What is the exact error you are getting?
What does the path of the watch folder look like?
Such a path would be network in nature I would guess. I have a similar setup with VMWare, and while Windows often displays a shared folder as being on the Z: drive, it is actually a network share. I am not able to setup this share as a watched folder, although I get an error that doesn't sound like yours. Services such as those used by Watch Folder often have issues with the network protocols in use by programs like RDP. This may not be resolvable, and may require a scripted solution at the OS level.
Similar situation for me. The error I get is "The Watch Folder Service returned an error. Access is denied." The situation is another machine on my home network; I am administrator on both machines and have R/W properties for the drive in question. What do I have to do to be able to watch a networked computer's files in PSE?