Dubai crisis confirms undue leverage fears: Roubini Global

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Dubai World, the investment arm of the Middle Eastern nation, has said it cannot repay, at least on time, debt to the tune of USD 60 billion. It's a move that has come as a rude shock to the entire Asia Pacific region, and sent tremors that are being felt across the globe.

In an interview with CNBC-TV18, Arnab Das, MD - Market Research & Strategy, Roubini Global Economics gave his perspective on the implications of the development.

Here is a verbatim transcript of the exclusive interview with Arnab Das on CNBC-TV18. Also watch the accompanying video.

Q: How are you reading the developments that have happenned. How serious are these?

A: I think it's quite serious because it is the first major credit event since the financial system was stabilised, and since the rally got underway in March of this year. I think it's quite important because it confirms what many of us have been concerned about that there are still important pockets of stress of overvalued assets and excessive leverage out there in the world at large and that these would eventually lead to further shoes dropping.

I think it's quite important in that sense. I think what the main implication is that people in the market are going to have to differentiate now much more between countries and individual issuers of debt and equity that have strong balance sheets and those that have weak balance sheets.

Until now, for the last six months or so we been having a very powerful liquidity fuelled rally in which correlations of risky assets went up sharply and basically what happenned was a fall in the dollar, steepening in yield curve in the US and a rally in practically everything else substantially led by free and plentiful liquidity in the world, which basically drove everything up all at once together albeit to varying degrees.

I think now there is going to be much more differentiation because it's clear that despite the wall of liquidity, not everybody can refinance their debt if they are excessively leveraged.

Q: As you rightly mentioned that something that was talked about a while now. Even in the past we found that one of the richer emirates was bailing out the other this time round two then there is a cause of hope that the richer Abu Dhabi will probably bail out this particular crisis as well. Do you see that happening and if that happens do you see the crisis being less belittling so to speak?

A: I think in a sense this would be a test of how united the United Arab Emirates are. So in principle, there should be some considerable cohesion across the region. Whether that makes the underlying problem of countries or sectors of the markets out there or individual names that have balance sheets stresses go away, I think that is quite a different matter.

If other countries in the immediate United Arab Emirates, if other parts of the emirates or the broader regions, say Kingdom of Saudi Arabia, effectively bails out Dubai, that's fine for Dubai. But not every distressed obligor out there is going to have a sugar daddy and is not going to be bailed out.

Q: Our policymakers here have so far said its early days, we need to study the issue to really understand the impact. On two real issues the concern seem to be; one is that remittances and the second is of course on the property market. As you are well aware that was really a place where a lot of property development was happening, lots of joint ventures globally were being struck, how do you see both these segments being impacted?
 
A: I think property markets around the world have suffered something of a downdraft. But in Asia there has been an updraft in correspondence with the fall of the dollar. That we think reflects a substantial flow of capital from the developed world particularly the Unites States to other countries with higher interest rates and higher short-term growth prospects and in many cases higher, medium and long term growth prospects, in search of higher returns.

Many countries in emerging markets, and in emerging Asia in particular, have responded by trying to manage their exchange rates. In some sense, some countries have formally pegged or have repegged as in the case of China for the dollar and some countries are managing their exchange rates around the world.

And what that is doing is creating or increasing the amount of liquidity in the domestic market of the destination countries of these capital inflows. So there are different responses that different governments are taking. Some governments, as I am sure you are aware, like Brazil, Taiwan, Indonesia has talked about, and India has talked about this as well. They are raising barriers or taxes to capital flows, to capital inflows.

Other countries like China are considering or taking measures to limit the flow of credit into certain segments of the market, including property, which would have a similar effect. We think that this capital flow equation is likely to be a long-term trend or a sustained trend for a period of many months, if not a few years.

While the developed world goes through a very slow recovery because of the balance sheet stresses it faces, and correspondingly monetary policy will remain very easy with zero interest rates in some key countries particularly in the United States and Japan for the foreseeable future.

So we think there will be more of this leakage of capital from the developed world into emerging markets, currency markets and asset markets that will fuel asset price inflation in emerging market countries, which would need to be dealt with by policymakers.