UPDATE 1-N. Caucasus strife is Russia's top problem-Kremlin

By Guy Faulconbridge and Denis Dyomkin

MOSCOW, Nov 12 (Reuters) - Russian President Dmitry Medvedev on Thursday warned the Russian elite that an upsurge of violence in the Muslim-dominated North Caucasus had become Russia's single biggest domestic problem.

The patchwork of republics along Russia's southern flank have seen a wave of attacks in recent months, which local leaders say are fuelled by a potent mixture of clan feuds, poverty, Islamism and heavy-handed tactics by law enforcement agencies.

Medvedev, in his state of the nation speech to lawmakers, officials and religious leaders, said Russia would continue to fight international terrorists and 'bandits' in the region.

His comments were the starkest yet by any senior official about the fast-deteriorating situation in the southern republics. Security experts say a wave of suicide bombings there could spread to Moscow if not checked.

The Kremlin chief also issued a public rebuke to local officials, who he said were stealing some of the billions of dollars of budget money sent by Moscow to the North Caucasus.

'Now on what in my view is the most serious domestic political problem for our country -- the situation in the North Caucasus,' Medvedev said.

'I will speak openly -- the level of corruption, violence, and clan dominance in North Caucasus republics is simply unprecedented,' the president said.

Kremlin officials say privately that the North Caucasus is a cross that Russia's elite has to bear, though they admit endemic corruption among officials has bred poverty and driven youths into the hands of Islamist rebels.

Opponents of Medvedev and his mentor, Prime Minister Vladimir Putin, warn that Moscow's policy of throwing oil money at the North Caucasus while using the army and police to crack down hard on militants has failed.

'The volumes of state financing for the North Caucasus are significant but the effectiveness of the spending of that money leaves a lot to be desired - part of the funds are almost openly being stolen by officials while unemployment and, as a result mass poverty, have reached emergency levels,' Medvedev said.

Unemployment in the republic of Ingushetia was running at over half of the economically active population and the figure in neighbouring Chechnya was about 40 percent.

Locals say violence is spiralling out of control in the mainly Muslim region of Ingushetia, where leader Yanus-Bek Yevkurov was wounded in an assassination attempt on June 22.

'We will continue the fight against international terrorism without compromise (and) destroy the bandits,' Medvedev said, adding that economic backwardness was helping to radicalise the young in some of the republics.

'We will do everything to make sure the lives of people in the North Caucaus become prosperous, and we shall deal with those who who hinder us.'

(Editing by Angus MacSwan) Keywords: RUSSIA MEDVEDEV/NORTHCAUCASUS

(guy.faulconbridge@reuters.com, +7 495 775 12 42)

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