhabi or Qatar is backed by serious money. Dubai is a lot more leveraged," said Youssef Affany, a relationship manager at Citi who specialises in the region.
"There will be some level of solidarity from the emirates and the big neighbour, Saudi."
Analysts expect financial support from Abu Dhabi, a neighbouring member of the United Arab Emirates and home to most of the country's oil, to keep Dubai afloat. But Dubai might have to abandon an economic model that focused on heavy real estate investment and inflows of foreign money and labour.
Earlier this year, Dubai headed off investor concerns that it would default on its debt by launching a $US20 billion bond programme in which the central bank of the UAE, the world's third-largest oil exporter, bought the first $US10 billion slice.
Dubai said it had raised a further $US5 billion as part of that programme, placing the debt with two Abu Dhabi-controlled banks. But the move raised questions over why Dubai had not raised the entire $US10 billion tranche it had planned to sell on the international market.
OPTIONS FOR DUBAI?
If creditors reject proposals to postpone near-term debt obligations until May 2010, the Dubai government could be forced to hold a firesale of its international real estate.
International property advisers are bracing for a potential slew of instructions to sell trophy assets owned by Dubai World.
"We do expect the Dubai government to step up efforts to raise capital via real estate sales, and sales of their UK assets in particular," James Lewis, a member of the Gulf capital markets team at property consultant Knight Frank, told Reuters.
One fund manager said Dubai could not separate the debts of DP World from the Nakheel bond at the heart of Dubai's problems.
The $US3.52 billion bond, which was originally due to mature on Dec. 14, 2009, traded as high as 110 percent of par value on Wednesday before the Dubai government said it would ask creditors for a standstill.
On Thursday, the bond traded at 72, and Nakheel's Islamic bond prices extended losses, reaching their lowest level since February.
"Trust is the basis of all credit. It can take decades to build up credit-worthiness and moments to destroy it. They have the money to pay the Nakheel bond," said the fund manager.
"DP World can't be kept separate. If that's an asset of Dubai World, ownership of that can presumably be attached by Nakheel creditors."