Will Dubai Debt Tremors Spread?

Investors and governments around the world continued to intensely watch Middle Eastern financial centers Monday as stock markets in Dubai and its oil-rich neighbor Abu Dhabi each suffered nearly 10 percent drops. The question now: just how far could the contagion spread?

The crisis began last week when Dubai stunned global investors by announcing that the quasi-sovereign Dubai World would not be able to make payments on time for some of its $60 billion in debt. In recent years, the company invested in many high-profile and risky real estate projects, including artificial islands in the shape of a palm tree, and spent heavily to acquire pricey global assets.

Most experts believe Dubai is not large enough to set off financial repercussions outside the Middle East. Markets in the U.S. and Europe were stable on Monday after taking dips late last week.

But fears remain that investors could flee risky markets altogether in the coming days in search of safer havens for their money regardless of a market's strength. That's essentially what happened last September after the failure of Lehman Brothers heightened worries about most financial institutions and forced global credit markets into a standstill.

One key indicator analysts are watching now is the amount of interest that investors demand to lend money to emerging markets and heavily-indebted countries.

Already, there are signs investors are punishing the riskiest public and private borrowers, as well as global banks with heavy exposure in the Middle East. The cost of borrowing for debt-laden countries in Eastern Europe and Greece and insuring against default for Irish banks has risen in recent days. The development will make it much harder for countries running mounting deficits to pay for bailouts and stimulus packages to turn over their debts in the coming months and years. The shares of HSBC and Standard Chartered, which have lent heavily to Dubai, have fallen sharply.

So far, the largest fallout remains with Middle Eastern companies and governments. The extent to which the United Arab Emirates federation and its wealthiest member-state, Abu Dhabi, which has vast oil reserves, guarantee Dubai's debts could affect how investors view many other local companies previously believed to have the implicit backing of their governments. At a minimum, many observers have essentially called last week the end of Dubai's role as a global financial center.

Ratings agency Moody's Investors Service Inc. said Monday the crisis is unlikely to harm the credit quality of the Abu Dhabi government and the federal government of the United Arab Emirates.

But if the last year has taught us anything, it's that anything can happen. For now, it's more wait and see.

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