The initial signs that Dubai’s economy has been recovering over the past few months will be reversed as a result of the announcement that Dubai World is restructuring around $26bn of debt, according to ratings agency Moody’s.

Exposure to Dubai World and its subsidiaries in the local banks and contractors is high, says Tristan Cooper, head analyst for Middle East sovereigns at Moody’s. This means that “employment levels and confidence will suffer and that local banks will become even more reluctant to lend into the domestic economy.”

Cooper added, “As Dubai’s resilience has already been weakened by the effects of the global economic crisis, it is likely that the tentative economic recovery seen over the past six months will be reversed by recent events.”

Dubai will also be challenged by a “drawn out and painful” recovery, unless Abu Dhabi provides substantial and sustained support.

In the longer term, Dubai’s inability to access capital markets funding could hit its ability to continue developing the city’s infrastructure. This poses the danger that neighbouring states which can afford to finance infrastructure development will erode the gap between their cities and Dubai, making Dubai a less attractive business hub for the region.