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Ukraine

The Bad Economics Of Crimean Independence

Whatever political and ethnic forces are at play, all sides must remember that Crimea's finances and infrastructure are Ukrainian to the core.

The port of Sevastopol is the hub of the Crimean economy
The port of Sevastopol is the hub of the Crimean economy
Dmitri Butrin, Aleksei Shapovalov, Anna Colodovnikova and Anastasia Fomicheva

MOSCOW – The new regional government of Crimea would in theory be in a unique position to double-dip on aid from both Kiev and Moscow. It is just one twist in the crucial economic question that must be considered in any discussion of Crimean independence from Ukraine.

After a recent meeting in Moscow between Russian Prime Minister Dmitry Medvedev and senior finance officials of the new Crimea regional government, the Kremlin says it is preparing a financial aid package for Crimea. The Vice Premier of the new Crimean government said that the region would need around $1 billion in aid and $5 billion in “investment.” Considering the population of Crimea is around 2 million, that is less per capita than the aid that Russia gave to South Ossetia after hostilities broke out there with Georgia in 2008.

The Russian Finance Ministry hasn’t revealed the exact contents of its offer, but it seems to be considering some combinations of loans and pure aid.

The region of Crimea is entirely integrated into Ukraine. In spite of the fact that all of Crimea’s tax revenue stays in the region (other regions in Ukraine contribute 50 percent of tax revenue to the federal budget), around 70 percent of Crimea’s monthly government expenditures are funded by transfers from Kiev.

It received around $350 million from Kiev in 2013 and, excluding customs taxes, collected around $200 million locally. It appears quite clear that when the leaders of Crimea were discussing finances with Moscow, they were trying to see if Russia could replace that money.

Still, even in the face of such negotiations, it is politically difficult for Kiev to refuse to send Crimea its usual cash transfer, because that money helps legitimize Kiev's assertion that Crimea is part of Ukraine.

“We are fulfilling all of our financial obligations to Crimea, and time will tell what the future holds,” a Ukrainian finance ministry official declared this week.

The Ukrainian government also is expected to pays retirement benefits to residents of Crimea. Ukraine's Social and Political Ministry reported that pensions in Crimea were fully paid in February, even though Kiev only received 24% of the region’s contributions to the state pension fund in February. Further complicating matters, Russia could refuse to pay the current government in Kiev, which it considers illegitimate, the yearly rent of $97 million for its naval base in Sevastopol (of which $6 million is ultimately sent back to the city of Sevastopol). It could make those payments directly to Crimea's pro-Russian regional Prime Minister Sergei Aksenov.

It is fully possible that the autonomous government in Crimea could accept financial transfers from both Russia and Ukraine – both sides are prepared to pay, especially because there is already a precedent and infrastructure set up for accepting “investment” from Russia through special funds. But it’s unlikely that Russia will agree to spending $5 billion on investment in Crimea. Any money meant to “unify” Crimea with Russia will not materialize for at least three or four years.

The energy conundrum

Further complicating matters is energy policy. Separating Crimea from the rest of Ukraine in terms of energy production would be a long-term infrastructure and financial project. Although Ukraine depends on Russia for much of its energy, the energy in Crimea is mostly produced at power plants located elsewhere in Ukraine. Crimea only produces about one-tenth of the energy it consumes, with the rest sent in from other parts of Ukraine. Russia and Crimea are separated by the Strait of Kerch at the entrance of the Black Sea, and there are no underwater cables through the Strait.

[rebelmouse-image 27087854 alt="""" original_size="573x600" expand=1]A 2009 map of existing and proposed Russian natural gas pipelines to Europe. (Samuel Bailey via Wikipedia)

Southern Russia has the energy capacity to supply power to Crimea, says Vladimir Sklyar, an energy analyst. But he thinks that Crimea would need to have gas-based power plants, which would cost around $1.8 billion to build and could take up to 3 years to open.

It wouldn’t be too difficult for Crimea, which also lacks an oil refinery, to get oil through its ports, experts say. It’s worth noting that cargo trains have continued to run to Crimea from the rest of Ukraine even during the crisis. There is a clear understanding that unless Crimea’s sea ports could be blocked, there is little sense in trying to put the region under siege. But if the question of electricity – which Crimea depends on for its supply of fresh water – isn’t solved, no other investments from Russia really make sense except short-term investments to ensure the region’s independence and possibly off-shore gas exploration.

Crimea’s dependance on Russian aid would inevitably increase. Spa tourism plays a big part in the Crimean economy, and the 2014 season already seems to be a bust because of the conflict, leaving all those who depend on tourism without an income. If you consider that, financing Crimea could easily cost Russia $100 million per month.

And that would come in the form of grants, not loans. Because no one would ever count on Crimea, no matter what flag it flies, being able to service debt and have a budget surplus in the future.

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