Oleksii Kushch
Macroeconomic Analysis of ORDO
and ORLO Economies
Objective analysis of the economies of occupied parts of Donetsk and Luhansk regions ('Separate Districts' - ORDLO, aka self-proclaimed 'Donetsk People's Republic' and 'Luhansk People's Republic', DPR and LPR respectively) is hindered by the lack of accurate information. However, such an analysis is necessary as hybrid forms of war involve not so much a military resolution to a conflict but rather an information and economic confrontation. In fact, we are dealing with a confrontation of minds (information and ideological field) and the potentials of economic systems. The cover of the DPR and LPR serves as a buffer in the conflict between Ukraine and the Russian Federation, in which not only new weapons are tried out but also different ideologemes like «Novorossia/Malorossia» as well as hybrid economic models.
It is extremely dangerous to see the territories not controlled by the government as an «empty nut» or a zone from the Stalker movie by Tarkovksyi. Russia most probably already has its own multifaceted plan on how to use these newly created formations for its long-term invasion of our economic and political system. And the economic section is definitely one of the priorities.
Unfortunately, over the past couple of years Ukraine has practically not attempted to create a clear-cut economic policy regarding the occupied territories. The only decisions made in this respect were several stages of blockade. The first stage started in 2014 with the suspension of transactions of state-financed organizations, bank institutions and payment of pensions and social welfare. Then the blockade of land transport system was introduced and finally in 2017 a complete industrial blockade was launched when businesses, which conducted legal and tax re-registration in cities of Ukrainian jurisdiction were ultimately cut off from the state transport, payment and fiscal systems. Because of those measures Ukraine lost 30-35 bln UAH in tax income per year, including 800 mln UAH in military tax as well as 1.5-2 bln USD in export revenue. Losses touched upon power and coking coals deliveries in particular, which affected the whole technological chain of Ukrainian mining industry. Over 40 enterprises, which were cut off Ukraine in that way, went trough a «nationalization» procedure with imposed temporary administrations and inclusion into the economies of LPR/DPR.
Economy of ORDO
According to the Decree of the Cabinet of Ministers of Ukraine, the list of localities that are temporarily beyond the control of Ukrainian government includes the following big cities of Donetsk region: Donetsk, Horlivka, Debaltseve, Dokuchaievsk, Yenakieve, Zhdanivka, Kirovske, Makiivka, Snizhne, Torez, Khartsyzk, Shakhtarsk, Yasynuvata. Districts: Amvrosiivskyi, Starobeshivskyi, Shakhtarskyi, partly – Artemivskyi, Volnovaskyi, Mariinskyi, Novoazovskyi, Telmanivskyi and Yasynuvatskyi.
Assessment Methods
Regarding the potential of this territorial economic district, which appeared randomly, the following may be said. Its parameters may be assessed within two basic areas: actual state of affairs caused by rapid rupture of existing economic ties, unrecognized international status, military actions and the need to look for a new concept of development; and the potential state of affairs, i.e. what may happen in the future under conditions of stifling military conflict, absence of legal solution as to integration of these formations into the political body of Ukraine and continuation of Russia's efforts as to their integration into its economic space.
We shall use the statistical data of 2014 as a basis for comparison. This period is ideal for conducting an analysis. First of all, despite the military actions, Ukraine did not terminate collection of statistical data and most enterprises of the region continued their work by inertia. Basic technological connections were still functional. All the more, most of big enterprises of the region were part of Renat Akhmetov's business structures and part of Russian business, hence it was still possible to manage them successfully under partly chaotic conditions. At least, temporary. Secondly, economic transactions in the region managed to absorb the effects of general crisis, which revealed itself most significantly in Russian trade and transport blockade, painful reorientation towards the European markets as well as devaluation of national currency – hryvnia. If we took the 2013 as the basic period all these factors would not be considered and the indices would turn out higher than they really were. Thirdly, in the statistical data for the year 2014 we already do not have the data for social and budget sector and banks meaning that we only have the net industrial potential of the region available.
Potential Economic Model
and Technological Chains
To consider the possibility of implementing an efficient economic model in the region, we must understand the following critical features of such a model: technological chains, integration with foreign markets, transport logistics, access to Russian markets.
