Final essay for ‘Warsaw Summer School: Order, Border and Disorder’ Economic Consequences of the Annexation of Crimea Professor: Dr Kerry Longhurst Written by: Vladyslav Pererva, 6083 1  Introduction In the end of November 2013 the second revolution in Ukraine began, “The Revolution of Dignity” as it is called by Ukrainians. The Revolution started as a protest against the decision of the president Victor Yanukovich to fail the signing of the Association Agreement with the European Union. This association meant changing of a direction in the international politics of Ukraine from Russia (which was ‘traditional’ priority) to Europe. Most Ukrainians wanted this agreement to be signed. First people protested, but Yanukovich made another fateful decision to use physical force against peaceful (at that moment) activists. But no one expected thousands people to rise next day. In few days millions revolted all over the Ukraine. Almost three months there were riots in the streets of Kyiv, the capital of Ukraine, as in many regional centers. Finally, Yanukovich escaped to Rostov, Russian Federation. Protestors hoped that the Revolution defeated this old system, but for new, young and weak Ukraine this was only a beginning. Just in few weeks after that new threat came. Unknown and undefined ‘green men’ appeared in Crimea. Russia began a military intervention in the Autonomous Republic of Crimea and the city of Sevastopol, administrative divisions of Ukraine, and during that time local pro-Russian authorities (that were not recognized by the government of Ukraine) declared Crimea's independence and held a disputed referendum on the March, 16th. According to this referendum, 97% of Crimean residents voted to join Russia. Two days after Vladimir Putin, the president of Russian Federation, announced the annexation of Crimea. This case shocked the whole civilized world and the annexation was recognized only by some states-allies of Russia. And, as always in such situations, it led to certain consequences. 2  Main body Background Crimea, which still has an ethnic Russian majority, has been a semiautonomous region within Ukraine. It has had its own Parliament, but the Ukrainian government had veto power over its actions. From 1783, Crimea was a part of the Russian Empire, incorporated into it as Taurida Oblast. In 1796, Crimea was merged into Novorossiysk Governorate, and in 1802, it was again separated from it into Taurida Governorate. A series of short-lived governments were established during first stages of the Russian Civil War, but they were followed by White Russian and, finally, Soviet (Crimean ASSR) incorporations of Crimea into their own states. After World War II and the deportation of the Crimean Tatars, the Crimean ASSR was stripped of its autonomy in 1946 and was downgraded to the status of an oblast. In 1954, the Crimean Oblast was transferred from the Russian SFSR to the Ukrainian SSR by decree of the Presidium of the Supreme Soviet of the Soviet Union. However, it was unclear whether the transfer affected the peninsula's largest city of Sevastopol, which enjoyed a special status in the postwar Soviet Union, and in 1993, the Supreme Soviet of Russia claimed Sevastopol was part of Russia, resulting in a territorial dispute with Ukraine. Current situation As a result Russian government took these territories ‘back’. Vladimir Putin used a situation when Ukraine was weak and unstable. At that moment provisional government was in power. It was just a beginning of transformation of the whole system and economy was exhausted. Army was almost completely ruined by Yanukovich’s regime. It was just a ‘piece of cake’ for huge powerful state like Russia. But still Putin faced a couple of problems directly connected to the annexation of Crimea. Economic consequences For Russia Moscow has pledged to spend billions of dollars on everything from higher pensions to a bridge linking the region to Russia, with almost $7 billion (4 billion pounds) earmarked this year alone. It isn't all expenses. Russia also stands to save billions of dollars on rent it paid for the Sevastopol naval base of the Black Sea Fleet, and has acquired valuable property and natural resources in Crimea. But Ukraine is also counting the costs, and has vowed to hit Russia with lawsuits running into hundreds of billions of dollars. Russia has formally denounced the 2010 3 Kharkiv Agreements under which Russia provided a $100 discount per thousand cubic metres for Ukraine's imports of Russian gas as rent for the Sevastopol naval base, home of Russia's Black Sea Fleet. The deal, which extended the base lease until 2042, cost Russia's budget around $4 billion a year, or around $40 billion over the period covered by the