Dubai's financial health has come under scrutiny after a major, government-owned investment company asked for a six-month delay on repaying its debts.
Dubai World, which has total debts of $59bn (£35bn), is asking creditors if it can postpone its forthcoming payments until May next year.
Dubai World has also appointed global accountancy group Deloitte to help with its financial restructuring.
The company has been hit hard by the global credit crunch and recession.
It was due to repay $3.5bn of its debts next month.
The request for a delay in repayments led to major credit ratings agencies downgrading a number of state-backed companies.
Following six years of rapid growth, the Dubai economy has slumped since the second half of 2008.
This has led to Dubai property prices falling sharply.
The Dubai government said in a statement that the request to delay debt repayments also applied to property developer Nakheel, a Dubai World subsidiary.
"It's shocking because for the past few months the news coming out has given investors comfort that Dubai would most probably be able to meet its debt obligations," said analyst Shakeel Sarwar, of SICO Investment Bank.
Dubai is one of the seven self-governing emirates or states that make up the United Arab Emirates.
Analysts say the Dubai government has paid the price for a flamboyant economic model centred on foreign capital and giant construction projects.
Questions are now being raised about Dubai's ability to repay its debts, said the BBC's Middle East correspondent Jeremy Howell.
Some have speculated it is likely to turn to the more economically conservative Abu Dhabi emirate to bail it out.
Global credit rating agency Standard & Poor's, which rules on a company's or government's ability to repay its debts, said the announcement "may be considered a [debt] default".
Our correspondent said: "Standard & Poor's and Moodys immediately downgraded all six state-backed corporations in Dubai, downgrading some to junk status."
Junk is the term commonly used to describe bonds that are rated below investment grade by ratings agencies.
The Dubai World announcement was made on the eve of the Eid al-Adha Muslim festival, which will see many government agencies and companies close in Dubai until 6 December.