Can Dubai fall-out be contained? Most say Yes

Dubai's neighbours have stepped in to shore up its banks ahead of what is expected to be a rough week for the debt-stricken commercial mecca of the Gulf region. Already today the main stock markets in Dubai and Abu Dhabi have closed sharply down  - 7.3 per cent in the former, the biggest loss in a year, and 8.3 per cent in the latter, a record-breaking one-day fall.

The UAE central bank set up an emergency liquidity facility to ease fears about its banking system, while Dubai's rulers are preparing a charm offensive to repair damage caused by the city-state's effective loan default last week on its flagship Dubai World investment vehicle.

But UAE banking officials did not offer specific support to Dubai, raising worries of a rift between the profligate city-state and the UAE federal government. This suggests the more conservative-leaning member states of the federation may not wish to offer Dubai unconditional financial support.

While Western bankers say they believe damage from the crisis can be contained and the UAE will ultimately bail out Dubai, investors are shaken. Already today the main stock markets in Dubai and Abu Dhabi have closed sharply down  - 7.3 per cent in the former, the biggest loss in a year, and 8.3 per cent in the latter, a record-breaking one-day fall.After today’s falls in stocks, brokers believe the fall-out from the affair could taken months or years to pass through the financial system. On Friday, Dubai triggered the biggest stock market slump in three months in Asia and Europe’s  worst drop since April.

"I'm not desperately worried that we're going to go into some death spiral," Nicholas Field, a stock manager at Schroders, told Bloomberg. "This is not going to turn into some sort of major prolonged move downward."

Still, British banks are Dubai's most exposed non-Gulf lenders (a combined $49.5bn of loans outstanding, according to an RBS report) and there will now be a period of introspection over lending standards to a development model dependent on the idea of a limitless demand for luxury, branded lifestyles, celebrity chefs, fashion, gambling and Russian prostitutes.

But the debt crisis could knock on to Airbus and Boeing. Dubai's government-controlled Emirates carrier has more than $30bn worth of planes on order from Airbus, including 53 of the double-decker A380s and 70 of the forthcoming A350 widebodies. Dubai's leasing firm DAE Capital has placed orders for a further $12.6bn of Airbus planes. Shares in Airbus parent European Aeronautics Defence & Space Co fell more than three per cent on Friday.

The year-long surge in commodities like oil and copper, too, have been hit by Dubai-related fears. Investors are concerned that key consuming areas could be hit if Abu Dhabi doesn't bail Dubai out.

Over the weekend - before UAE central bank announced its emergency funding plan - Bank of America warned that Dubai's debt woes could still worsen to become a "major sovereign default" that could cut off capital flows to emerging markets.

"One cannot rule out - as a tail risk - a case where this would escalate into a major sovereign default problem, which would then resonate across global emerging markets in the same way that Argentina did in the early 2000s or Russia in the late 1990s," BOA strategists wrote.

Those fears may be reduced but they have not been put to rest. ·