Dubai Default: Moral Hazard For Sovereign Debt

November 26, 2009 by Douglas A. McIntyre

Dubai World, the de facto sovereign fund for the desert nation, has essentially defaulted on a large part of its debt. It has asked creditors for a “standstill” on paying back its $60 billion debt until May or perhaps later. Most of the debt is attached to the fund’s real estate arm known as Nakheel.

According to The Wall Street Journal, “The cost of insuring against a Dubai default rose sharply again Thursday in London, to $547,000 per year per $10 million in debt. That was up from $318,000 on Tuesday.”

This may not be the end of it. If Dubai is bailed out by other Arab nations or creditors give it reasonable terms to ease it obligations, sovereign commitments will have their own example of a “moral hazard” to consider.

Ireland is facing questions about the risk of default of its national debt obligations. There have recently been questions about the real value of Croatia’s sovereign obligations. The ratio debt to annual GDP, one of the potential markers for long-term solvency problems, is over 100% in Zimbabwe and Lebanon.

Loans from the IMF are seen as potential solutions to nations like Iceland and Ireland where national debt burdens are acute. The moment the agency or groups of nations begin to bail out countries which cannot cover their own obligations (as Arab nations might do for Dubai), the temptation to default on sovereign debt will rise sharply.

Douglas A. McIntyre