The Dubai government will not guarantee the liabilities of its precariously indebted Dubai World holding company, leaving creditors to face "short-term pain" that could run into the billions of dollars.
Last week's request for a six-month standstill agreement on a $3.5bn (£2.1bn) tranche of Dubai World's $59bn debt sent shockwaves through world stock markets. Yesterday saw exchanges in the Gulf hit harder still when they opened for the first time since the announcement, following the four-day Eid religious holiday.
Nasdaq Dubai dropped by 7.3 per cent, its worst fall for more than a year. In Abu Dhabi – the fellow United Arab Emirates (UAE) member widely expected to come to Dubai's financial rescue – the bourse lost 8.3 per cent in its worst-ever day of trading.
Dubai World's most pressing problem is its Nakheel real-estate division, which has been the developer most exposed to the city-state's collapsed property bubble. It is Nakheel's problems with $3.5bn of sukuk – Islamic bonds – due in two weeks that triggered the crisis.
Yesterday, Nakheel asked the Dubai stock exchange to suspend trading in all three of its sukuks until it is "in a position to fully inform the market".
Meanwhile, amid deafening silence from Dubai's ruler, Sheikh Mohammed al-Maktoum, the government was keeping its distance from the problem. In a television interview yesterday morning, the director-general of the Department of Finance, Abdul Rahman al-Saleh, warned that lenders to Dubai World faced "short-term pain".
"Creditors need to take part of the responsibility for their decision," he said. "The government is the owner of the company, but since its foundation it was established that the company is not guaranteed by the government."
British banks are thought have up to $50bn of exposure to the wider UAE. Bank stocks continued to suffer yesterday – with Lloyds off by 5.9 per cent and RBS by 4.5 per cent – despite reassurances from the UAE Central Bank at the weekend that it was creating an emergency liquidity facility for both local and international banks. Speculation is rife as to the form of Dubai World's restructuring and the role of Abu Dhabi, which so far has said only that it will offer help on a "case-by-case basis". Deloitte, the accountancy firm, was appointed at the weekend to manage the restructuring, but no details are expected before the middle of the week. Options include repaying the December sukuk and rescheduling remaining debts, or instituting of a six-month debt holiday.
Another alternative is that the group sell some of its vast portfolio of assets. Profitable ports group DP World has been ring-fenced, but other assets range from hedge funds to hotels to the Turnberry golf course in Scotland.
The biggest problem is the uncertainty because of the lack of clarity from Dubai. David Buik, of BGC Partners, said there was unlikely to be a major impact in the UK, adding: "Dubai won't pull out of its investments in the UK because it needs both the diversification and the reciprocity in terms of trade."
Even banks were unlikely to suffer unexpected losses, he suggested, saying: "Any intelligent person looking at the scale of the building in Dubai could see what was coming. We can be confident the banks will have made significant provisions for bad debt in Dubai."
Over the longer term, Dubai's travails will put paid to the trend for quasi-sovereign risk, where companies benefit from an implicit state guarantee, said Shahin Vallée, of BNP Paribas. He added: "The implication is a re-pricing globally of what people were considering as quasi-sovereign risk [in places like Russia and Latin America]."
Unlikely casualty: Press freedom
Newsstands in debt-ridden Dubai were barred from selling The Sunday Times at the weekend because it contained a photo-montage of the ruler, Sheikh Mohammed al-Maktoum, sinking in a sea of debt. The mock-up was deemed so insulting as to infringe local traditions of deference.
The news paper was unexpectedly drawn into the fracas about Dubai's finances with its two-page article headlined "The Sinking of Dubai's Dream". "We cannot accept a personal insult," said an official at the United Arab Emirates Media Council. "It is against our traditions."
The UAE – of which Dubai is one of seven member states – has a strict media code prohibiting the publication of criticism of any of the sheikhdoms' rulers. In the aftermath of the crisis sparked by last week's revelation of Dubai's $80bn debt crisis, the local media as well as government officials have spoken out against what is perceived as negative coverage in the international press.
Despite The Sunday Times being held back from distribution this week, the media council stressed that it had not been banned altogether. And its sister publication, The Times, was on sale as usual across the Gulf yesterday.
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