Ben Aris in Tbilisi -

Last November simmering tensions with Russia flared up into a major show down 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 USA 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 has become 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 has ceded and are backed by Moscow is the source of regular clashes with Russian forces.

Energy was another major concern. In Jan 2006 there were two explosions on the main gas supply pipeline to 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 kW/hrs of which 7.8bn are generated domestically.

Even in the worst of the blockade Russia didn't cut Georgia off form its gas supplies, but clearly the small country has serious energy insecurity 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 Russia has over the republic.

Now Saakashvili is talking about puling out of the CIS. Georgia initiated the creation of GUUAM -- a trade alliance that included 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% GDP growth last year because it forced everyone to diversify their supplies and customers. Ironically the Russian embargo has made the economy more robust and ended up open new markets to Georgian goods like China and 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.

Significant fiscal consolidation -- 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 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."

The Russian embargo was an unmitigated disaster of Kremlin foreign policy and only the latest in a series of diplomatic gaffs Putin's team has made since they gained full control of the foreign ministry in 2004. Russia's overestimated it clout in the region and shyly sent its 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 most countries, is partly due to Bendukidze, an ethnic Georgian who made a fortune as a Russian industrialist in the 1990s to head up Georgia's reform effort.

"No one was happy when our major trade partner slapped an embargo on us," Bendukidze 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.