Technological chains are based on the following elements: coking coal-coke-metal; steam coal-electricity-metal. As we see, a certain type of coal opens each chain, whilst a metal is always a closing element. Disruption of these chains may lead to loss of competitive advantage on price: quality products of the region cannot be competitive on world markets. Loss of advantage on price poses a threat of rapid decrease in production volumes. It is evident on the example of 1990s crisis: industry players were controlled by different groups – some controlled coal mining, the others controlled metal smetlers and coke production and the state was in charge of power industry. All this resulted in decline of economic indices, reduced number of workplaces and several months of salary back pays. Only having all these enterprises united into one technological chain within a single financial and industrial corporation helped create a profitable regional business.
Currently, the technological chains mentioned are completely disrupted, but if we consider occupied territories on a local scale, then it is possible to restore them locally. This requires a new organizational structure that would build the chains anew and ensure the necessary rhythm of material resources flow.
Yet, export of end products is impossible without having the status of international trade subject, which the unrecognized territories do not have and will never have. Such significant amounts of metal and coal are obviously too much for the domestic needs. The only option for the DPR is to bring end products to Russian internal market. But there is a serious obstacle here. Russia exports metal to external markets and in this respect it is a competitor for Ukraine. Russia also does not need the extra metal as it is going to become a colossal dumping hit for its own producers: in January-May 2017 according to the Federal Customs Service of Russian Federation data, the total volume of products exported from the country equalled 138.5 bln USD, with metal accounting for 9.9% of the general value of export. This is also true for coal export: according to the Ministry of Energy of Russian Federation, last year their export equalled 163.5 mln ton having increased by 16.5% over the past year. Repeat export of metal and coal from DPR to Russian enterprises is impossible because of a high risk of international sanctions, penalties and litigation. In such a way, all this mass of unnecessary products will have to be absorbed by Russian internal market.
Logistics and Sales Markets
An important part here is played by logistics: metal and coal transportation can only be performed by railway and marine transport but the Mariupol port is not available for this. Hence, the only way out is the transportation of products to Russia by railway. But for this Russia needs to recognize DPR railway companies and open direct freight traffic. So far nothing has been done even for passenger transportation. It is because a decision like this may entail international sanctions and suits filed against Russian railways, which are too integrated into world capital markets and dependent on Western technologies in their future development.
An important element here is also the creation of a quasi bank system to ensure capital flow between enterprises of DRP and the «budget». Here, unlike in logistics, everything is much more simple. We will touch upon the issue further in the text.
As far as integration of DPR into the market of Russian Federation goes, this direction was mentioned in Minsk agreements as well, which establish the right of certain districts of Donetsk and Luhansk regions to conclude economic collaboration agreements with border regions of Russian Federation. We are talking about the following clause of the agreement: «Assistance from the central government to cross-border cooperation between the individual areas of the Donetsk and Luhansk regions and regions of the Russian Federation».
Economic Zoning
and Labour Potential
From the viewpoint of territorial and economic zoning, the uncontrolled territories of Donetsk region were part of Donetsk and Sub-Dnieper economic district formed back in times of Ukrainian SSR. Donbas was the most powerful territorial and productive complex inside the district with the share of over 40% of industrial products. Over 80% of all staff employees worked in heavy industry. Coal resources of Donetsk were combined efficiently with iron ore deposits of Kryvorizkyi basin, the cascade of Dnieper hydropower plants, atomic energy and convenient ports. The technology was based on a complete metallurgic cycle. The needs of cycle were met by heavy engineering industry, which manufactured mining, energy and rolling machinery. Chemical industry, coke production in particular, was also important.
In DPR people live predominantly in compact town agglomerations with large areas of low populated territories in rural parts. Almost 70% of people live in Donetsk-Makiivka and Horlivka agglomerations. High mortality rate and low birth rate are evident of demographic shifts towards old age population and the decrease of number of working population and youth. Similar demographic indices are characteristic of territories where senior citizens (over 60 years old) make up approximately 50% of the population. According to official data, living in DPR are over 660 thousand retired persons, almost a third of the total population.
In 2016 the average number of staff employees in Donetsk region made up 456,700 people having decreased by more than 640,000 in comparison to the year 2013. This is a result of external and internal circumstances. The first group includes the impact of general economic crisis as the number of staff employees was decreasing in other regions of the country as well, namely in Eastern and Southern. External reasons emerged under the influence of such factors as a military conflict and blockade of the territories not controlled by the Ukrainian government. In general the potential number of staff employees on uncontrolled territories can be estimated at a maximum of 0.5-0.6 mln employees (based on the circumstances of 2013), approximately a half of whom are employees of budgetary sector institutions and state monopolies (post offices, railways, gas transportation system etc). Out of the 0.2-0.3 mln of staff employees who worked in industry on uncontrolled territories of Donetsk region, after three years of active military conflict and close down of almost 50% of all enterprises and «nationalization» of companies registered under Ukrainian laws, only 80-100 thousand are currently employed full-time and receive salary according to different estimates . Total staff losses of the region (employees who moved to other regions and emigrated to other countries, chiefly Russian Federation) may be estimated at 0.5-0.6 mln of staff employees.
