THE recent troubles that Dubai World, a Dubai governmentowned company, has been having with

repayment of its debts is a grim reminder of the fact that the global financial crisis is possibly not over
yet. In fact, the fundamental causes for the financial distress that Dubai finds itself in are not much
different from what caused the economic meltdown in the US two years ago: excessive consumption and
highly-leveraged real estate bets. What is different, however, is that the Dubai government chose to wash
its hands of what was seen as quasi-sovereign debt, debt owed by wholly-government-owned companies,
though not explicitly guaranteed by the owner. This has important implications to emerging market
capital flows. 

Moreover, the potential economic fallout on the Dubai economy will have ramifications on India’s
bilateral trade as also the livelihood of around half a million NRIs in the country and their inward
remittances to India. The markets, however, have taken a rather sanguine view of the Dubai events and
have shown remarkable resilience in recovering from the shock announcement of Dubai World seeking a
‘standstill’ in debt servicing, in less than 48 hours. 

The total debt of the Dubai government and other government-owned entities is estimated to be in excess
of $100 billion, much beyond the estimated GDP of the tiny country. Being not endowed with oil
resources of any consequence unlike its neighbours, Dubai had relied on massive borrowings to build an
economy reliant on trade, tourism and realty. In addition, Dubai invested heavily in foreign assets —
casinos, luxury hotels, commercial property, luxury ocean liners, etc — substantially financed by
international borrowings. The global financial meltdown in 2007 hit the pillars of its growth strategy —
trade and tourism — very hard, resulting in near-empty commercial buildings and abandoned
construction projects leading to property prices tumbling to less than half the peak levels. 
Against this background, servicing the massive debts raised to create these assets became difficult and
Dubai World, one of the government-owned entities owing some $59 billion to international banks, asked
for a standstill as regards debt servicing from its borrowers for six months in late November.  
The contrast between how the US, the ultimate capitalistic country, and Dubai, the aspirer, handled the
crises is too stark to ignore. In the US, several privatelyowned banks — including investment banks
having no retail depositors’ interest to protect — have been bailed out with large doses of taxpayers’
money. In Dubai, international lenders to governmentowned entities that were generally assumed to be
sovereign risks, despite the fine print, have been left alone to nurse their massive credit-related wounds.  
In the credit markets, for a government-owned company, whatever is the legal position, ‘limited liability’
is just an academic detail and, in reality, these companies are considered sovereign risks based on several
precedents. With perfect hindsight, it is possible to argue that Dubai, in fact, should have been treated
as an exception given that it is one of those unusual instances when the borrowings of the government
entities are substantially in excess of the GDP of the country and, hence, by definition, too big to be
considered a sovereign risk in the conventional sense of the term. 

THE received wisdom in the market is that when pushed to the wall, Dubai’s oil-rich neighbours may
consider extending a helping hand at least to prevent lasting damage to the region. A year ago, the travails
of Dubai World would have been easily absorbed by the market without demur because debt restructuring
was ongoing on a massive scale across the globe. It is only because the global markets had, in effect,
assumed that the worst of the global meltdown was behind us that the Dubai episode came as a shocker.  
If truth be told, despite the current state of denial, the international banks that have lent some $59 billion
to Dubai World are in no financial position to take even a partial writedown on these assets, having barely
survived the last onslaught on their balance-sheets. It is now certain that the process of cleaning up bank
balance-sheets by writing off bad debts and recapitalising them will have to continue for a while further
before we return to the business-as-usual mode. 

Being one of the largest trading partners of Dubai, India’s trade of some $20 billion per annum, including
re-exports, could be at considerable risk if the uncertainty over the economic future of Dubai is not
quickly resolved. In addition, the likely reduced level of economic activity is certain to lead to
unemployment and repatriation of at least some of the half a million NRIs employed in the country, thus
putting to risk about a tenth or more of the annual $50 billion worth of workers’ remittances to India.
Moreover, at least $1 billion worth of investments of Indian companies in several business ventures in
Dubai, especially in the real estate sector, would need to be marked down if the crisis remains unresolved
for long. 

The larger impact, however, is the question mark on the very concept of quasisovereign debt paper.
Government-owned corporates have traditionally enjoyed quasi-sovereign status in the credit markets,
commanding a very fine pricing on their debt paper. India has often used this route in the absence of an
international sovereign debt programme by encouraging government-owned institutions to borrow from
the international credit markets. Post the Dubai World travails, the international credit markets are
unlikely to offer quasi-sovereign status and fine pricing to government-owned corporates without an
explicit sovereign guarantee. 

Unlike several emerging market economies, India with its democratic traditions, established institutional
checks and balances and an impeccable credit history would continue to command respect in the
international credit markets. However, the damage to the concept of quasisovereign debt issued by
emerging markets has already been done and a likely fallout of this is the potential hike in risk premia on
capital flowing into west Asia or, indeed, emerging markets in general post the Dubai debacle.