gas contract expiring in 2019. Russia says it is owed $11 billion already paid to Ukraine for the years 2010-13, when the discount was applied in advance for extending the lease on the base beyond 2017. Ukraine’s authorities say they regard the agreement as still valid and have vowed to take Russia to court for violating it. They have also threatened legal action against Russia's gas exporter Gazprom to lower gas prices, a step used successfully by other countries. Reducing the price to the average for European customers would in effect negate the benefit to Russia from annulling the gas- for-base agreement, as Ukraine pays around $100 more than the average following the end of its discount. Another issue is Ukrainian military equipment in Crimea. Ukraine's Defence Ministry has estimated its value at 18 billion hryvnias ($1.7 billion). Russia has said it will return the equipment of military units that remained loyal to Kiev. However, Russia says most Ukrainian military units in Crimea defected to Russia and it is not yet clear how much equipment it will return. At the same time Ukraine says it is preparing a case against Russia in the international maritime tribunal over its ships in Crimea. Even before the promised increases in public sector pay and pensions, Crimea's budget received subsidies from the central government, which were projected at 3 billion hryvnias ($260 million) in 2014. Russia's Finance Ministry values the subsidy at 55 billion roubles ($1.5 billion) this year, including the initial costs of raising pay and pensions. Russia has made various promises about building new infrastructure to bolster its links with Crimea and reduce the region's dependence on Ukraine. As Russia's transport minister has said, a proposed road and railway bridge linking Crimea to Russia could cost at least 100 billion roubles ($2.8 billion). Three new power stations would cost up to 100 billion roubles, Russia's energy minister has told. Depending on the route and capacity, a new gas pipeline to Crimea could cost between $200 million and $1 billion. Russia has also promised to spend generously on upgrading public infrastructure in Crimea such as schools, hospitals, roads, airports, the water supply system and a new university. It has pledged to support agriculture, including 80-100 combine harvesters for immediate dispatch. Russia's finance minister has said Russia is preparing to spend up to 243 billion roubles ($6.8 billion) to support Crimea in 2014, including both recurring expenditure on higher pensions and wages, and one-off infrastructure spending. 4  Huge amounts of money are promised to be invested in Crimean infrastructure. Is Russian economy strong enough? We can analyze this. For example, Russian Government decided to save on Yakutsk region to invest money in Crimea. Previous Russian Ministry refused to build a new bridge over the river Lena, and now offers to reduce the expenses for the highway M-56 “Lena” from Yakutsk to Transsib. At first it was planned to use 115 billion roubles for 1200 km of the road in 6 years. Now Ministry of Finance will reduce this amount for 44 billion that will be sent to Crimea and Sevastopol as part of the development program for the region. The incorporation of Crimea into the Russian economy will be a further significant drag on growth, analysts say. Before the annexation, Russia's budget was slightly in deficit, according to Finance Minister Anton Siluanov. Already, 74 of Russia's now 85 regions take more from the federal budget than they contribute, and Crimea is expected to join the ranks of the most heavily subsidized. It should be mentioned that about 560,000 of the region's 2 million people are pensioners, many of them military veterans with enhanced benefits. In addition, there are roughly 200,000 state-sector employees in the region, meaning that over 40 percent of the peninsula's population is directly dependent on budget spending. "Overall the present state of Crimea, by our analysis, makes it about an average subsidized Russian region -- it is about at the same level as, say, the North Caucasus, Tuva, or Buryatia," says Karen Vartapetov, an analyst at the Moscow office of the Standard & Poor's rating agency. "That is, by its average income, pensions, and per capita GDP, it roughly corresponds to those regions." Vartapetov says the "minimal estimate" of the direct budget subsidies for the Black Sea peninsula, even without the tax breaks and special subsidies that have been discussed in recent weeks, would be about $1.1 billion annually. He adds, however, that the resources in Russia's Reserve Fund and National Welfare Fund are sufficient to meet this burden. But using these resources to subsidize Crimea could prompt