Emerging Markets-Selloff on Georgia conflict, Argentina fears

NEW YORK, Aug 8 (Reuters) - Fighting between Russia and Georgia involving a breakaway republic and plunging confidence in Argentina’s future ability to fund its financial obligations cast a pall over emerging market assets on Friday.

Stocks in the sector fell to fresh one-year lows, largely on the back of sinking Russian equities which bore the brunt of investor unease about clashing Russian and Georgian forces.

Morgan Stanley Capital International's emerging markets stock index .MSCIEF fell 1.82 percent to 989.81, its lowest since August 2007.

An overnight assault by Georgian troops and artillery into separatist South Ossetia sparked more fighting, with Moscow sending in troops in response to retake the region which it has supported against the pro-Western government in Tbilisi.

Russia's benchmark RTS stock index fell 6.5 percent on Friday .IRTS, nearing a 14-month low set on Wednesday, while the rouble fell versus a basket of currencies split 0.55 for dollars and 0.45 for euros.

External factors such as a surging U.S. dollar contributed to weakness in most emerging market currencies.

For Georgia's 2013 Eurobond, sold in April, the military conflict caused a 5-point drop in price to bid 90.50, yielding 10.095 percent, according to Reuters data XS0357503043=R.

“People are getting concerned the strong-arm tactics used in Russia historically may be coming back. They have tons of money from eight years of high oil prices to replenish their army. ... It could remain a source of risk aversion for emerging markets overall,” said Paul Biszko, senior emerging markets analyst at RBC Capital Markets in Toronto.

Both Standard & Poor’s and Fitch Ratings cut their credit ratings by one notch on Georgia, citing the conflict and the potential to limit foreign investment which plays a crucial role in funding development in the former Soviet republic.

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At the same time investors piled into financial insurance to protect their investments in Argentine debt on rising concerns that its window for financing future spending needs is deteriorating with falling commodity prices.

Moody’s Investors Service told Reuters late on Thursday it was going to review the credit rating outlook for Argentina in coming weeks given concerns over the funding issue as well as a tense political environment after a bitter fight over a now-defeated agriculture tax plan.

“Moody’s said they may downgrade the outlook and I think that triggered new fears among investors,” said Biszko.

A widely held belief that Argentina is underreporting inflation and relying too heavily on the goodwill of Venezuela to buy its debt has caused a flare-up in risk aversion despite the nation’s sizable foreign currency reserves of $48 billion.

On Friday Argentina confirmed the recent sale of a $1.46 billion 2015 U.S. dollar-denominated bond, but was vague on the exact terms, unnerving investors.

“The perception that Argentina was willing to validate a yield of over 15.5 percent, as was the case at the time of the announcement, made some observers very uncomfortable,” Lehman Brothers analyst Guillermo Mondino wrote in a research note.

The expectation is that Venezuela will then sell a large portion of the bonds in the secondary market at a time when liquidity is low and risk aversion is high. This is likely to drive prices lower for Argentina’s outstanding debt issues.

Argentina’s five-year credit default swaps, which protect investors against such things as defaults or credit restructurings surged higher on Friday.

The cost to insure $10 million worth of Argentine debt rose by 69 basis points, to roughly 885 basis points, according to the latest CDS prices from data provider Markit. That means investors are spending $885,000 annually over five years to insure their bonds, a rise of $69,000 in the last 24 hours.

Argentina's portion of the benchmark JPMorgan Emerging Markets Bond Index Plus (EMBI+) 11EMJ.JPMEMBIPLUS, a key gauge of investor risk aversion, weakened significantly.

Yield spreads widened by 43 basis points to 727 basis points over benchmark U.S. Treasuries while total returns fell 4.86 percent.

Overall, the EMBI+ widened by 5 basis points to 295 over U.S. Treasuries.

Argentina's benchmark Discount bond due in 2033 ARGGLB33=RR fell 2.062 points in price to bid 68.188.

The Boden 15 fell 3.75 points in price to bid 57.75, yielding 18.562 percent ARARGE03F144=R. Argentine-issued Boden paper was given to people who had frozen deposits in Argentine banks after the 2002 debt default. (Editing by James Dalgleish)