Investors' fears about the future of Dubai saw the cost of insuring $10m of the emirate's debt rocket today to $535,000 (£325,000), from $435,000 the day before. The cost of insuring the debt against default had been $320,000 prior to the announcement that Dubai World, the country's main holding company, was seeking a standstill on its debt repayments, according to Markit, a financial data provider.
The price of protection against debt default soared throughout the region, including in Abu Dhabi and Bahrain. "More volatility can be expected as investors await details of the restructuring," said Gavan Nolan, an analyst at Markit.
The reaction was exacerbated by the lack of transparency around the debt deal, investors said. The announcement came after Dubai's markets closed until next week for the Eid al-Adha holiday, adding to the uncertainty. A conference call for creditors had to be postponed after the lines collapsed.
The government has appointed the accountancy firm Deloitte to manage the debt restructuring, but creditors – which are mostly European banks – still do not know how much room they have to manoeuvre.
Bank shares plunged because of worries about their exposure to the country. HBSC, which had a loan book of $17bn in the United Arab Emirates as of 2008, according to the Emirates Banks Association, lost 4.8% of its value. Standard Chartered, the second biggest foreign lender in the UAE, tumbled 5.8%.
The collapse was not unexpected, some investors said. Dubai borrowed $80bn in a four-year construction spree as it aimed to reduce its dependence on falling oil supplies and turn itself into a tourist attraction and a financial centre.
Dubai World, the state-run holding company that has asked for a delay in its loan and bond payments, has total liabilities of about $59bn. The most immediate payments were for $3.5bn of bonds due on 14 December, from the unit's property division Nakheel.
The effect of the halt to debt payments will be mostly felt in the Persian Gulf economies. The harm done to emerging markets from the debacle and the loss of confidence in risky assets may slow economic recovery, according to Richard McGuire, a strategist at Royal Bank of Canada. "These credit incidents will further underpin risk aversion and concerns on counter-party risk that will limit lenders' appetite to return to the market, and you could argue that there could be a limited recovery from here, as credit channels remain constrained in the UK and the US."
The price investors pay to protect themselves against default on Britain's sovereign debt rose one basis point to 68bps – more than twice what investors pay for France. The higher the perception of risk, the more countries will have to pay investors to borrow funds. Britain is perceived to be riskier than France and Germany because of the weak state of its public finances.