Russia Stocks Tumble as Battle Rages in Georgia

Rapidly escalating violence in Georgia -- including a reported Russian air strike near the capital -- helped send emerging stockmarkets to their lowest level in almost a year on Friday, with Russian markets worst hit.

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An overnight assault by Georgian troops and artillery into separatist South Ossetia overnight sparked wider escalation, with a Georgian official saying Russian jets hit an airbase outside capital and with more Russian troops sent into the region.

A senior Georgian official said the two countries were close to war.

Russian equities fell 6.52 percent to a 14-month low, with the benchmark emerging markets index down 1.68 percent, falling through the psychologically important 1000 level to hit 991.22, their lowest since August 2007.

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.

Traders said it might increase further when New York opened.

Russia's rouble currency lost 1 percent against a euro/dollar basket.

" There was an initial reaction of shock felt in Russian debt spreads but now everyone is trying to understand if this is a short-term escalation in tensions or if there will be a negotiated ceasefire at some point," said Deutsche Bank strategist Marc Balston.

Analysts said the conflict was undermining sentiment towards other emerging countries.

"The military conflict is obviously adding to negative sentiment, not just for Russia but for emerging markets in general," said emerging market strategist Nigel Rendell at Royal Bank of Canada. "If it is still continuing after the weekend I think we will see further weakness."

Emerging equities had already seen a sell-off in recent weeks, undermined by high oil prices hitting growth prospects as well as worries developing economies would suffer second-round effects of a deepening economic slowdown in the developed world.

Recent slight falls in oil prices -- coupled with worries over the security of investments after Prime Minister Vladimir Putin attacked coal firm Mechel and the head of BP's joint-venture quit the country in a growing row over control -- had already seen sell-off's in Russian stocks.

They are now down 25 percent this year compared to an overall 20 percent for benchmark emerging equities.

The conflict is also seen likely to prompt a downgrade of the ratings of Georgian sovereign debt.

Georgia has little in the way of traded international instruments except for its $500 million Eurobond launched earlier this year, which is relatively illiquid.

Ratings agency Fitch warned on Thursday before overnight fighting that an escalation to all out conflict could hurt its creditworthiness.

Fitch said earlier in the year that any conflict between Georgia and Russia would be more likely to prompt a downgrade of Georgia than its much larger neighbour.

But it warned any conflict sparking a division with the West might make it more difficult for Russian firms to refinance their corporate debt.

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