Industry
In 2014 Donetsk region produced goods and services for the sum of 376 bln UAH, with salaries to staff employees in industry making up 28 bln UAH. The number of enterprises exceeded 11 thousand and the number of employees was over 463,000. A part of that potential was left behind on occupied territories. In 2014 the main industrial centres, which are no longer controlled by the Ukrainian government, produced industrial products and services for the sum of 238 bln UAH and the wage fund for staff employees was over 14 bln UAH with the number of employees exceeding 170 thousand people.
The diagram, which shows distribution of gross regional product in Donetsk region in 2014, testifies to the fact that almost 63% of economic potential landed in uncontrolled territories (DPR).
That time economic parameters of the DPR key industrial centres (Donetsk, Horlivka, Khartsyzk, Yenakieve, Makiivka, Dokuchaievsk, Kirovske) are shown.
The chart offers data on the key cities (uncontrolled territories). Small localities are hard to analyze as their economic activity has virtually stopped. The main economic potential is centered in Donetsk. 203 bln UAH in goods and services and almost 12 bln UAH in wage fund. The second and third places are held by Yenakiieve and Makiivka: 12 and 10 bln in goods and approximately 0.5-0.6 bln UAH in remuneration fund for staff employees. In such a way, Donetsk-Makiivka industrial agglomeration accounts for over 95% of industrial potential of DPR. All in all, the potential of the main cities on uncontrolled territories may be estimated at 238 bln UAH.
As far as Horlivka and Hartsyzk go, their industrial potential is almost completely lost for DPR, even though in 2014 the two cities had an output of 9 bln UAH combined, a wage fund of 800 mln UAH and 14, 500 of staff employees. There are two main reasons for that: the main industrial potential of Horlivka is focused on chemical industry ('Stirol') and Russian Federation is unlikely to take the blame for putting it into operation Moreover, even if the plant resumed work, the chemical products would be impossible to sell due to low demand on the main markets and the profitability of products will be significantly higher than in Russia. In Khartsyzk, the main productive asset is Khartsyzk Pipe Plant producing pipes for main gas and oil pipelines. In view of international character of gas contracts with Russian Federation and new transit projects, no one is Russia will be willing to risk them due to new sanctions for the use of products with unrecognized certificate of origin.
Export Potential
The chart shows assessment of possible export from uncontrolled territories. In 2014, export from Donetsk region enterprises decreased from 12.4 bln USD to 8.4 bln USD, that is by 4 bln USD. The share of enterprises which landed in DPR can be estimated at 5-6 bln USD as based on this criteria. Most of them were either closed, put on hold or moved to Russia in 2015. A few of those enterprises underwent repeat registration at fiscal bodies of Ukraine and continued working until a complete industrial blockade was launched. Even a smaller number of enterprises provided partial employment under the control of self-proclaimed government. Considering the fact that markets of Europe, Asia, America, and Africa are from now on closed for the DPR enterprises, there is only a potential chance for them to supply their products to Russia. Even with maximum restoration of local industrial capacities, the volume of such export will hardly exceed 1 bln USD annually or less than 500 USD per capita.
Agriculture
The agricultural potential of DPR can be assessed according to the chart. If compared to 2014, gross grain harvest decreased from 2,362 thousand tons to 1,536 thousand tons in 2015, i. e. by 826 thousand (a 35% drop). Oil plant harvest, primarily sunflower, decreased during the same period from 740,100 to 528,000 (a 29% drop), gross potato harvest decreased from 778,000 to 397,000 (by 49%) and vegetable harvest - from 485,000 to 208,000 or by more than twice. In view of the fact that even in crisis periods of 2014-2015 agriculture was having a better dynamics as compared to industrial production, we may blame decrease volumes on uncontrolled territories. The agricultural potential of territories, namely their Donetsk region part, may be assessed at 0.8 mln tons of grain, 200,000 tons of sunflower, up to 380,000 tons of potato and almost 280,000 tons of vegetables. Consequently, if we look at food procurement, it will be impossible to satisfy domestic needs of DPR even in the long-term perspective. If we take the 2014 numbers as maximum, then the gross harvest of grains on the territories will not exceed 0.5-0.8 mln ton. These figures will be much lower in reality. For a sufficient grain procurement it is necessary to harvest at least 1 ton of grain per capita, and with respect to DPR the number will be over 2 mln ton of grains annually. In such a way, in the nearest future this formation will depend almost entirely on humanitarian aid and even in case of industrial complex restoration and its integration into the economic space of Russian Federation, DPR will, tentatively speaking, have to exchange coal and metal for grain and other food products imported from Russian agricultural regions (Rostov region, Krasnodar region).
