* High level of short interest on Vienna stocks -Sungard
* More underperformance on ATX index seen in near term
* ATX falls as Erste slumps on eastern Europe problems
By Sudip Kar-Gupta
LONDON, July 4 (Reuters) - Bearish bets against Austrian stocks are on the rise after Erste Bank's 15-percent tumble on Friday flagged the downside of exposure to emerging Central and Eastern Europe economies.
The conflict between Russia and Ukraine - countries in which the Austrian market's biggest companies have significant business ties - has already contributed to the Vienna stock market underperforming in 2014.
Then on Friday, Hungary's parliament approved legislation that the central bank estimates could cost the financial sector - including Austrian banks Erste and Raiffeisen - a total 600 to 900 billion forints ($2.6-$3.9 billion) in compensation for borrowers.
Investors' "short" positions on Austrian equities, as measured by the amount of shares out on loan as part of a bet that their price will fall, are up about 50 percent since the end of 2013, according to data from research firm Sungard released on Friday.
Vienna's benchmark ATX equity index was down 3.3 percent on Friday, underperforming other western European markets, after Erste's share price fell on its warning of a record loss due to hits from Romania and Hungary.
The three biggest stocks on the ATX - oil and gas group OMV , Erste and Raiffeisen - have all been hit this year by problems in central and eastern Europe, once seen as a obvious area for Western businesses to expand as ex-Communist countries adopted free-market policies.
Now OMV, the longest-standing Western trade partner of Russian gas monopoly Gazprom, has been affected by the conflict between Ukraine and Russia, while in May Raiffeisen had to write down the book value of its Bank Aval unit in Ukraine by 216 million euros.
Smaller companies in the ATX market have also been hit, with challenges in eastern Europe prompting profit warnings from Telekom Austria and utility EVN in the past two weeks.
"Austria is likely to suffer while there are still problems in eastern Europe," said Kevin Lilley, European equities fund manager at Old Mutual Global Investors, who sold his fund's shares in Raiffeisen and OMV earlier this year.
Some investors have viewed the ATX as offering an attractive mix of exposure to the solid economic growth of Germany and the German DAX index, and an entry-point to future growth in eastern Europe, given the exposure of Austrian banks to that region.
However, problems in eastern European economies have contributed to the ATX falling by around 4 percent since the start of 2014, underperforming a 5 percent gain on the DAX, which has hit record highs.
Karl Loomes, market analyst at Sungard's Astec Analytics, said short interest on Austrian stocks - as measured by borrowing levels - is still about 50 percent higher than December last year.
To profit from the stock price going down, short sellers can borrow a security and sell it, expecting that it will decrease in value so that they can buy it back at a lower price and keep the difference.
"In fact, the greatest gains in borrowing have come about when the stock prices underwent short-term rallies, hinting that short sellers may have been, and perhaps still are, growing pessimistic regarding the country's share prices," said Loomes.
Thomson Reuters Datastream graphics show a sharp divergence in the performance of the ATX against the DAX from April onwards (http://bit.ly/1t5gYOA), and Commerzbank equity strategist Peter Dixon expected this to continue in the near term.
"I don't see any reason for a sudden improvement in sentiment towards Austrian equities in the near term," he said.
(Editing by Lionel Laurent/Ruth Pitchford)