Aug. 8 (Bloomberg) -- The ruble dropped the most in 3 1/2 years and Russia's 30-stock Micex Index fell to a 22-month low after Prime Minister Vladimir Putin said ``war has started'' in the breakaway Georgian region of South Ossetia.

Credit-defaults swaps, a measure of bond risk, climbed the most since March after Georgia's Interior Ministry said jets bombed the towns of Gori and Kareli near the breakaway region of South Ossetia.

The ruble fell the most against the central bank's basket of dollars and euros since that gauge was introduced in February 2005. The Micex plummeted, bringing its decline this year to 28 percent after oil slid 19 percent. Russian ``volunteers'' are pouring over the border to help defend South Ossetia from Georgian forces, Putin told U.S. President George W. Bush in Beijing, according to Putin spokesman Dmitry Peskov.

``We didn't need this,'' said Ivan Mazalov, who helps manage $5 billion in shares of companies from the former Soviet Union at Prosperity Capital Management in Moscow. ``It's not going to break the Russian economy, but war is bad for investor sentiment.''

Bombings by Russian warplanes followed an attack by convoys from Russia on Georgian forces near the South Ossetian capital of Tskhinvali, Georgian Interior Ministry spokesman Shota Utiashvili said by phone today from Tbilisi, Georgia. Russia's government earlier denied the bombing claim, and the Defense Ministry accused Georgia of ``unleashing a dirty, reckless scheme.''

`Last Nail'

The dispute between the countries ``adds to bruised investor sentiment'' in Russia and is ``potentially damaging to Russia's external relations, particularly with the West,'' JPMorgan Chase & Co. wrote in a note to investors. ``Clearly a war would not support investor confidence and would further fuel the debate about political risk.''

The ruble weakened as much as 1.3 percent against the dollar-euro basket and was at 29.7052 by 4:28 p.m. in Moscow, from 29.3585 yesterday. The basket mechanism was introduced as a way of limiting the impact of the ruble's fluctuations on the competitiveness of Russian exports.

``This is the last nail in the coffin,'' said David Tavadian, head of fixed income and derivative sales at Calyon Rusbank SA, a Moscow-based unit of Credit Agricole SA. Calyon's Russian loan book is worth $7 billion. ``It tells people that in Russia you have to be careful.

The ruble-denominated Micex sank 5 percent to 1,363.35. The dollar-denominated RTS Index slumped 5.8 percent to 1,734.90, the biggest one-day drop in more than six months.

Energy companies dropped as oil headed for its fourth decline in five weeks, while Bank of Georgia tumbled in London.

Energy Stocks

Shares of Rosneft, the country's biggest oil producer, sank 4.5 percent to 213.40 rubles, extending its weekly decline to 12 percent. OAO Lukoil, the second-biggest oil producer, dropped 4.1 percent to 1,862.01 rubles. Oil and gas companies comprise about 55 percent of the Micex Index.

OAO Sberbank, the biggest bank in Russia, sank 4.3 percent to 61.36 rubles, its lowest in 21 months. Bank of Georgia, the republic's biggest bank, dropped 21 percent to $12.50 in London, a record low.

Credit-default swaps on Russia rose 11 basis points to 113, the biggest one-day gain since March, according to CMA Datavision prices at 10:45 a.m. in London. A basis point on a credit-default swap contract protecting 10 million euros ($15.1 million) of debt from default for five years is equivalent to 1,000 euros a year.

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent in the event of a failure to adhere to debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

Inter RAO

A ``significant escalation or a prolonged conflict'' in Georgia would be ``likely'' to affect Georgia's credit rating, Edward Parker, emerging markets credit analyst at Fitch Ratings, said by telephone today.

OAO Inter RAO, a Russian power generator with plants in Georgia, dropped 1.56 kopeks, or 19 percent, to 6.56 kopeks in Moscow. A kopek is one hundredth of a Russian ruble.

Inter RAO owns the Mtkvari Energetika power plant in Georgia, half of which is currently in operation. The company also has the AO Khrami GES-1 and GES-2 hydropower plants under trust management, which provide 110 megawatts, or 10 percent of Georgia's power production, according to the company's Web site.

OAO Polyus Gold, Russia's biggest gold producer, tumbled 53.8 rubles, or 5.6 percent, to 916 rubles. Gold fell to an eight-week low in London on speculation dollar gains will spur sales by investors who bought the metal as an alternative.

To contact the reporters on this story: William Mauldin in Moscow at wmauldin1@bloomberg.net; Emma O'Brien in Moscow at eobrien6@bloomberg.net

Last Updated: August 8, 2008 09:14 EDT