The surge of violence in Georgia caused Russian shares to plummet on Friday and helped send emerging stock markets to their lowest level in almost a year as investors suddenly saw all emerging markets as riskier.
An overnight assault by Georgian troops and artillery into separatist South Ossetia sparked more fighting, with a Georgian official saying Russian jets hit an airbase and with more Russian troops sent into the region. A senior Georgian official said the two countries were close to war - a scenario few had expected days earlier.
Russian equities fell 6.52 percent by 1410 GMT to a 14-month low, with the benchmark global emerging index down 1.93 percent, falling through the psychologically important 1000 level to hit 988.71, their lowest since August 19 2007.
Ratings agency Moody's said the conflict should not change its rating of Russia's sovereign debt [nL8572913], but analysts said the conflict was destroying enthusiasm for Russian assets which had looked promising weeks earlier given high oil prices.
But recent attacks by Prime Minister Vladimir Putin on New York-listed firm Mechel, Russia's largest coal producer, over its pricing strategy and an ongoing struggle for control of oil giant BP's local joint-venture TNK-BP have raised concerns over security of investment. "Today's events and that their consequences are further deteriorating investor demand towards Russian assets," said Commerzbank analyst Michael Ganske.
He described the conflict as "the bloody next act in a screenplay that could be named "how to destroy the investment story of one of the strongest credits in the emerging markets universe", meaning Russia. Russian equities are now down 25 percent so far this year, compared with 20 percent for emerging equities globally.
The impact on broader emerging market sentiment helped undermine the emerging currencies just as they were also being pressured by a rebound in the dollar. "Georgia is having a marked impact on equities," said BNP Paribas currency strategist Shahin Vallee. "On the currencies, I think it is mainly the dollar but it is probably also around 40 percent Georgia."
Russia's rouble lost 1 percent against its dollar/euro basket, while other free-floating emerging currencies fell more. The Turkish lira was down 1.25 percent, South Africa's rand down 3.42 percent while the Czech crown was down 0.71 percent against the itself weaker euro.
Benchmark emerging sovereign debt spreads widened six basis points to 296 above US treasuries, an unusually large move implying that investors were suddenly viewing the government debt of emerging economies as riskier. The cost of insuring Russian debt in the credit default swaps market also increased, with five-year spreads increasing to 116-117 basis points from Thursday's 102, meaning it would cost $116,000 to insure $10 million of debt.
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