LONDON, Aug 27 (Reuters) - Emerging currency losses deepened on Tuesday, pushing Turkey's lira to a fresh record low against the dollar as fears of Western military action against Syria added to the flight from riskier assets.
It came as a number of emerging currencies hit multi-year lows even though U.S. Treasury 10-year yields, which such currencies tend to track, were off two-year highs.
Turkey would be in the frontline if military attacks are launched on Syria. Higher oil bills and a refugee influx from the neighbouring conflict could exacerbate its $50 billion-a-year funding gap.
But the lira is also feeling the heat from Turkey's reluctance to raise interest rate to a level that provides investors with adequate rewards for the risks.
"Markets haven't bought the monetary tightening they announced last week as foreign investors think interest rates are not high enough to attract inflows to fund the large current account deficit," said William Jackson, an economist at Capital Economics in London.
He predicted that Turkey could be forced to raise its lending rate by another 50-100 bps if lira selling continues.
The currency fell more than 1 percent to another record low, bringing year-to-date losses to almost 12 percent while two-year bond yields touched Jan. 2012 highs around 10.4 percent and shares fell 2.5 percent.
Five-year credit default swaps used to insure exposure to Turkish debt, jumped 11 basis points to 14-month highs of 242 bps, according to Markit.
Lira losses spiralled after Governor Erdem Basci said he was prepared to use the central bank's net reserves of $40 billion to defend the currency but said he would not use interest rates.
The Syrian situation is an added complication.
"Turkish yields continue to inch higher and we do not rule out that this could get a bit out of hand if the Syria situation escalates," Danske Bank analysts told clients, adding it was exiting its lira position.
Israel's shekel, also exposed to events in the region, fell more than 1 percent to the dollar.
Political risk was prompting a broader-based flight to safer assets such as yen and Swiss franc.
"We are not calling for a major rebound any time soon. What we need to see is EM exports rebounding and people feeling that real interest rates in emerging markets have adjusted adequately and we are not there yet," said Bhanu Baweja, head of global emerging markets strategy at UBS in London.
The South African rand lost 1 percent.
In Asia, the Indian rupee slid to another record trough while Indonesia's rupiah, Malaysia's ringitt and Thailand's baht all hit multi-year lows .
The rupee was impervious to news of almost $30 billion in infrastructure projects as approval of a $20 billion cheap food plan raised fears of a spending spree before 2014 elections.
"(Reserve Bank of India) have to let the rupee find its own value," Baweja said. "That's the one sensible thing they are doing -- they are not standing in front of this trade."
The yuan remained the outlier, posting modest gains again. With a year-to-date rise of almost 2 percent, it is the only Asian currency to appreciate in 2013.
The hefty currency losses also caused a stampede out of emerging equities which fell 1.2 percent though losses were tempered by Shanghai's 0.2 percent gain.
Indian shares fell 3 percent while Russian shares fell 1.3 percent despite the rising oil price.
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