DUBAI/LONDON (Reuters) - Dubai struggled to ease fears of debt default yesterday after its move to delay repayments at two flagship firms shook confidence in the Middle East as a centre for investment and a source of capital.

Dubai's debt problems, a hangover from a property boom that produced the world's tallest building, have shaken trust among Western investors who turned to the Gulf region for help during the global financial crisis.

The emirate said on Wednesday it would ask creditors of Dubai World, the conglomerate behind its rapid expansion, and Nakheel, builder of its palm-shaped islands, to agree a standstill on billions of dollars of debt as a first step towards restructuring.

Yesterday Dubai tried to revive some confidence by saying its profitable DP World, which operates over 40 ports around the world, would not be involved in the restructuring. DP World is majority owned by Dubai World, but also has shares listed on NASDAQDubai.

"It might be a move to distinguish the solvent from less solvent companies in an attempt to shift the weight away from the less exposed entities," said John Sfakianakis, chief economist at Saudi Fransi bank.

But European banks shares, which had picked up in recent months on hopes that the worst of a global economic crisis was over, fell to lows not seen since May on fears of their exposure to Dubai's debt.

Shares in companies in which Gulf investors own big stakes, including the London Stock Exchange, UK grocer J Sainsbury and German carmakers Porsche and Daimler, also fell sharply on concerns the holdings would be cut to meet obligations at home.

Exposure to Dubai World could be as high as $12 billion in syndicated and bilateral loans, including existing loans for Nakheel and Istithmar, the investment arm of the Dubai government, banking sources told Thomson Reuters LPC.

International banks are seeking to clarify their position as they formulate their response to the standstill request and are assessing the implications for lending to Dubai and the Gulf.

"This is very serious and will have implications across the region," a senior banker said.

In a sign that Dubai's problems could hurt global fundraising efforts for its neighbours, Saudi-backed Gulf International Bank pulled a bond sale due to priced this week, sources said.

GIB had been expecting to raise at least $500 million but Dubai's move will likely lead to a risk reassessment of debt issued by the region's sovereign-linked firms.

Yesterday's announcement also sent the cost of insuring Dubai's debt against default soaring and bond prices tumbling.

Dubai World, whose slogan is "The sun never sets on Dubai World" has $59 billion of liabilities, its subsidiary Nakheel said in August, a large proportion of Dubai's total debt of $80 billion.

Dubai's credit defaults swaps are being quoted as high as 500-550 bps, some traders said, while the cost of insuring Qatari, Abu Dhabi and Bahrain debt has also surged.

Analysts downplayed the fallout for the wider region, however, pointing out that Dubai funded its growth through loans whereas its neighbours are mostly major oil and gas exporters.

"I would not rush into talking about contagion. Anything from Abu Dhabi or Qatar is backed by serious money. Dubai is a lot more leveraged," said Youssef Affany, a relationship manager at Citi who specialises in the region.

Analysts expect financial support from Abu Dhabi, a neighbouring member of the United Arab Emirates and home to most of the country's oil, to keep Dubai afloat.

But Dubai will most probably have to abandon an economic model that focused on heavy real estate investment, borrowing and inflows of foreign capital.

Earlier this year, Dubai headed off investor concerns that it would default on its debt by launching a $20 billion bond programme in which the central bank of the UAE, the world's third largest oil exporter, bought the first $10 billion slice.