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Market waits for Dubai reality check
Commentary: Who else has built castles in the sand?
By Craig Stephen
Last Update: 7:57 PM ET Nov 29, 2009
HONG KONG (MarketWatch) -- Focus this week may remain on the fallout from the potential Dubai debt default, which saw the Hang Seng Index lose 1,000 points on Friday.
The immediate consensus is the direct damage is expected to be limited in this part of the world. While HSBC HBC and Standard Chartered SCBFF were both sold down heavily due to their Middle East exposure, mainland Chinese banks who stick largely to domestic lending should be unscathed -- much like in the subprime crisis.
Still, investors' fear of the unknown has been heightened and with that risk aversion.
If the modern day castles built on Dubai's sands have collided with the harsh reality of economics in a bubble aftermath, what other asset classes or countries could be found wanting?
HSBC said on a note Friday warned that the restructuring of Dubai World could be a catalyst for a further unwind of flows into more risky asset classes.
Into that camp come emerging markets, as well as some of the leveraged carry-trade investments. And before anyone gets too comfortable, one lesson of the subprime crisis is that contagion takes time to play out, and uncertainty and lack of visibility alone can be damaging. After assessing the direct exposure held by banks, there are also potential follow-on asset liquidations to consider.
At the very least, the Dubai situation should give investors reason to take a fresh look at portfolios and anything raising similar solvency fears.
In a new note, Mainfirst Securities in Hong Kong say a lesson from the demise of "Wally World" is that "that economic rationality will always ultimately prevail, however long it takes."
Few appear surprised that Dubai has finally fallen down. It is easy to understand why the emirate gets labeled a special case after constructing some of the most grandiose property projects, as well as the tallest building in the world. All this was done, moreover, with a zero income-tax rate.
My own experience visiting Dubai last year was sheer amazement at the scale of the construction. It completely dwarfed Macau's casino-building boom which was then taking flak for overbuilding. My taxi actually got lost in a giant building site on the way to my hotel.
But step back and arguably many of ingredients of Dubai's problems are less unique -- that is, overly ambitious property developments fuelled by plentiful and cheap money, resulting in asset prices increasingly detached from economic reality.
Surely, it is not much of a stretch to group into this bracket luxury property in Hong Kong, the huge casino and hotel developments in Macau, or the near-empty commercial towers and hotels in Shanghai's Pudong business district.
Dubai has seen its bubble turn to bust, and now solvency rather than liquidity will be the driving issue for the economy and financial system. The hope is that this is not the first shoe to drop, as debt burdens come under renewed scrutiny in the weeks ahead.
The plus, at least for China and the rest of East Asia, is that economic growth appears to be increasingly gravitating east. Macau has on its doorstep a seemingly never-ending flow of mainland Chinese gamblers and tourists. Dubai's geography offers little unique advantage, relying on increasingly hard-up European tourists being airlifted in. Its ambitions as a regional financial hub will struggle to recover, even if a debt default is averted.
Meanwhile in the Far East, it appears as if talent as well as capital is heading only one way.
Last week, it was announced that Fidelity Investment head Anthony Bolton was relocating to Hong Kong from the U.K. to launch and manage a new China-focused fund. This comes on the heels of the move by HSBC to bring their chief executive to Hong Kong from London. This could lead to a reinforcing cycle if key people -- and not just capital -- are gravitating to countries with low tax rates and national debt. Before the worry was just jobs and manufacturing had gone to China.
We can expect the Dubai situation will lead to a renewed scrutiny of heavily indebted countries. As many Western economies prepare to exit their stimulus programs and grapple with record deficits, the unpalatable recipe could be higher taxes and lower growth.
With that, the potential for sovereign-debt defaults will also be closely watched. It is easy to see the fallout ratcheting up political tensions to a whole new level. For instance, it will be a bitter pill to swallow if majority-state-owned British bank RBS RBSPF takes a multi-billion-dollar loss on a Dubai default, as has been speculated. In the end, British tax payers could pick-up the tab for the sybaritic excesses in tax-free Dubai.
That said, some brokers are still resolutely upbeat.
"Dubai will not fail, and the bigger picture is that the world is far more than this Middle Eastern playground," say strategists at Cantor Fitzgerald. Instead, equity falls now represent a buying opportunity.
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