Georgia violence hurts Russian, emerging markets

(adds Georgia ratings downgrades)



* Georgia violence shocks markets, emerging equities fall

* Russian markets lead dive, equities down 6.5 percent

* Hurts across emerging equities, currencies

* Credit rating agencies downgrade Georgia

By Peter Apps

LONDON, August 8 (Reuters) - 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 airbases 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 6.51 percent by 1650 GMT to a 14-month low, with the benchmark global emerging index .MSCIEF down 1.93 percent, falling through the psychologically important 1000 level to hit 988.19, their lowest since August 19 2007.

Ratings agencies Standard & Poor's [nWNA7736] and Fitch [WNA7738] both announced downgrades on Georgia, saying the fighting raised economic fears and threatened the country's creditworthiness.

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 (MTL.N), Russia's largest coal producer, over its pricing strategy and an ongoing struggle for control of oil giant BP's (BP.L) 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.



OTHER MARKETS HURT

"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 TRY= was down 1.25 percent, South Africa's rand ZAR= down 3.42 percent while the Czech crown EURCZK= was down 0.71 percent against the itself weaker euro.

Benchmark emerging sovereign debt spreads 11EMJ widened six basis points to 296 above U.S. 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.

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.

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

The ratings agencies said they were concerned the violence could jeopardise foreign investment which has been key to covering Georgia's relatively wide current account deficit, currently 20 percent of gross domestic product.

They warned increased government expenditure could also widen the budget deficit, while any impact on domestic confidence could damage the banking system and currency.