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Emerging stock markets around the world will undergo a risk reassessment after the news of a $59 billion debt payment suspension in Dubai, and a correction from current market highs looks inevitable. These overbought markets are very vulnerable to sudden shocks.

S&P told the Financial Times the Dubai decision ‘may be considered a default under our default criteria, and represents the failure of the Dubai government (not rated) to provide timely financial support to a core government-related entity.’

Eid holidays

Bond markets responded with credit spreads immediately widening. But Gulf stock markets are closed for the Eid religious holiday, and this will give the government time to clarify its intentions. Markets will likely tumble when they reopen.

The $59 billion debt mountain belongs to Dubai World whose assets range from the Jebel Ali Free Zone to the quoted ports operator DP World and Nakheel, the developer of three palm-shaped islands. Two palm islands lie abandoned as well as a map of the world formed from smaller reclaimed islands.

At the same time as the debt repayment suspension, the government appointed Deloitte’s Aidan Birkett as Chief Restructuring Officer to ‘oversee the restructuring process and ensure the continuity of Dubai World’s operations’. His report will be eagerly awaited by creditors who are very unhappy about the debt suspension.

Only a few weeks ago creditors were assured that the $3.5 billion Nakheel Islamic bond due in December would be repaid. Some speculators had bought the bond earlier this year at a massive discount in expectation of a huge profit that will not now transpire.

A statement said Mr Birkett ‘will start to assess and evaluate the extent of the restructuring required. As a first step, Dubai World intends to ask all providers of financing to Dubai World to “stand still” and extend maturities until at least May 30, 2010′.

But Dubai is not alone in its debt problems. Banks have been falling over themselves to lend money to emerging markets in recent years, and since the financial crisis there has even been a view that emerging markets carry less risk than developed countries.

Carry trade risk

The carry trade of borrowing in US dollars and investing in emerging markets for high returns is a liquidity bubble and an accident just waiting to happen. Perhaps the situation in Dubai should be regarded as a wake-up call.

Investor perception of stock market risk has just hit a five-year low in the United States. Any contrarian investor would have to conclude that such monstrous complacency could only come before a market crash, as indeed it did last autumn.

Shocks in emerging markets like Dubai are the flutter of butterfly wings that produce a hurricane elsewhere, and $59 billion is a bit more than a butterfly. Investors should exit all stock markets and buy bonds or precious metals or short emerging markets. Gold hit $1,195 as this article was written.

Disclosure: None

Source: $59 Billion Dubai Debt Default Could Have Much Wider Implications