Inflation
Low salary and pension levels (low payment capacity), dependence on foreign currency support (Russian ruble) as well as integration into Russian price market have caused the consumer price index of DPR to be at low levels in 2017 - if we were to believe the local «Department of statistics» data, of course. But due to lack of other data we are obliged to use those mentioned above.
In 2017 maximum price growth in comparison to December of the previous year was recorded in May-June (1,.2-4% monthly). In December, however, inflation decrease could be noticed: from 0.7% in January to 0.1% in March. Annual calculations of inflation based on the results of the first half of the year make up 7-8% or 3.7% annually.
Gross Regional Product (GRP)
Forecast for the Next 2-3 Years:
The above mentioned indices were characteristic of the year 2014, when the destructive processes have not yet embraced all aspects of economic life in the region. That was the maximum, which is hardly possible to achieve at this moment. If we take an adjustment coefficient of 50%, it will yield us about 110 bln UAH in products and services per year (4.2 bln USD), a wage fund of 7 bln UAH, approximately 80,000 of staff employees working in industry and over 7 thousand of average monthly salary in industrial sector.
In order to implement this model Russian Federation would need to change its migration policy. If previously Russia was trying to employ refugees from Donbas in low populated areas of the Far East and cancel the requirement for labour certificates in Crimea, then starting with 2017 the situation changed drastically. At least there are first signs of change. According to Presidential grant in the amount of 471,000 RUB given to Krasnodar Centre for Regional Development, the organization is supposed to study the possibility of implementing repatriation programme of Donbas refugees back to territories of Luhansk and Donetsk region that are not controlled by the Ukrainian government. The need for such a study may be caused by one thing only: Russia is planning to restore industrial capacities of DPR already lacking qualified workforce and all this is happening amid a high unemployment level. Thus, at Makiivvuhillia (Makiyivcoal) enterprise, for instance, there has been a lack of shaft engineers over the past year. The decrease of qualified workforce means that in order to restore the industrial capacities of DPR at least at 50% of 2014 potential, a repatriation of up to 50,000 staff employees from Russian Federation is needed, which may account up to 200,000 people with family members (according to various data, almost 600,000 residents of Donetsk and Luhansk regions went to Russia starting from 2014 where they received temporary residence permits and on whose welfare almost 18 bln RUB were spent over two years).
Regarding macroeconomic indices of the future model and with data of «department of statistics of DPR» as to population of 2.3 mln people taken as basis, we receive an estimated volume of gross regional product (RGP) in the amount of 1,800 USD per capita. If we consider agriculture, trade and budget sector, then the sum may increase up to 2,000-2,500 USD. To compare Ukrainian GDP in 2016 made up approximately 90 bln USD, i.e. 2,000-2,200 thousand USD per capita. Consequently, if we consider the worst case scenario in which there are no structural reforms in Ukraine and the raw material based model of national economy continues to stagnate, while the DPR implements a quasi industrial regional model of economy which is focused on Russian internal market, the GDP indiсes per capita in Ukraine and on uncontrolled territories (DPR) may achieve parity.
It is worth noting that these indices must be taken as indicators of economic activity that are relevant for the present moment. This is a benchmark which may be achieved on condition that the economies of uncontrolled territories are integrated into the economic space of Russian Federation and the latter is not yet ready for this. It would be extremely difficult to surpass that benchmark as any type of investment, external or internal, are out of the question with an unrecognized status and hence the structural reconstruction and modernization of production facilities may be ruled out completely, even as a hypothetical forecast. At least until these territories are again controlled by Ukraine.
GRP Forecast for Late 2017
After «nationalization» of Ukrainian enterprises and with external administration imposed on them, the volumes of product supply to Russian markets have not yet been established.
