Dubai will ask creditors of two of its flagship firms for a standstill on debt worth billions of dollars as a first step toward restructuring Dubai World, the conglomerate which spearheaded the emirate's breakneck growth.

The government's announcement on Wednesday, which also said consultants Deloitte had been appointed to help with the restructuring, sent the cost of insuring Dubai's debt against default soaring and bond prices tumbling.

Dubai World has $59 billion of liabilities, its subsidiary Nakheel said in August, a large proportion of Dubai's total debt of $80 billion.

Dubai World intends to ask all providers of financing to Dubai World and Nakheel to 'standstill' and extend maturities until at least 30 May 2010, the government said in a statement.

Nakheel, the developer of palm-shaped islands owned by Dubai World, has a $3.5 billion Islamic bond maturing on December 14 and more debt worth 3.6 billion dirhams ($980 million) due on May 13 2010. Limitless, another Dubai World developer, has a $1.2 billion Islamic bond maturing on March 31 next year.

It's shocking because for the past few months the news coming out has given investors comfort that Dubai would most probably be able to meet its debt obligations and most analysts were of the view that Nakheel's commitments would be met, said Shakeel Sarwar, head of asset management at SICO Investment Bank.

Abu Dhabi has been supportive of Dubai, but it appears this support is not enough for Dubai to meet its obligations on time.

The cost of insuring Dubai government debt against default using 5-year credit default swaps soared, jumping over 100 basis points to 420.6 from a close of 318 one day earlier. Nakheel's Islamic bond prices fell more than 20 points to 87.

The market had expected a timely repayment of the $3.5 billion sukuk and spreads had narrowed. This will destroy a lot of confidence, said Eckhart Woertz, economics program manager at Gulf Research Center.

The standstill requests comes as a surprise, especially after additional finance from Abu Dhabi has been raised, Woertz added.

Dubai's economy has been hit hard as the global credit crunch saw an end to a six-year boom in the region and sent the emirate's once-flourishing property sector into decline.

DEBT RAISING

In a separate move the government said was not connected to the Dubai World restructuring, Dubai raised a further $5 billion as part of a $20 billion bond program launched this year, half of what it previously said it would raise.

The $5 billion tranche had a maturity of five years and paid four percent interest and was placed with two Abu Dhabi-controlled banks, the National Bank of Abu Dhabi and Al Hilal Bank, officials said.

The first $10 billion tranche in the program was taken up by the United Arab Emirates central bank earlier this year as Dubai sought to raise funds to support state-linked companies.

The $5 billion was placed with two banks controlled by the Abu Dhabi ruler or government, a move likely to underscore the continued support for Dubai from its wealthier neighbor.

Although it has not come from a federal source ... both of the banks are Abu Dhabi-government controlled banks, Malik said. It's in line with our view that there will be limited pure-private interest, she said.

Economist David Butter at the Economist Intelligence Unit said the bond was an elegant way for Dubai to avoid going back to the central bank, owing to the difficulty of attracting interest from international banks.

Dubai will be able to state that it has raised what it needs from the market, without any suggestion of an Abu Dhabi bailout, he said.

Dubai has said previously that the proceeds from its bond scheme would underpin companies such as Nakheel, as part of its drive to build tourism as an alternative to its dwindling oil.

But further details are scarce about what Dubai has done with the first $10 billion, what it plans to do with the new $5 billion, and why it only issued half of what it said it would issue only weeks earlier.

Any news from the financial stability fund has been absent since it has been launched, said economist Caroline Grady at Deutsche Bank.

We haven't heard anything other than the headline in May that some of the money was used to refinance debt at Nakheel. (Reporting by Rachna Uppal, Andrew Hammond, Matt Smith, Nicolas Parasie, Enjy Kiwan and Carolyn Cohn; Writing by Thomas Atkins; Editing by Andy Bruce)

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