Moscow now counting considerable cost of military campaign in the Caucasus

ANALYSIS:€17 billion in capital was withdrawn from Russia in the wake of its operations in Georgia, writes Daniel McLaughlin

AS THE European Union frets that criticism of the Kremlin's campaign in Georgia could jeopardise vital Russian energy supplies, Moscow is already feeling the economic impact of its military intervention in the Caucasus.

Western condemnation of the Kremlin's decision to send tanks into Georgia and unilaterally recognise the independence of the rebel regions of Abkhazia and South Ossetia swiftly translated into capital flight from Russia, a sharp downturn on its stock market, tougher lending conditions from foreign banks and a sudden weakening of the rouble.

Investor confidence has been further undermined by falling oil prices, by allegations by prime minister Vladimir Putin of price irregularities against major mining firm Mechel and by a very ugly spat between BP and its oligarch partners in Russian joint-venture TNK-BP.

The central bank intervened to prop up the rouble after it lost about 9 per cent of its value against the dollar since July and spent more than €9 billion defending the currency in August alone, the largest such monthly outlay by the bank for at least a decade.

The benchmark RTS index of Russian stocks has dropped to its lowest level in two years, sending Russia tumbling down the list of most-desirable emerging markets, as political fall-out from the Georgia conflict exacerbated the effect of the global equities downturn.

Perhaps the starkest indicator of the change in sentiment towards Russia is the finding of French bank Paribas that more than €17 billion in capital was withdrawn from Russia in the wake of its operations in Georgia, which the Kremlin claims halted a campaign of genocide by Tbilisi's forces against the separatist South Ossetians.

Russian companies are also finding it harder to borrow and attract investment in an atmosphere of heightened uncertainty about the country's reliability and political direction.

Russian firms took on 87 per cent less debt in August than they did the previous month, while barely €2 million in new equity was raised last month, compared to more than €650 million in July.

Some analysts draw comparisons with the financial crisis of 1998, when a devaluation of the rouble, falling oil prices and a default on government bonds conspired to strip the Russian stock market of three-quarters of its value in just nine months.

Like 1998, inflation is now rising in Russia (and expected to hit 15 per cent this year), while the stock market is vulnerable because of its preponderance of commodity stocks that are susceptible to boom-and-bust cycles, and the heavy involvement of foreign investors who are easily spooked by talk of a "new cold war" between Russia and the West.

In many ways, however, the self-confident Russia run jointly by Mr Putin and his protegé, President Dmitry Medvedev, is far stronger that the country which was overseen by a shaky Boris Yeltsin a decade ago.

Flush with earnings from record oil prices, Russia has paid off all its Soviet-era sovereign debt and now holds some €420 billion in foreign currency and gold reserves.

It also enjoys a trade surplus and received a small but timely boost last week when BP and its Russian partners in TNK-BP resolved their management dispute, amid western fears that the firm was being softened up for takeover by a Kremlin-backed company.

However, as Russia's bankers and businessmen seek to mitigate the effects of their leaders' actions in Georgia, the finance ministry is contemplating a new drain on resources - the long-term cost of propping up Abkhazia and South Ossetia, with reconstruction work on the latter expected to absorb more than €280 million of the Kremlin's cash this year alone.