As a result, 90% of export potential of DPR and over a half of its GRP is made up by coal mining (almost 10 mln ton). With the price per ton set at 50 USD, the total value of coal mined may be estimated at 500 mln USD annually. The budget sphere which is partly receiving donations from Russian Federation, is valued at 35-40 bln RUB a year (up to 600 mln USD), which form the largest part of internal solvent demand for goods and services and ensure internal trade turnover. With budget sector the total valued of GRP may be currently estimated at up to 1 bln USD or less than 500 USD per capita or four times less than on the rest of the territory of Ukraine.
As far as donations from Russia are considered, the following should be noted: if DPR exports up to 10 mln ton of coal annually, then it must cover its domestic social needs completely. But a dynamic and planned sale of such big shipments of coal is impossible today (due to blockade and excess of coal that is mined in Russia itself). In addition, the unrecognized status calls for price dumping, which is why total losses on price of coal shipments in DPR may be estimated at 200-300 mln USD. In such a way, if we disregard expenses for war and two army corps formed in Donbas, Russian donations to DPR may be assessed at 300 mln USD per year or nearly 20 bln RUB.
Economy of ORLO
Uncontrolled areas of Luhansk region (LPR): cities of regional importance - Luhansk, Alchevsk, Antratsyt, Bryanka, Kirovsk, Krasnyi Luch, Krasnodon, Pervomaisk, Rovenky, Sverdlovsk, Stakhanov, districts - Antratsytivskyi, Krasnodonskyi, Lutuhinskyi, Perevalskyi, Sverdlovskyi and Slovianoserbskyi.
In economic respect, LPR is a lifeless piece of Luhansk region. Having it as a separate subject of Minsk negotiations may be explained by one reason only: Russian Federation hopes that LPR and DPR will be included into the political body of Ukraine on the ground of a special law and amendments to the Constitution. For this purpose it is necessary to keep the Luhansk «address» as well, otherwise a positive outcome of Minsk negotiations will be unattainable. If the Russian Federation were to exit Minsk agreements and pull a Transnistria in the south-east of Ukraine, then most likely LPR would be added to DPR as a trailer car or the two formations would be put together under a common name like «Novorossia».
Industrial and Labour Potential of LPR
To consider the macroeconomic indices of Luhansk region in 2014, then we are at 45 bln UAH in products and services in real sector of economy, 6.2 bln UAH in wage fund, almost 130, 000 employees and 3,233 enterprises. Out of those, in 2014 cities which are temporarily not controlled by the Ukrainian government (LPR) accounted for 31 bln UAH in goods and services, over 4 bln UAH in wage fund for staff employees with their number exceeding 71,000 and the number of enterprises being 472.
The diagram, which displays distribution of gross regional product in Luhansk region in 2014, testifies to the fact that almost 70% of economic potential landed on a territory not controlled by the Ukrainian government (LPR).
That time economic parameters of key industrial centres of LPR (Luhansk, Alchevsk, Antratsyt, Rovenky, Sverdlovsk, Stakhanov) are displayed.
As we see the situation is quite different in LPR than in DPR. While in DPR the main economic, scientific and human potential is focused mainly in Donetsk-Makiivka agglomeration, in LPR amid the depressive districts oriented towards coal mining, Lunansk as an administrative centre is also looking a bit lifeless. In 2014 Luhansk had 343 industrial enterprises with output of 9 bln UAH worth of products, wage fund of 0.6 bln UAH and staff employee number of over 16,000. Even in 2014 average monthly salary in the region was below 4,000 UAH. Today it may be estimated at 3,000 UAH (in industry, except for mining).
At the same time, LPR has two apparent centres of economic gravitation. One of those is Alchevsk with densely located iron and steel works and coke processing facilities, which belong to ISD corporation, namely: iron and steel works which is on the list of strategically important plants of Ukraine and the coke processing plant supplying coke for the production cycle of the former. Alchevsk Iron and Steel Works is supported not so much by the Ukrainian transnational corporation ISD but rather by huge Russian capital or so-called political investments made by Russian Federation into Ukraine, which helped them buy loyalty of President Yanukovych back in 2010-2013. At present ISD is managed by a so-called controlling creditor – Russian Vneshnekonombank, which is the actual manager of corporate assets. Shares of natural persons – Serhii Taruta and Oleh Mkrtchan (24.99% each) have been arrested on the suit of VTB. As of today huge Russian capital with a significant share of state participation is the main hindrance to Russian Federation recognizing the international status of LPR/DPR, as this would mean they have to write off approximately 10 bln USD as direct losses of Russian financial structures. The aim of Russian industrial and financial groups on this issue is to make Ukraine accept the integration of uncontrolled territories into Ukrainian legal field and use the pause to sell the above mentioned assets to private investors even with a significant discount.
