The Thing Is: Russia's credit reputation is on the ropes

For the past three-and-a-half weeks Russia has proudly worn a badge of respectability with the world's investment community.

Vladimir Putin's government has long yearned for it and when credit rating agency Moody's finally awarded Russia its first investment grade status, the country celebrated. Never mind that the announcement was tainted with suspicions of insider dealing in the Russian bond markets, the upgrade meant that the country was no longer considered dodgy, unstable, corrupt or risky. It was front-page news in Moscow and Russia's stock market rallied.

How things have changed. Last weekend's arrest of the Yukos chief executive, Mikhail Khodorkovsky, threatens to blacken the county's reputation as a safe place to do business.

Moody's is standing by its credit upgrade. Unlike its rivals, the group rates Russia purely on its ability and willingness to pay its debts. "Short of Yukos shutting down all its oil production and Russia blowing out its budget surplus, I do not see a risk to the investment rating," says Moody's vice- president, Jonathan Schiffer.

Other rating agencies, Standard and Poor's and Fitch, take a different view and factor in political risks to their equations. Both were expected to consider an upgrade next year, after the March presidential elections, but the Yukos affair could have blown that. If the crisis deepens and tensions between the Kremlin and Russia's rich oligarchs increase, the country may even face the humiliation of a downgrade.

Edward Parker, the chief Russia analyst at Fitch, says: "If the conflicts escalate and the risks materialise then we would need to reflect that in the rating." Helena Hessel, the director of Standard and Poor's sovereign rating group, says: "There are two main constrains that keep Russia at below investment grade: the political environment and the structure of the economy. Yukos is an illustration [of the political] point."

The arrest of Mr Khodorkovsky spooked many investors inside and outside Russia. But far from trying to dampen down the concerns Mr Putin's government has fanned the flames.

On Thursday, Russian prosecutors froze 44 per cent of the shares in Yukos. The company denounced it as illegal and said that the shares didn't even belong to Mr Khodorkovsky. "This development casts serious doubts about the prosecutors' respect of property rights," says J J Traynor, an oil analyst at Deutsche Bank. "Following the seizure of the stake, we think risk of this Yukos-versus-authorities conflict expanding to other companies has increased."

The Yukos affair has fractured Mr Putin's government into three camps: the liberals, the pro-oligarchs and those who want to see Russia's rich tycoons locked up.

In a warning to Mr Putin, Arkady Dvorkovich, the deputy-trade minister and a member of the liberal camp, said on Thursday that there was a danger the Yukos investigation could spread to other companies. "The risk that past sins will be re-examined exists," he said.

Investors were further unnerved by the resignation of the Kremlin chief of staff, Alexander Voloshin, who was widely seen as pro-oligarch. This means that the balance of power has shifted to the siloviki, the secretive former KGB clan, which is said to be fuelling the campaign against the oligarchs.

Perversely, the Yukos affair has helped to unite Russia's oligarchs, who have always been suspicious of each other. Together, they are attempting to highlight the dangers of any escalation in the probe.

The arrest of Mr Khodorkovsky is viewed as politically motivated since he has hinted of ambitions to run for president in 2008. Analysts believe that the investigation is a warning shot to other oligarchs to back off. But it appears to be having the opposite effect.

Alexei Mordashov, the chairman of Russian steel giant Severstal and one of Russia's prominent oligarchs with his campaign for Russia to join the World Trade Organisation, says: "Business is part of society and should be involved in all of society's activities, including politics."

However, hawkish Pentagon advisor Richard Pearle called on Friday for Russia to be kicked out of the G8, the club of the world's eight richest nations. If the Yukos saga drags on then Russia dalliance with world-wide respectability could be short-lived.