Abu Dhabi’s $10bn bailout of the Dubai government has reduced the cost of insuring the emirate’s debt against default, but borrowing costs remain high as investors and analysts fear future instability.

The loan on 14 December enabled state-backed holding company Dubai World to repay international investors the $3.5bn sukuk (Islamic bond) issued by its real estate developer Nakheel, which matured on the same day.

In the wake of the bailout, the spreads on five-year credit default swaps (CDS) – the instruments used to insure government borrowing – fell to 430 basis points from 540 basis points. Each basis point equates to an annual cost of $1,000 to insure $10m of debt over the duration of the deal.

But borrowing costs are still relatively high compared with last month. Prior to 25 November, when the Dubai government announced it was seeking a six-month freeze on repayments on about $27bn of  Dubai World’s debt, the average price for insuring Dubai borrowing was about 300 basis points. 

Analysts say the emirate’s reputation has been damaged. “It will take a long time to fully restore Dubai’s reputation in the capital markets,” says Philipp Lotter, corporate analyst at ratings agency Moody’s Investors Service in Dubai. “There is still unpredictability with regard to the [government’s] policies [on supporting state-backed firms], and that makes every maturing debt a potential cliffhanger.”

One UK fixed-income analyst says the potential of a default at Nakheel has left “a bitter aftertaste in many investors’ mouths”.

He adds that investors in new Gulf debt issues will probably demand higher interest payments to compensate for the opaque decision-making of regional governments.