Former England manager Capello has favoured players based in the Russian league since taking over from Dick Advocaat last year, meaning the likes of Arshavin and Reading striker Pavel Pogrebnyak have been shunted into exile.
But O'Neill, who is preparing his side for tomorrow's Windsor Park meeting with the Group F leaders, has given Capello his full backing.
He believes the Italian has put together a side with more heart than the one that shone briefly at Euro 2012 before fading badly.
And O'Neill agrees with Capello that Arshavin does not fit that mould.
"I think the biggest difference is that Capello's Russia work harder than Advocaat's Russia," said O'Neill.
"I saw them in the Euros under a different manager and the players who have come in since then give Russia a higher work ethic than they have when Arshavin plays.
"Arshavin was arguably one of the players of the tournament back in Euro 2008. There's no doubting his quality, but he's in a difficult position in his career at the minute and the national team is probably stronger without him."
Indeed, O'Neill believes that in future the number of Russian exports to foreign leagues may dry up completely.
"If you believe the salaries people talk about in Russia you see why the top players would stay there," he said.
"The Russian players typically seem to enjoy being based in Russia. The whole squad is home-based at the moment and I think their players haven't done as well outside of Russia.
"Look at the likes of Kerzhakov, in Spain, (Roman) Pavlyuchenko, Arshavin, even (Yuri) Zhirkov at Chelsea.
"They were never really established as players at those clubs but they are exceptional players.
"The make-up of the squad is not a surprise to me, that it is 100 per cent home-based."
Tomorrow's match is O'Neill's ninth in charge of the national side and the elephant in the room remains his lack of a victory since taking over from Nigel Worthington.
Nevertheless, there have been encouraging signs, such as the valiant 1-1 draw against Cristiano Ronaldo's Portugal and O'Neill's continued attempts to bring through a new generation.
Although his contract only runs until the end of the current campaign, it is a project he is eager to see through.
"The job for me was always until the end of this campaign but I have enjoyed the challenge," he said.
"If the association felt they wanted me to continue to the Euros I would do that, simple as that.
"It takes you six months to learn the nature of the job and what's expected.
"The relationship with myself and the players is strong and can only continue to develop. Certainly, I would welcome that opportunity.
"Equally, if the association felt they wanted to go in a different direction then I would accept that and be grateful for the opportunity I've been given."
While most fans probably accept a return to tournament football for the first time since 1986 is going to be a huge ask for any manager, O'Neill has no problem with aiming high.
"I've been in the job a year and we've only had 22 days to work with the players, so that's a challenge," he said.
"You have to mould a team. We'll always be a team that is more than the sum of its parts. In the period of time we have had with the players that's what we have tried to work on.
"I believe this is a group of players who can win games at international level, be competitive and, given time, can get the opportunity to get close to qualification for a major tournament."
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