How will the Dubai crisis affect the world?

Of the many countries that gorged on debt in the boom years, Dubai stood out. Very soon the Emirate's investment arm, Dubai World, a state-controlled company and state-owned, racked up $59 bn in debt building lavish projects.are vacant. They aren't generating any income right now. And probably they have just run out of cash. Now its inability to pay its bills is sending a wave of fear rippling through global markets.

The fear has sent the Dow Jones Industrial Average down more than 150 points last Friday. Other countries, like Greece and UK to emerging markets and European and US banks could be in trouble.

What we are now facing is a solvency issue and not a liquidity issue. They have requested Dubai World and real estate developer, Nakheel to skip 6 months of interest payment. You can print as much money as you want but you have to pay the interest on time.

Exposure to Dubai World could be as high as $12 billion in syndicated and bilateral loans, including existing loans for Nakheel and Istithmar, an investment arm of Dubai's government.

It has little oil wealth and acts as the trading, tourist and financial hub of UAE. It borrowed heavily to finance a real estate boom as Western bankers believed that Abu Dhabi, the Gulf's richest oil economy, would bail it out. But it didn't open its wallet as Dubai's debts spiraled.

Foreign banks have $130 bn of exposure to UAE with UK having $51 bn. US banks have $13 bn. These figures are a negligible 0.4% of foreign banks' total cross border exposure. But one area of concern is that some troubled UK banks have large credit exposure. RBS with $2.3 bn, Stanchart and Barclays with $10 bn and HSBC with $17 bn.

One of the main issues now is of credibility and the potential impact on future fund raising. By the numbers a tremor in Dubai should not shake the world banking community. Their largest creditors are the domestic banks.

There is certainly a possibility of a contagion effect, a ripple effect, to trigger another credit crunch or crisis of confidence that leads people, investors, to pull back.

Debt financing is a key pattern of financial leverage in modern economic operations. In the mean time, the judgement and measurement of risks are pivotal to determining the ratio of a leverage. A high leverage ratio may help augment profits under favorable market conditions, while it can also be destructive in an adverse economic environment.

Some of the Indian companies that could be affected by the crisis are Nagarjuna Construction, L&T, Voltas, Bnak of Baroda, Omaxe, Spice Jet, Aban Offshore, Geojit Finance, Federal Bank, etc.

Dubai's debt crisis could be China's opportunity to snap up gold and oil assets. China's $2.27 trillion in foreign exchange reserves are mostly parked in U.S. treasuries. That could give China a buying opportunity to put some forex reserves into gold or oil reserves.