Russia’s Plans for Crimea : the Economic Development

Part One:

Economic Development: First Steps, First Challenges

Russia’s annexation of Crimea on March 18, 2014 has raised issues related to the economic impact of such a move for Moscow. The takeover of the peninsula as well as Moscow’s involvement in the Ukrainian crisis have sparked economic sanctions from the Euro-Atlantic community. On the diplomatic stage, Western countries have sought to isolate Moscow and boosted their efforts to ease Kiev’s economic rapprochement with the EU. Beyond the political and diplomatic cost of the annexation for Moscow, the question is to what extent could Crimea be a burden for Russia’s economy? This first article tackles this issue by examining Russian plans to develop the peninsula. A second article will deal with plans to beef up Russia’s Black Sea Fleet and military assets in Crimea.

Economic Development of Crimea: How to Attract Investments?

Although the figures have fluctuated during the past months, it is now possible to draw a picture of Russia’s plans with regard to Crimea’s development. Plans to develop the economy of the peninsula involve mainly Russian government as well as private investors. The challenge nevertheless will be tough to meet: Crimea has benefited from very few money flows since the collapse of the Soviet Union. Russia was prevented from investing in the peninsula, and Kiev was reluctant to spend money for the Republic of Crimea, one of the most Russophile and Russian-speaking parts of then newly independent Ukraine.

Soon after the annexation, President Putin created the Ministry for the Development of Crimea and appointed Oleg Saveliev as the head of this new ministry. Concrete plans to develop the peninsula still remain vague, although some measures have already been outlined in a strategic document called ‘concept of development of Crimea until 2020’, released in early May. Moscow’s idea is twofold: attract investments, and develop and refresh Crimean infrastructures (ports, railways, airports, power plants and distribution network). By 2020, Moscow intends to spend up to 825 billion rubles (US $24,2 billion) to develop Crimea, including 695 billion rubles (US $20,4 billion) pumped directly from the Federal budget[1].

Tourism remains the most relevant way to attract money and to develop Crimea. Since the imperial era, the peninsula has been one of the favorite spots for the Russian elite, and during the Soviet period, Crimean resorts were very popular among middle and upper class Soviet citizens. Last June 17, Aeroflot’s low-cost subsidiary Dobrolyot launched two more regular flights from Russia to Simferopol, bringing daily services to the peninsula to 10 flights. With economy class seats available at 7 000 rubles (US $204) only if reserved about a month in advance, Dobrolyot’s objectives are to bring 200 000 passengers to Crimea in 2014. The combined total number of passengers flying from Russia to Crimea would be 650 000 to 700 000 for 2014, three times more than in 2013[2]. Due to the increase in the number of daily flights between Russia and Simferopol, Russia-Crimea airline traffic jumped to 60 flights per day in June 2014. Growing air traffic between Russian airports and Crimea will be further eased since the International Civil Aviation Office designated Russia as the main provider for air navigation services over the peninsula[3].

The Kremlin outlined an original way to attract tourists and develop Crimea’s economy. In an attempt to promote tourism and development, the Russian authorities have planned to invest US $1,5 billion to create a special gambling zone in the peninsula. Russia has tried to implement the American practice in opening gambling resorts in remote and isolated zones like in Las Vegas. Since July 2009, four Russian gambling zones (Krasnodar Territory, Kaliningrad Territory, Primorsky Territory and Altai Territory) have been established, and Crimea could become the fifth territory to open. However, Oleg Saveliev stated in May 2014 that the project to open a new gambling area in Crimea would be postponed to 2015 since Russian authorities had not been able to outline a comprehensive development plan[4]. Yet, in June, the Duma enacted a law supporting the opening of the Crimean gambling zone[5]. The first Crimean casino is slated to open in 2016, most probably somewhere in the southern part of the peninsula, and the launch of the gambling zone is likely to create around 10 000 jobs in Crimea[6].

Russian authorities have considered another possibility to ease money flows into Crimea: in March 2014, Prime Minister Dmitri Medvedev recommended granting peninsula the status of special economic zone to boost investments. According to a bill introduced before the Duma in late April 2014, anyone who invests a minimum of 150 million rubles in Crimea in three consecutive years will be exonerated of all taxes, excluding income taxes (10% average). Moreover, the rate for the income taxes for the residents of the peninsula has been set to 0%[7]. The Kremlin hopes to attract Russian offshore capital back to Crimea, including those which have flown to Cyprus and those which could be subject to Western economic sanctions[8].

Yet, the development of Crimea requires proper and attractive infrastructures to support and to boost economic expansion of the peninsula. This point remains the main challenge for the Kremlin and Russia’s economy.

The Urgent Need to Develop Transport and Energy Infrastructures

The question of the Crimean transport and energy infrastructures has quickly raised after March 18. Although airlines and ferries can connect the peninsula to Russia, there is nevertheless the need for direct communications between Crimea and mainland Russia. Since Crimea largely relies today on the Ukrainian side for its energy supplies, Moscow has also started to draw a plan for energy supplies.

