Dubai said on Wednesday two of its flagship firms planned to delay repayment on billions of dollars of debt as a first step toward restructuring Dubai World, the conglomerate that spearheaded the emirate's breakneck growth.

The sudden move by the Gulf government led Standard & Poor's and Moody's Investors Service to deeply downgrade several government-related entities. Moody's slashed some units to junk status and S&P said the restructuring could be considered a default.

The government's announcement, which 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.

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

Analysts expect financial support from deep-pocketed Abu Dhabi, a neighboring member of the United Arab Emirates, to keep Dubai afloat. But Dubai will likely have to abandon a flamboyant economic model that focused on heavy real estate investment and inflows of foreign capital.

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.

SIX-MONTH STANDSTILL

The government said in a statement: 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.

Moody's cut ratings on some government-related entities to junk status, while S&P cut ratings on some entities to one level above junk.

S&P said the restructuring 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.

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

The announcement appeared to be timed to minimize its impact on markets; it came after the stock market shut and just before the eve of the long Eid al-Ad holiday, which will close many firms and government offices in Dubai and the Gulf until December 6.

But the cost of insuring Dubai government debt against default with five-year credit default swaps soared, jumping over 100 basis points to 420.6 from a close of 318 a day earlier, according to CMA DataVision. 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.

Dubai's economy was hit hard as the global credit crunch over the past year ended a six-year boom in the region and sent the emirate's once-flourishing property sector into decline.

Dubai's announcement Wednesday shook the confidence of investors in government debt elsewhere in the region; credit default swaps for Abu Dhabi, Saudi Arabia and Qatar also rose, by more modest amounts.

Investor confidence in Saudi Arabia has been hit this year by up to $22 billion of debt restructurings at the country's Saad and Algosaibi groups.

DEBT-RAISING

In another move Wednesday which 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. The $5 billion was half of what it had previously said it would raise.

The $5 billion tranche, with a maturity of five years and paying 4 percent interest, was placed with two Abu Dhabi-controlled banks, National Bank of Abu Dhabi and Al Hilal Bank, officials said.

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

(Reporting by Rachna Uppal, Andrew Hammond, Matt Smith, Nicolas Parasie, Enjy Kiwan, Carolyn Cohn; Additional reporting by Ciara Linnane, Caryn Trokie, John Parry and Walden Siew in New York; Writing by Thomas Atkins; Editing by Andy Bruce, Andrew Torchia and Kenneth Barry)

United arab emirates Dubai