MUMBAI, Nov 27 (REUTERS) : Indian stocks and the rupee skidded on Friday as Dubai's debt woes sparked fears over corporate exposure to a key trading partner and that foreign funds will lose their appetite for risk.

Banking, property and construction-related shares were among those hardest hit, after Dubai said two of its flagship firms planned to delay repayment on billions of dollar of debt. Foreign investors have poured roughly $15 billion into Indian stocks this year, helping drive a 75 percent rally through Thursday, and were among the sellers on Friday.

Dubai said on Wednesday it wanted creditors of Dubai World and property group Nakheel to agree to a debt standstill as it restructures Dubai World, the conglomerate that spearheaded the emirate's breakneck growth. Dubai World had $59 billion in liabilities as of August.

"Whenever this sort of situation arises you will see a flight to safety, but I think within the emerging markets space India and China clearly are the favourites, so to that extent they will be protected on the downside," said Manish Sonthalia, portfolio manager at Motilal Oswal.

The benchmark Sensex pared losses to 2.2 percent on buying at lower levels in mid-afternoon trade after falling as much as 3.8 percent, outperforming the 4 percent drop in the MSCI Index of non-Japan Asia.

India and the United Arab Emirates, of which Dubai is a member, are separated by the Arabian Sea and closely linked by the millions of Indians who work in the region. Indians make up about 40 percent of the UAE's population, accounting for 10 to 12 percent of India's inward remittances, CLSA said in a report.

The UAE was the second-biggest export destination for India during the nine months through December 2008, accounting for $14.6 billion, or 11.15 percent of India's total -- a share that has been rising and closing in on the United States.

"This event would be a trigger for investor risk aversion and that could slow down the flow of capital into emerging markets, and Indian stocks would be affected by that," said Gaurav Kapur, senior economist at ABN Amro Bank in Mumbai.

Minister for trade Anand Sharma said India's economy was unlikely to be hard-hit by the situation in Dubai. "India is a very large economy. I don't think some development in the real estate in Dubai is going to impact the Indian economy," he told reporters.

While Indian banks are heavily focused on the domestic market, they are active in handling remittances from overseas workers and India's banking index was down 3 percent.

Bank of Baroda, which had a total exposure in the UAE of around 100 billion rupees ($2.1 billion) according to its chairman, saw its shares fall about 7 percent. The mid-sized lender has 10 branches in the Gulf, more than any other Indian bank, according to CLSA, but the exposure is mostly related to remittances, the brokerage said.

SENTIMENT HIT

Several market players said the biggest impact of Dubai's difficulties would be on sentiment. "The market was expensive, and it was looking for a reason to correct, and Dubai happened to be one," said Anand Shah, head of equities at Canara Robecco Mutual Fund. "Fundamentally, we are not impacted. But, if the risk appetite comes off, the liquidity flow could reduce," he said.

Many Indian companies were quick to play down their exposure to Dubai. Engineering conglomerate Larsen & Toubro said it had exposure to Dubai of $20 million to $25 million. India's largest listed realty firm, DLF, and second ranked Unitech said they had no exposure to Dubai, and leading private bank ICICI Bank said it had no material exposure.

Real estate shares were down 3.83 percent. Nagarjuna Construction said it was slowing down its real estate operations in Dubai. "We have only one real estate project in Dubai, to develop 1.45 million sq feet ... and right now in the Dubai real estate market we are going slow on this project," Y D Murthy, executive vice-president, finance, said.

Emaar MGF, a joint venture between Indian financier MGF and the UAE's Emaar Properties, is one of several Indian property firms planning a listing. It has filed papers with the market regulator to raise about $830 million, about half the amount it had planned to raise in 2008.

Emaar MGF declined comment, saying it was in a silent period after having filed the prospectus for its share offering.

"For real estate per se, the pressure would be due to lack of investor appetite at a time when a slew of IPOs are lined by local real estate companies," ABN Amro's Kapur said.