MOSCOWMOSCOW (Reuters) - Russian President Dmitry Medvedev expressed frustration on Thursday over his government's inability to break the vicious circle of red tape and corruption which he said was hampering small businesses.

Medvedev, who took office in May, has promised to ensure the "rule of law" and make the economy more stable and life easier for small and medium-size businesses, which he wants to become major drivers of economic growth.

"One of the first decrees I signed after taking office was a decree scrapping administrative limitations on business activities," Medvedev told an ad-hoc meeting of government and local officials in the central Russian town of Gagarin.

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"We made the first step and that's it. Nothing else," the 42-year-old former lawyer, known for his gentle manners, added barely hiding his anger.

Medvedev's predecessor, Vladimir Putin, presided over the longest Russian economic boom in a generation, driven by high prices for oil and gas, Russia's biggest exports.

But Putin also presided over an expansion of the Kremlin's involvement in the economy and studies show red tape and corruption spread during his eight-year presidency.

Nearly 27,000 graft-related crimes were registered in the first half of 2008, a 10 percent rise from the same period last year, according to official figures. Experts say the figure represents just a tiny part of the real volume of such crimes.

"We need to create a favorable investment climate in this country," Medvedev told the televised meeting.

A dispute over the future of Russian oil venture TNK-BP and probes of major coal firms such as Mechel, Evraz and Rapadskaya have raised fund managers' concerns about Russia's investment climate.

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Medvedev, who did not mention these problems, stressed that small businesses needed special protection.

"If you want, small businesses are the means of reviving our country," he said. "Even if we involve 40 or 50 percent of people in business, we would see a totally different country."

"STOP TERRORISING BUSINESS"

Small businesses now account for less than one tenth of Russia's gross domestic product. The $1.3 trillion economy is driven by the sale of oil, gas and natural resources and a consumer boom.

Medvedev said officials were using discretional checks to extort bribes from businessmen and he criticized routine red tape which many owners say costs them a large chunk of profits.

"Our law-enforcement bodies should stop terrorizing business," Medvedev said.

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He said another problem was that companies sometimes sought to bypass the law, thus encouraging corruption in officialdom.

"As a result we see a vicious circle," he said. "On the one hand (officials) use every opportunity to extort money from business. On the other hand, businesses provoke corruption with their actions," Medvedev said.

Simplifying rules for running small businesses is the key to success, Medvedev said: "In the ideal world, small businesses should have few reasons to turn to courts or lawyers."

Medvedev said earlier on Thursday he signed a comprehensive plan to fight corruption, which will soon be put to action.

"In this country they give special meaning to (Kremlin) signals," he told officials. "You can consider I gave you such a signal."

(Editing by Mary Gabriel)