Crimea’s Not So Bright Future

03.30.15
RIA Novosti
World News /30 Mar 2015
03.30.15

Crimea’s Not So Bright Future

By Alina Yablokova for Global Risk Insights

Last week, Russia celebrated the first anniversary of Crimea’s “integration” into the country. A year ago, in a disputed referendum, Crimea had voted to join Russia after two decades of being part of independent Ukraine. The scale of last week’s celebrations that swept across Russian regions and the Black sea peninsula shows that the euphoria that had sparked back in spring 2014 is still not over.

An opinion poll conducted by the Ukrainian branch of GfK, a market research organisation, demonstrates that 93% of the people living in the peninsula are happy with the Crimea’s inclusion in Russia. Yet, despite the hype and strong patriotic sentiments, this year has been a tough challenge for peninsula inhabitants.

Since the takeover, Crimea has been adapting to Russia’s economic system. To smooth the transition, the Russian government poured enormous amounts of money in subsidies into the region. Last year 125 bn Russian rubles ($2 bn) were spent and a minimum of 100 bn rubles ($1.7 bn) is expected to be allocated to Crimea’s development this year.

Additionally, the local government has been allowed to retain its VAT profits that, according to the Russian legislation, are normally what feeds the federal budget. Therefore, Crimea has become a leading ‘recipient’ region of Russia, with 85% subsidisation level, and a burden for the battered Russian economy.

However, there is yet little visible result of these capital injections and most of the socioeconomic improvements are still only on paper.

Crimeans feel the spiraling cost of food and services acutely. A drop in the flow of goods into the peninsula is generally responsible for this price hike. Indeed, total imports declined by 86% and exports by 80% just between January and October 2014.

Firstly, Ukraine, the main source of provision for the peninsula, imposed a blockade on Crimea after the takeover and, today, Kiev supplies only small amounts of fresh fruits and vegetables. Secondly, even before the United States and the European Union imposed an embargo on Crimea by barring their businesses from trading with and investing in the republic, a compelling number of Western businesses significantly reduced or discontinued trading with the peninsula to avoid penalties elsewhere.

Crimea has rapidly lost its traditional suppliers of raw materials and existing market for its goods, and was unable to replace them effectively. Therefore, though the Black Sea peninsula has never been a prosperous region, it has recently experienced a particularly deep and sudden economic recession.

Infrastructure problems prevent basic supplies

Because of the operational uncertainty that emerged after Russia seized control over Crimea, most of the foreign businesses pulled out. For instance, McDonald’s restaurants, Apple stores and UniCredit SpA bank were all forced to close down. At a later stage, Crimea’s “divorce” with Ukraine also brought about the transportation isolation as well as water and electricity supply insecurity from Kiev.

Indeed, Ukraine suspended all railway and land connections to Crimea. This does not only restrict the movement and economic activity of Crimeans, but also means that Russian products can only reach the peninsula by sea, as all land routes go through Ukraine.

Crimea has never been a major trading hub and its ports are predominantly touristic or military, and consequently small. Therefore, deliveries of Russian products by ferry from Krasnodar region to the peninsula are restricted and expensive, contributing to the scarcity and the high price of products in Crimea.

The Russian government has launched the construction of a multibillion-dollar bridge to connect mainland Russia to the newly integrated republic. Nevertheless, it will not be completed sooner than 2018.

Experts believe that the bridge is essential for Crimea’s development within Russia and its self-sufficiency. However, Russia’s current budgetary deficiency could suggest that the project’s completion might be delayed.

Additionally, Crimea is reliant on Ukraine for 85% of its water supply and for 83% of its electricity demand. The peninsula has been experiencing recurrent supply shortages and cuts.

The standoff between Ukraine and Russia on the crisis in Donbas only deteriorates the situation in the Black Sea peninsula. This situation is largely responsible for the agricultural and industrial shortfalls experienced during the past year.

Investment environment supported by weak Russian lifelines

The current malfunctioning of Crimea’s financial markets imposes additional obstacles to the flow of investment into the republic, even from Russia. Both MasterCard and Visa suspended their services in the peninsula, making cash the only means of monetary transactions in Crimea.

However, from April onwards, the service will be available again after transactions will officially come under the control of a Russian processing centre on an agreement with the mentioned companies.

Additionally, Russia has undertaken a number of initiatives to bring investments into Crimea. For instance, since January 2015, a free economic zone with tax preferences and other advantages was established in the republic and will be in place for the next 25 years.

Although such measures could attract investors, today’s overall economic climate is likely to render them only marginally important. To boost business in Crimea, Russian lawmakers have to formulate special legislative clauses and provide additional subsidies to the republic.

However, due to the Western economic sanctions and low oil prices, Russia’s budget has significantly contracted. Thus, the economic situation in Crimea and its investment climate will depend directly on Russia’s capacity to restore its battered economy.

Crimea is going through a painful transition to integrate into Russia’s economic space. Indeed, it will take time for the peninsula to replace its lost suppliers and markets. The republic is still highly dependent on Ukraine, and thus extremely vulnerable from an infrastructural perspective. Additionally, Crimea is experiencing the effects of sanctions that harmed the operational environment in the region.

The overall investment climate in the Black Sea peninsula is thus highly unfavourable. Yet, it is reasonable to believe that if Russia successfully fixed its infrastructure, restored its financial markets, and supported investors with subsidies, Crimea could become an attractive economic zone in a five-to-ten year span.

The future of the peninsula largely depends on Russia’s own economic prospects.

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