SERIOUS MONEY:Russia's behaviour may damage markets, but in the long run it will prove self-defeating, writes Charlie Fell

What a difference a decade makes. Ten years ago, the US was widely believed to be the world's only economic superpower. The "Goldilocks" economy was thriving, the fiscal position was in surplus and its large current account deficit was easily financed by private capital in search of the high future returns expected to arise from the technology-driven productivity miracle.

Meanwhile, the Russian economy was in a state of collapse as the former superpower defaulted on domestic debt and declared a moratorium on payments to foreign creditors. Turn the clock forward and the world of 1998 is barely recognisable today.

The US economy is on the edge of recession and faces several headwinds, including the worst housing downturn since the 1930s and the most debilitating financial crisis in decades. Its persistent current account deficit is no longer financed with private capital but public monies from largely undemocratic countries from the East.

Meanwhile, the Russian bear has enjoyed average growth rates of more than 7 per cent over the past five years, its debt has been upgraded to investment grade and it holds roughly $600 billion in foreign exchange reserves amounting to more than two years of imports.

Not surprisingly, the emerging economic power is demonstrating a level of assertiveness and self-confidence not seen for decades.

Russia's assertiveness has seen its relationship with the West become increasingly hostile in recent times. Nato's relentless expansion eastward into the former Soviet Union has sparked fears in Moscow that the US intends to encircle, weaken and dismember the country.

Matters came to a head once US-backed Georgia launched an attack on South Ossetia and the Russian bear responded vigorously. Russia demonstrated in one fell swoop US impotence in the East and ensured that potential Georgian NATO membership will be postponed indefinitely. George Bush's protestations have fallen on deaf ears as the Kremlin believes that its actions are entirely consistent with the Bush doctrine of pre-emptive warfare.

The stakes are high as Russia appears reluctant to relinquish its territorial gains in the fully-fledged US satellite. The dispute is unlikely to end in a hurry as Russia is aware that it is in its best strategic interest to keep the conflict unresolved.

More importantly, US criticism of its aggressive action in Georgia could convince Moscow to reject America's calls for a further set of UN sanctions on Tehran.

It could also step up sales of military equipment to Iran, including surface-to-air missiles, which would limit the effectiveness of an air attack on Iran.

Moscow is likely to increasingly use its position as a major exporter of oil and gas to further its foreign policy goals.

It is the world's largest exporter of gas and the second largest oil exporter and in a world of rapidly depleting reserve, its influence continues to grow. European energy dependence is rising as indigenous supply declines.

Russia has already demonstrated its willingness to use the energy weapon to punish foreign neighbours including Lithuania, Poland and Ukraine.

The security of energy supply has become increasingly important in recent years, but Moscow has increasingly limited access to its energy resources to all but its circle of allies.

Additionally, confiscation of assets appears to happen at will. However, the need for foreign capital, technological know-how and expert labour to develop its large resource base means that its current strategy is likely to be self-defeating. Indeed, Moscow's misguided strategy is already showing up in production numbers, which have posted year-on-year declines for eight consecutive months.

Russia is simply not as powerful as it looks. Its growth rates of recent years have been laudable, but its investment rate is not sufficient to sustain the recent pace. The country's investment rate at roughly 20 per cent is far less than the 30 per cent rates apparent in the emerging economies of Asia.

Furthermore, its infrastructure is crumbling. Plant and equipment in the manufacturing industry is on average more than 20 years old - three times the OECD average.

Roughly half of its fuel pipelines are more than 25 years old and the resulting loss of oil each year is substantial. Its roads, railways, power lines and water supply also require extensive upgrading.

The lack of new investment means that Russia is internationally competitive in few industries apart from military hardware or nuclear power stations, for which overseas demand is limited.

Russia also faces a serious demographic challenge, which alongside its low investment rate hampers its future growth potential. The country's fertility rate is half the replacement level and consequently, the working population is expected to decline for at least the next two decades.

Roughly one-eighth of the population is aged 65 years or older and the dependency ratio continues to rise. Immigration rates are far too low to ease the problem. The implications for future growth are obvious.

Geopolitical risk of a kind not seen in two decades has returned and can no longer be dismissed as an immaterial market factor. Russia has become increasingly aggressive to the West and the fall-out from the Georgian conflict could extend to the Middle East. Russia's game of roulette could gather momentum and negatively impact financial markets, but in the long run it will prove entirely self-defeating.

www.sequoia.ie