May 5 (Bloomberg) -- When Vladimir Putin hands Dmitry Medvedev the keys to the Kremlin on May 7, he may be locking his presidential successor into an economic box.

Russia is riding so high on rising oil and gas prices that it has little incentive to diversify beyond commodities. The energy industry produced more than two-thirds of the nation's export earnings and more than a third of the state's 2007 revenues, which totaled $315 billion.

The government has ignored advice from the World Bank and other organizations to invest in other industries, start-up companies and infrastructure. Instead, the central bank has amassed $530 billion in gold and foreign-currency reserves; Putin has put $130 billion of that in a sovereign-wealth fund that would provide no more than a two-year cushion if energy prices fall.

``This route may lead to a dead end,'' Economy Minister Elvira Nabiullina said at a Finance Ministry meeting last month. ``We no longer have the advantages of a cheap ruble, cheap labor'' after a decade of average annual economic growth of 7 percent that pushed up wages and the currency, making Russia less competitive.

At the same time, the political system Putin, 55, created discourages changing course. Russia is, in effect, a one-party state, with Medvedev handpicked by Putin to become president, while Putin installed himself at the head of the United Russia party and has laid plans to become prime minister. Regional governors, once elected, now are Kremlin appointees, most of them United Russia members.

Easy Victories

With a heavy boost from the state-controlled media, United Russia won December's parliamentary election with 64 percent of the vote; Medvedev, 42, won 70 percent in the March presidential vote.

``There's no prospect of dislodging the current political system because there are no democratic mechanisms in Russia,'' says Stanislav Belkovsky, a former Kremlin adviser who heads the Institute of National Strategy in Moscow. ``A change of regime can only come about if it collapses from within.''

There's little chance of that, because the party, with 2 million members, is dominated by elites who control much of the country's wealth and have a stake in the status quo. Russia's top 100 billionaires -- including eight United Russia members in the parliament -- have $522 billion in combined assets, Forbes magazine says. They benefit from a business system beset by bribery and largely directed by government officials.

Outside Investment

``Russia needs to start tackling areas such as corruption, reducing the role of the state and improving the rule of law,'' says Chris Weafer, chief strategist at UralSib Financial Corp. in Moscow. Otherwise ``they're not going to get the level of investment they need'' from outside Russia.

At the moment, there's little reason to tackle such issues, and won't be as long as the commodities boom rolls on. Crude-oil prices, at $116.32 on May 2, have more than quadrupled since Putin came to power in 2000, driving a 70 percent increase in Russia's gross domestic product.

The state's share of Russia's oil production has risen to 44 percent, from 6 percent in 2000, after it took over most of OAO Yukos Oil Co. and OAO Sibneft, Weafer says. The gas industry is almost entirely in the hands of state-run OAO Gazprom, the world's largest producer.

Gold and Currency

Russia's gold and foreign-currency reserves, up more than 40-fold from $12.3 billion in 1998, would allow it ``to carry on with everything as is if there's a soft drop'' in energy prices for ``a year or two,'' says James Beadle, manager of about $200 million in bonds and stocks at Pilgrim Asset Management in Moscow.

A sharper or more sustained fall in energy prices might be another matter. The World Bank and the Organization for Economic Cooperation and Development have urged Russia for years to reduce its reliance on oil and other commodities with volatile prices.

Economic ``growth remains highly dependent on the prices of oil and gas,'' a 2002 World Bank report said. The Paris-based OECD warned in 2004 of ``distorted development associated with over-reliance on the natural resources sector.''

``If we are talking about creating an innovative economy, we shouldn't be building our long-term strategy on oil and gas,'' says Vladimir Golovnev, a United Russia member and deputy head of parliament's economic policy committee.

A Top Priority

Before being replaced by Nabiullina as economy minister in September, German Gref said building up infrastructure to boost non-commodities industries and start-up businesses was a top priority.

So far, though, government officials have yet to do much more than talk about such problems. ``We are looking at a period of years when oil dependency will remain very high,'' Weafer says. ``To start real growth in other areas, Russia will have to spend a lot of money on building up infrastructure'' that has been neglected for years.

The state did move last year to begin using some of the money Putin squirreled away, increasing spending by 40 percent and creating a state nanotechnology company and a development bank to channel funds to other industries.

A state-run seed-capital firm, OAO Russian Venture Company, was set up in August 2006 with 5 billion rubles ($211 million). The cabinet this year plans to outline a program to become a global high-technology leader by 2020.

``We need to create good conditions for small- and medium- size businesses,'' says Golovnev. ``Business is the foundation of any economy. It's the goose which lays the golden egg, but to lay golden eggs it must grow up from a chick.''

Extorting Bribes

Small and mid-size companies account for 15 percent of Russia's GDP, compared with at least 40 percent in western Europe, says Golovnev, himself an entrepreneur who employs 12,000 people at a work-clothing manufacturer he and three friends started in 1992. Golovnev, 38, says corrupt officials extorting bribes prevent the success of other entrepreneurs.

Yury Neshitov, 60, a hydro-construction engineer who studied at the St. Petersburg State Polytechnic Institute, says he has been unable to generate interest for his apartment- ventilation system in Russia and began seeking European investors.

``The top-down efforts to stimulate venture-capital financing in Russia have been inefficient,'' Neshitov says. ``Bureaucratic control has meant kickbacks and lack of transparency.''

Berlin-based anti-graft watchdog Transparency International last year said that businesspeople and analysts perceive Russia as being among the most corrupt countries of 180 it studied, with a ranking of 143. Deputy Prosecutor-General Alexander Buksman estimated in November 2006 that corrupt Russian officials take about $240 billion in bribes a year.

Under Putin, the country has suffered from ``colossal corruption, with no parallel in Russian history,'' former Deputy Energy Minister Vladimir Milov and former Deputy Prime Minister Boris Nemtsov said in a February report.

Medvedev has pledged to combat corruption, which he says pervades the government on ``an enormous scale.''

To contact the reporters on this story: Henry Meyer in Moscow at Hmeyer4@bloomberg.net Sebastian Alison in Moscow at Salison1@bloomberg.net.

Last Updated: May 4, 2008 16:22 EDT