Investors see broader shadow from Georgia conflict

LONDON (Reuters) - The sudden outbreak of the Georgian conflict has left investors looking nervously at other economies in the region, with Ukraine and the Baltic states seen particularly exposed to a resurgent oil-rich Russia.

Russian equities and the ruble have already fallen on the conflict, while Georgia has faced credit ratings downgrades and is seen likely to suffer further economic fallout even if the actual fighting ends quickly.

"Going to war with Russia is bad for your creditworthiness, to put it mildly," said Edward Parker, head of emerging European sovereigns and ratings agency Fitch.

"I don't think what has happened substantially changes the fundamentals for other countries but it may be a wake-up call to some people who hadn't properly appreciated potential Russian impact in the region," he said, adding he did not expect any broader ratings impact outside Georgia.

Outside the two main combatants, investors see the most exposed countries as Georgia's fellow former Soviet states bordering Russia, such as Ukraine, the Baltic states and some central Asian countries.

"You'd expect this to affect sentiment towards them, as it is more evidence of Russia trying to exert control over its nearest neighbors," said Andrew Brown, who helps manage $10 billion of emerging equity for Aberdeen Asset Management.

Russia cut off gas supplies to Ukraine in January 2006, while Baltic states Lithuania and Estonia have both been hit by cyber attacks on government websites. Lithuania's attacks followed a ban on the use of Soviet symbols, while Estonia linked its attacks to a dispute with Moscow over the removal of a statue of a Red Army soldier from a square in the capital.

By the end of Friday, the cost of insuring Ukrainian debt through the credit default swaps market had increased to 402 basis points from 390 in July, implying that it was seen as riskier by traders -- although it narrowed again on Tuesday.

"A more aggressive Russian foreign policy within the former Soviet Union is likely to pose a threat to Ukrainian asset prices in due course," Citi said in a research note, warning Ukraine's economy was also threatened by high inflation.

Many of the former Soviet states have dollar or euro denominated Eurobonds, although most are highly illiquid and it is hard to tell if they have responded to the crisis.

But Lars Christensen, head of emerging markets research at Danske Bank in Copenhagen, said there were key differences -- particularly in that the Baltic states were already members of the European Union and NATO.

"Obviously people will also be looking at the former Soviet republics with borders with Russia," he said. "The big difference is that you do not have any particular disputed border regions -- except for a very small area of Estonia -- or areas with a large Russian population."

ENERGY STRANGLEHOLD

Central and eastern European countries such as Poland that were once under Russian domination during the Cold War were seen largely unaffected, although some analysts pointed to a long-term impact on Europe in general from a more active Russia with a stranglehold over energy supplies.

Monument Securities said the former Soviet Union was expected to meet some 15 percent of global oil demand next year, with Germany dependent on Russia for 39 percent of domestic gas and Finland and Slovakia 100 percent dependent.

"A worsening in relations between Russia and the West would put at risk Russian supplies of gas to European countries," Monument analyst Stephen Lewis wrote in a research note, saying both Germany and France were battling diplomatically for access to Algerian gas as a result.

Central European currencies -- treated for most of the last year as emerging safe havens from the developed world credit crunch -- have sold off in recent days.

However, analysts say this has been largely separate from the Russia-Georgia conflict, and more to do with signs of a U.S.-centered economic slowdown spreading to Europe.

With few traded Georgian assets, the biggest market loser from the conflict so far has been Russia itself.

Even though equities recovered much of their losses on Tuesday after a ceasefire announcement, Russian stocks remain down 20 percent so far this year. Investor sentiment has already been soured by Prime Minister Vladimir Putin's criticism of foreign-listed coal firm Mechel and a battle for control over oil giant BP's local subsidiary.

Ultimately, some foreign investors feel that while the Russian economy might boom, their money might not be safe.

"It's been one thing after another ... highlighting the lack of regard for the rule of law in Russia," said Aberdeen Asset Management's Brown, whose fund is structurally underweight Russia. "It's hard to find companies that aren't in some way connected with the Russian government, which we don't particularly trust."

(Editing by Ruth Pitchford)