Crimean railways urgently need to be refreshed and expanded. According to the Russian Minister for Economic Development, Alexei Ulyukaev, Russia may have to invest up to 100 billion rubles (US $3 billion) to develop transport infrastructures in Crimea[9]. However, the bill is likely to be much higher than this rough estimate. Indeed, only the cost of the construction of the bridge across the Kerch Strait has been assessed at 283 billion rubles to 349 billion ruble (US $8,2 to $10,1 billion), 70% of which will be paid by the Federal budget, and mostly pumped from the National Wealth Fund. The 4.5 kilometers automobile and rail bridge across the Kerch Strait should be built by 2018, and Russian authorities plan that its construction will take no longer than 3.5 years. Moscow has sought foreign investors to support the project, and so far China International Fund and China Railway Construction Corporation have already displayed a strong interest in the Kerch Bridge and are ready to partly fund the project, as are South Korean companies[10]. Russia has also drawn plans to beef up Crimea’s railways network, mainly the Kerch-Feodossia-Djhankoi line (207 kilometers), and to build a new line connecting Simferopol to Feodossia (nearly 120 kilometers)[11]. Once the Kerch Strait Bridge is built, the heart of Crimea will be directly connected to Russia’s Kuban, putting Simferopol, and Sevastopol (the Sevastopol-Simferopol line already exists), from a few hours from Novorossiysk.

The other issue is energy supplies to Crimea. Currently, the peninsula produces 10% to 30% of its needs, while the rest of the electricity, around 1,400 megawatts, comes from Ukraine. To deal with Crimean energy supplies, Russia plans to build two new power plants. The first one would be built directly on the peninsula and would deliver 500 to 600 megawatts, whereas the second plant would be located near Novorossiysk and would have a capacity of 600 megawatts. It has been reported that the latter plant would cost between 20 and 30 billion rubles (US $580 to $870 millions), and 2 to 2.5 years would be required for its construction[12]. All these plans require large public investments and will undoubtedly weigh on the Russian Federal budget as well as on Russia’s economic growth.

What will be the Impact on Russia’s Economy?

Beyond economic sanctions adopted by most of the Euro-Atlantic community against Russia due to the Ukrainian crisis, the integration of the peninsula and Sevastopol to the Russian Federation is likely to have a substantial cost for Russia’s economy in the short and middle term.

Most of the Russian growth forecasts predicted in early 2014 had to be reassessed in light of the integration of Crimea to the Russian Federation, and the subsequent sanctions. The IMF has already cut down its 2014 growth forecast for Russia from 2.0% to 1.3% and the 2015 rate, originally set at 2.5%, has been reassessed at 2.3% in late spring 2014[13]. However, the World Bank has forecast an even worse situation for Russia’s economy, and has outlined two scenarios. Whereas the World Bank predicted 2.2% growth in 2014 and 2.5% in 2015, it has dramatically cut its forecasts to 1.1% (positive scenario) or -1.8% (negative scenario) for 2014, and 2.1% or 1.3% for 2015[14]. Even the Russian Ministry of Finance has outlined lower forecasts than initially expected: Moscow expects 1.1% growth in 2014 (initially 2.5%) and 2.6% in 2015 (instead of 2.8%).

In May, Alexei Uluykaev stated that the Russian government planned to cancel two major projects in order to save money and redirect funds to higher priority issues, including the development of Crimea. The project to build a 3 kilometers bridge across the Lena River in Yakutsk (estimated at US $1 billion) planned for 2020 has been cancelled as well as the project to expand the port of Taman in the Black Sea. It has been reportedly estimated that due to the cancellation of these two major projects, the Russian government would be able to redirect 112 billion rubles (US $3.2 billion) for Crimea’s development[15].

Interestingly enough, despite the tremendous cost for Russia’s economy of the seizure of Crimea, the Kremlin’s policy still enjoys fair support from the population. According to a survey carried out by the Russian institute Levada in June 2014, the number of people supporting the integration of Crimea and Sevastopol into the Russian Federation has increased from 28% in March to more than 40% in June[16].

Crimea’s integration to the Russian Federation will require major investments and is likely to hamper Russia’s economy and growth in the short term. After the Sochi Olympic Games, and with the coming 2018 Soccer World Cup, Moscow will have to decide upon strategic priorities with regard to the development of the peninsula. According to various figures, it could be expected that by 2020, Russia will have to disburse nearly 1 trillion rubles for Crimea. The main priorities are the development of the communication network, the construction of the Kerch Bridge and Crimea’s electricity supplies. Because of international sanctions, Western companies are unlikely to participate in supporting the development of the peninsula under Russian auspices, which is not the case of China for the time being. However, in the longer term, a successful economic integration of Crimea to the Russian Federation cannot be dismissed. Although tourism appears to be the main driver for the development of the peninsula, other assets are likely to benefit from Russian investments: agriculture would be one of them, but the shipyard industry and defense-connected activities are more promising drivers for the economic development of Crimea.