DUBAI — The shock from Dubai's move to suspend payments due on a slice of government-backed debt spilled over on Thursday into world markets and caused a sharp weakening in global Islamic bonds.


The move to restructure the state-owned Dubai World and the proposal to request a minimum six-month moratorium on its maturing debt has also triggered fears of a domino effect across the emirate's indebted state-run corporates, pushing debt rating agencies to slash the grading of Dubai companies.

The shock announcement has begun to undermine some stock prices, with traders in Paris partly blaming it for a 2.06 drop in the CAC 40 index on Thursday morning.

The fear of Dubai's default "fed a climate of insecurity and crisis of confidence at a time when fears are mounting about excessive public debt," said Xavier de Villepion, an analyst with Global Equities.

Islamic bonds in Asian markets were also weakened following Dubai's announcement, Dow Jones News reported.

A selloff in the sukuk (Islamic bonds) of the Indonesian government and Malaysia's national oil company Petronas was linked by people in the market to Dubai's decision, it said.

The once rapidly booming Dubai city-state, which has fallen a long way after being hit hard by the global financial crisis, said on Wednesday it intended to ask the creditors of its largest and most-indebted company -- Dubai World conglomerate which owns Nakheel, to "standstill" debt maturity for at least six months, as it restructures the company.

"Dubai World intends to ask all providers of financing to Dubai World and Nakheel to a 'standstill' and extend maturities until at least 30 May 2010," said a statement issued by the Dubai Financial Support Fund (DFSF).

Giant property developer Nakheel, part of Dubai World and until recently the jewel in the crown of Dubai's construction boom, was due to pay off about 3.5 billion dollars in maturing Islamic bonds in December.

Moody's rating agency said it downgraded six government-related companies, including Dubai World entities, while Standard and Poors downgraded the ratings of five of those companies.

"In our view, such a 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," S and P said.

Moody's said that it "always highlighted that the way the government will deal with Nakheel's upcoming liabilities will represent a litmus test for Dubai."

The government announcement was made after the closing of Dubai's stock market for a long Eid holiday, but the value of Nakheel's 2009 bonds dropped by 27 percent, according to EFG-Hermes regional investment bank.

"The last thing we would like to see is for a domino effect resulting in several debt obligations having to be extended," said a statement issued by the bank following the announcement.

Dubai's total debt reached 80 billion dollars last year, of which government companies owed some 70 billion dollars. Dubai World alone reportedly owes 59 billion dollars in liabilities.

"The intention to reschedule Dubai World's debt is disappointing. It is likely to be received badly by the market," economist Monica Malik, from EFG-Hermes told AFP.

"The market had become more comfortable with Dubai's debt position since the first quarter of this year. People had expected payment of Nakheel's bonds by December 2009," she said.

"Dubai's debt obligations for 2010-2011 are already high," she added.

EFG-Hermes' statement pointed out that Dubai's overall debt repayment schedule is expected to be 13 billion dollars in 2010 and 19.5 billion dollars in 2011.

The announcement came on the heels of a brighter note, when Dubai said it secured a further five billion dollars through a new bond issue, fully subscribed by two banks controlled by the government of Abu Dhabi.

The new bonds demonstrate that Abu Dhabi, the oil-rich partner in the UAE, is still ready to help Dubai, but the extent of that support remains unknown.

Dubai indicated on Wednesday that the newly raised capital will not be channeled to pay Dubai World's imminent obligations as it said that the conglomerate will go under restructuring, hiring a Deloitte officer to oversee its revamp.