difficult queries from other Russian regions. For Ukraine For the economy of Ukraine, that was already weak and broken, such situation is very dangerous. Yanukovich’s family stole huge amount of money. Officially this amount is equal to the whole budget of Ukraine. And annexation has its own consequences. The main direct economic consequence of the Crimea annexation is the loss of the Black Sea gas fields and a possible deterioration in the country’s energy sector. Resources in the northwestern part of the Black Sea shelf are estimated at 495.7 billion cubic meters of natural gas and 50.4 million tons of oil and condensate, in Kerch area - 321.2 billion cubic meters of gas and 126.8 5 million tons of oil and condensate, continental slope - 766.6 billion cubic meters of natural gas and 232 million tons of oil and condensate. The total gas potential of the Black Sea shelf is estimated at 2.3 billion tons of fuel. It is approximately 40% of total gas deposits in Ukraine. Though the industry requires large investments, the development of the Black Sea deposits was considered as an effective way to reduce dependence on gas supplies from Russia. The direct economic losses will arise from the nationalization of Ukrainian enterprises located in Crimea. "Chornomornaftogas", "Ukrtransgas", a series of powerful chemical industry enterprises, ports and more than 130 resorts can be nationalized. It is expected that the assets of "Chornomornaftogas" will be included into “Gazprom” and Russia will begin active development of oil and gas deposits of the Black Sea. For most private companies, nationalization is quite a remote risk. Ukrainian owners of the Crimean assets can face the problem of re-registration. After the annexation of Crimea all private property, including land, real estate, and companies must be re-registered in accordance with Russian legislation. The need for reissuing of shareholders' registers will result in a sharp increase of transaction costs for medium and large businesses. Loss of Crimean seaports can lead to short-term losses for their major customers – grain exporters. A transport blockade of the peninsula will lead to cargo traffic leaving from the Crimean ports to terminals in Mykolaiv, Kherson and Azov ports. Another problem is the possibility of blocking the Ukrainian ships passing through the Kerch Strait. A ban to cross the Kerch Strait will negatively influence export of agricultural and metal products. Having occupied the territory of Crimea, Russian troops seized Ukrainian military facilities. As a result, Ukraine has lost its military bases, equipment, ammunition, and fleet. The Ministry of Defense estimates losses at UAH 18 billion. The Crimean crisis has also caused indirect economic losses. In 2013 Russia was the largest trading partner of Ukraine with 24% of exports. The most important exporting industries to Russia are engineering, metallurgy, chemical industry and agriculture. Under such circumstances, the following question becomes urgent – can Russia refuse to use Ukrainian products? A significant part of Ukrainian exports to Russia is bought by state-owned companies. It is possible that Russians will not wait till creation of their own facilities, as their decisions are based more on political expediency than economic one. Cancellation of contracts will have a negative impact on the Russian economy, but this effect will be lesser than the impact on the economy of Ukraine. Mostly, Ukraine buys energy from Russia. In 2013, the share of this component in the structure of commodity imports was 62.2%. Although, in comparison with the 6 previous year, the volume decreased by almost 20% - to USD 14.5 billion. In addition, engineering, metallurgy and chemistry products form a significant share of imports from Russia. In 2013, Ukraine imported nuclear reactors, boilers, machinery worth USD 1.24 billion (94.7% comparing to 2012), ferrous metals – USD 0.81 billion (73.6%), electrical machinery – USD 0.79 billion (73.6%). Ukraine's dependence on Russian gas supplies is painful, and the increase in gas prices will have a negative influence on branches using gas as a raw material. Raising prices is just a matter of time. So called Kharkiv gas discount in the amount of USD 100 per 1000 cubic meters of gas was tied to the rent of the military base in Sevastopol. Though Ukraine does not recognize annexation of Crimea, Russia will not only cancel the discount, but also raise the gas price. Despite the obvious disadvantages, the expected sharp increase in gas prices has some positive effects. It will lead to reduction of energy dependence on Russia, the long-awaited implementation of energy saving technologies and the fulfillment of international