Ben Aris in Tbilisi -

Last November, simmering tensions between Georgia and Russia flared into a major showdown after Georgia arrested several Russians in Tbilisi on spying charges. The Kremlin was outraged and closed the borders to trade, killing Georgia's lucrative wine exports, cancelling all trains and planes between the two capitals and ejecting many Georgian nationals living and working in Russia.

"The embargo was the best thing that ever happened to us," said President Mikhail Saakashvili earlier this year. Lado Gurgenidze, the chairman of Bank of Georgia says that it only took a few weeks for the Populi supermarket chain, which the bank owns, to switch suppliers from Russian to Ukrainian companies.

The country has turned to the US as its lead foreign relations partner and Washington has welcomed such a staunch ally in the strategically important Caucuses.

US President George Bush went as far as visiting Tbilisi in 2005 and Georgia became an associate member of NATO last month. Georgia is in bad need of security guarantees, especially as the two festering regional disputes with Abkhazia and South Ossetia, which have seceded and are backed by Moscow, are the source of regular clashes with Russian forces.

Keeping the lights on

Energy was another major concern. In January 2006, there were two explosions on the main gas supply pipeline between Georgia and Armenia, which led to a significant reduction of gas supplies to the country. However, thanks to the country significant hydropower resources, Georgia is near to energy self-sufficiency: annual consumption is 8.3bn kWh, of which 7.8bn is generated domestically.

Even during the worst of the blockade, Russia didn't cut Georgia off from its gas supplies, but clearly the small country has serious energy security problems.

But here too, Georgia was spurred into action by the embargo and over the last two years two trans-Caucasian energy pipelines running from Baku became operational, providing Georgia with an independent energy supply and thus breaking the last real hold that Russia has over the republic.

Now Saakashvili is talking about pulling out of the CIS. Georgia initiated the creation of GUUAM - a trade alliance which includes Georgia, Ukraine, Uzbekistan, Armenia and Moldova. However, after Uzbekistan pulled out, it is now known as GUAM.

Despite being cut off from its largest export market, the Georgian economy still put in a very robust 8.9% growth last year because it forced everyone to diversify supplies and customers. Ironically, the Russian embargo has made the economy more robust and ended up opening up new markets to Georgian goods like China and the rest of the Far East.

Privatization is almost finished. Most of the large state assets have now been sold off including United Georgian Telecom, a fixed-line telecom company to a consortium of Georgian and Kazakh investors. Also the last of the six hydro power stations and all the distribution companies were privatized in 2006. Most of the remaining assets left to be sold are small pieces of real estate.

There has also been significant fiscal reform. A new tax code has been adopted that radically simplifies the tax system and allows for better tax administration. In particular, the number of taxes was cut from 21 to seven, while eliminating exemptions and broadening the VAT and profit-tax bases. On the expenditure side, the government has managed to substantially reduce its debt.

And the president has been slashing away at the government machine to reduce the number of permits, rules and officials that companies and people have to deal with.

Minister for reform, Kaha Bendukidze, told bne: "If you don't have permits, then you can't have corruption. Each piece of paper means you have an official that needs to sign it and extract a bribe for that signature."

Moscow miscalculates

The Russian embargo was an unmitigated disaster for Kremlin foreign policy and only the latest in a series of diplomatic gaffs that President Vladimir Putin's team has made since they gained full control of the foreign ministry in 2004. Russia overestimated its clout in the region and shyly sent its Georgia ambassador back last month. Although the travel embargo remains in place, Aeroflot is reportedly taking bookings for planes from Moscow to Tbilisi for July.

The ability of the economy to stand such a massive shock that would have felled some other CIS countries is partly due to Bendukizi, an ethnic Georgian who made a fortune as a Russian industrialist in the 1990s and now heads up Georgia's reform effort.

"No one was happy when our major trade partner slapped an embargo on us," Bendukizi told bne," but the economy is already reformed and could absorb this kind of shock. The embargo cut about 2% off GDP growth but not more."

Privatisation is finished and the state only has a few land plots and small companies left to sell. Bendukizi has slashed the number of permits and licenses in an effort to cut the endemic corruption and Saakashvili took the radical decision of sacking the entire traffic police corps to end the perennial bribe taking in the force.

Send comments to The Editor