Like a precious old treasure, lost and almost forgotten, Lahore's medieval walled city, a labyrinth of alleyways and bazaars, has suffered so much neglect that decay has nearly consumed it.

Now the first serious conservation project is about to begin, to restore a tiny portion of a once grandiose metropolis and seat of power, where Mughal princes, poets and courtesans mingled in the shadow of the royal fort and colossal Badshahi mosque just beyond its walls.

The Royal Trail, a route through the old city used by the former Mughal rulers of India to reach their palatial citadel, will be restored under a project starting this summer, backed by the Punjab provincial government and the World Bank.

The one-mile route winds by some of the city's greatest riches, including the beautifully adorned Shahi Hammam baths and the early 17th-century Wazir Khan mosque, covered in brilliantly colourful fresco and tile decoration.

Modernity has been the real vandal, with deterioration especially rapid over the past 30 years, when many of the old city's wealthy families fled its narrow, congested streets and architectural riches were turned into warehouses and cottage factories, as the area descended into squalor and low-rent commerce.

"It's so painful what I've seen. Such beautiful houses there were here, now gone," said Iqbal Hussain, an artist who lives in the towering 300-year-old brothel-mansion where he was born, and which he uses as a studio to paint the old city's prostitutes with unnerving realism. "I'm the only one left here. No one is bothered."

A 1988 conservation plan found that 1,427 surviving buildings were so important they were in need of immediate legal protection, which never materialised. An audit of those buildings in 2007 found that only 647 had survived.

Today, architectural gems stand in a painful state of decay, unnoticed amid the clutter. The old city has become so unappealing that the population has declined, from 200,000 in 1958 to some 145,000, while the rest of Lahore has ballooned.

Many old buildings and beautiful facades are hidden behind ugly modern extensions, while monstrous concrete structures have replaced buildings that collapsed or were pulled down. But amid the rot, a vibrant quintessentially Lahori culture and unique way of life still exists.

"Whatever is left, we can save. The atmosphere is still here, the ambiance. At one time, this was [all of] Lahore," said Yousaf Salahuddin, one of the few people from a noble old city family who still live there, in the sprawling 350-year-old Barood Khana mansion. "The good thing is that at least something, some restoration, is starting. This place was becoming a slum."

There are 52 main specialist bazaars, selling for everything from cloth, spices and bangles to kitchen utensils. Food stalls line every street, with sizzling, spicy specialities. The cramped streets are bustling with hawkers, men pushing handcarts laden with goods, rickshaws, motorcycles, people hurrying in all directions.

The restoration scheme has funding of £7m. Several hundred million might be required to cover the whole old city.

Masood Khan, of the Aga Khan Trust for Culture, advising on the restoration, said that truck and bus terminals on the edge of the old city were choking it with pollution and traffic to serve the factories, warehouses and markets within. Those transport hubs would have to be moved as part of any serious attempt to save the old city.

"There has been a complete abdication of municipal responsibility," said Khan. "Commerce has expanded like a cancer and eaten into the historic fabric."