financial donors’ requirements. Further deterioration of Ukraine’s investment attractiveness is an obvious reaction of foreign and domestic investors in view of the confrontation with the aggressor and the possibility of further occupation by Russia. It can negatively affect the pace of economic growth. For Crimea The major problems are linked to the separation of Crimea’s budget from Ukraine and of the Crimean financial system from that of Ukraine. In 2013, two-thirds of the Crimean budget was based on transfers from the central budget (80% in the case of Sevastopol). These disturbances have affected the banking sector in Crimea, where local branches of banks operate whose head offices are in Kyiv. The Crimean authorities are putting the Russian rouble into circulation, which will force banks to adapt to a new situation (the transitional period is to last until 2016). However, even before the referendum, the Crimean authorities had introduced severe limits on withdrawals from savings accounts denominated in Ukrainian hryvnia. Another particularly important issue for the residents of the peninsula is the uncertain income from tourism. Russia’s militarization of the peninsula could, especially in the short term, result in the collapse of proceeds from tourism, and strike especially hard at the small and medium businesses on Crimea’s southern coast. Approximately 70% of tourists coming to Crimea were from Ukraine, who in the current environment will probably not come any more. 7  There will also be problems with issuing new ownership and property documents, as Ukraine has blocked access to the central registry for Crimean sites, and the Crimean autonomous government did not make its own records. We should also expect pressure to be put on the Crimean Tatars, primarily to force them voluntarily to leave the land they occupy. If this is not associated with the legalization of owning at least those properties on which residential buildings have already been established, the Crimean Tatar community’s opposition to the new government will be strengthen, accelerating their radicalization. Conclusion “For every action there is a reaction”. And whole world can easily see major consequences of illegal actions done by one single country. Definitely, our international system is based on cause- effect relations. And the system itself exists to prevent such conflicts as Crimea annexation. I suppose there is a sort of illusion all over the world that this conflict is local, between two countries. Maybe it looks like this. But if we take a look on consequences of this crisis (not only in terms of economy, but also political and social effect), we could easily see that it is a threat to the whole world. Most part of all those problems will fall on Russia and Ukraine as the ‘only’ sides of this conflict, but sooner or later the rest of the world will feel these consequences. But talking about states-participants of Crimean crisis, Russia seems to have bigger economic recession than Ukraine. As for me, it is caused by two main factors. First, Crimea was part of Ukraine for 60 years, and during this time all infrastructure was optimized for Ukrainian system and technology. And now all this should be reformatted for Russian system and Russian law. Second, Crimea was a nonprofit region. Crimean budget mostly consisted of money supplied by central government (nearly 80% of dotation). So there is no profit from peninsula and it needs huge investments. Even some Ukrainian experts have said that loosing Crimea will relieve central budget from plenty of socio-economic problems. Anyway, there are certain losses and benefits for both sides of a conflict, and we will see how it goes afterwards. 8 Reference list 1. Crimean Peninsula, Wikipedia (http://en.wikipedia.org/) 2. Ukraine cries 'robbery' as Russia annexes Crimea, by Matt Smith and Alla Eshchenko, CNN (http://www.cnn.com/) 3. Costs and benefits from Russia's annexation of Crimea, by Jason Bush, Reuters (http://uk.reuters.com/) 4. ‘Let the whole Russia wait’, by Rain TV (http://tvrain.ru/) 5. Crimea Annexation Threatens Already Weakened Russian Economy, by Sergei Seninski, Radio Free Europe / Radio Liberty (http://www.rferl.org/) 6. Crimea Annexation: Main Consequences for Ukraine, by Glavkom (http://glavcom.ua/) 7. Economic Consequences of Crimea Annexation, by International Center for Policy Studies (http://icps.com.ua/) 8. The Consequences of the Annexation of Crimea, by Tadeusz A. Olszański, Arkadiusz Sarna, Agata Wierzbowska-Miazga, The Centre for Eastern Studies (Ośrodek Studiów Wschodnich im. Marka Karpia) (http://www.osw.waw.pl/) 9. Crimea Annexation: Losses and Benefits for Ukraine, by “Ukrainian Pravda” (http://www.pravda.com.ua/) 9