It can cope as long as the encoding declaration is the same as the actual one. For instance try:
<?xml version="1.0" encoding="UTF-8" ?>
at the top. Then open the file in Notepad, and save it making sure the encoding dropdown is set to UTF-8.
If this fixes the problem but your file is normally created programatically then we'll need to see how you create to see where the encoding is incorrcetly applied.