The Dubai government has asked investors owed money by state-owned Dubai World to allow it to suspend debt repayments until 30 May 2010 at the earliest, increasing fears that it will not repay tens of billions of dollars of debt owed by its state-backed companies.

On 25 November, the Dubai government issued a statement asking for a ‘standstill’ on repayments for the $27.2bn owed by Dubai World, its largest holding company. The request applies to all Dubai World subsidiaries, including real estate developer Nakheel, which alone has debts of $7.1bn.

Dubai’s announcement shocked investors, forcing up the price of insuring the emirate’s debt by 38 per cent during afternoon trading on 25 November. Spreads on the emirate’s credit default swaps (CDS), the instruments used to insure against debt default, surged from 320 to 440 basis points following the announcement.

Investors in neighbouring Abu Dhabi’s debt also reacted strongly, pushing up the cost of insuring its debt by 37 per cent from 100 to 137 basis points.

By the close of trading, investors had driven up the cost of insuring sovereign debt in every Gulf country. Of the region’s major borrowers, only Egypt avoided a sharp increase in its CDS spreads, according to Turker Hamzaoglu, an economist at Bank of America-Merrill Lynch.

“There will be some spillover effects,” says Hamzaoglu. “It is something that may hurt investor confidence in the region.”

The Dubai government also announced in its November statement that the Dubai Financial Support Fund, the government agency responsible for overhauling the emirate’s finances, will restructure Dubai World.

In late October, the government distanced itself from an estimated $63bn of debt accrued by state-backed companies, including Dubai World.

Its prospectus for a $2.5bn sukuk issue said “the Dubai government is under no obligation to extend support to any government-related entity”.