Alchevsk Iron and Steel Works is one the most modernized facilities of our country. Back in the day an EBRD loan in the amount of 150 mln USD was attracted for the construction of gas turbine power plant. Apart from this, with the help of investment from the corporation continuous casting machinery was put into operation as well as a convector workshop and renovated blast furnaces. In January-September 2013 the plant got almost 11 bln UAH in revenue which equals over 1.3 bln USD. Alchevsk Iron and Steel Works can produce almost 4 mln ton of rolled stock, more than 4.2 mln ton of steel and the same amount of cast iron.
Alchevskkoks (Alchevsk coke processing plant) is one of the top three coke processing plants of the country and with the help of five coke-oven batteries coke production may be increased to 3-3.5 mln ton.
For this reason industrial production rates in Alchevsk exceed analogous rates in Luhansk (for 2014): 17.5 bln UAH in end products which is twice as much, wage fund of almost 1 bln UAH (which also almost twice as much) and 16, 000 staff employees.
Considering current economic state, Alchevsk can become a real pro-Ukrainian enclave within LPR because unlike Donetsk and Luhansk, where partial employment problem can be solved with the help of state-financed organizations and the minimum solvent demand can be achieved with the help of pension payments, the only road to development here lies through restoration of full-fledged work of Alchevsk industrial complex, namely its coke processing and iron and steel industry. Because of the state of affairs with mining and iron and steel complex in Ukraine and in Russia, it will be hard for locals to find a job in other regions. At the same time, before the beginning of military actions Alchevsk had one of the highest salary levels in the region. In view of everything mentioned above, people of Alchevsk will be supporting reintegration of their town back into Ukrainian legal field as soon as possible.
Antratsyt is also standing out. It is where the largest Ukrainian mine Komsomolska is situated, where they mine steam coal which all Ukrainian thermal power plants are geared towards, with layer depth up to 1 km. The number of mine workers was approximately 4,000 and the volume of coal mined was over 1.5 mln ton.
Agriculture
With respect to agriculture, it is worth mentioning that LPR is completely cut off from the northern part of Luhansk region where the main agrarian complex of the region is situated.
As seen on the diagram, physical volumes of the main agricultural crops harvest did not change significantly in 2015 in comparison to 2014. Since a record harvest was recorded last year, the volume of agricultural production on uncontrolled territories may be estimated at 0.2 mln ton of grains which is not enough for a population of 1.3 mln people. In such a way, LPR, much like DPR, cannot do without additional humanitarian supplies of food and the only way out is to buy food for money received from selling coal (up to 200 mln USD).
GRP Scope Forecast
With regard for adjustment coefficient, economic indices of LPR (if we consider them as potentially possible) may be assessed as follows: approximately 20 bln UAH of goods (up to 0.8 bln annually), wage fund – 2-3 bln UAH and the number of staff employees – up to 60,000. Export potential of the region is exclusively coal and metal (in case of partial functioning of Alchevsk iron and steel works), export volume - within 0.5 bln USD (0.2 bln USD - coal).
The key problem in developing an economic strategy is going to be the economic potential of Alchevsk iron and steel island, able to generate up to 1 bln USD in revenue per year. But the launch of the latter will be limited because of violations of the title of existing owners, which resulted in almost complete impossibility of selling the products on external markets (without the permission of current owners) as well as supplying them to Russian Federation.
If Russia, in violation of international norms of investment protection, buys the products of «nationalized» Alchevsk Iron and Steel Works, the volume of regional product in LPR can make up 1 bln USD.
In such a way even if a new economic model were launched, the regional GDP volume would make up no more than 600-700 USD per capita, so if Russia exited Minsk process, LPR would have to be joined to DPR as an additional social carriage.
At present the region's economic potential is limited to coal shipments of 4-5 mln ton per year costing up to 200 mln USD. Social transfers make up almost 15 bln RUB or 250 mln USD annually. In this case regional GDP does not exceed 200 USD per capita annually, which is ten times less than on territories controlled by the Ukrainian government. Donations from Russian Federation may be estimated at 200-250 mln USD or up to 15 bln RUB annually. Amid active exportation of coal from LPR the size of donations is decreasing respectively.
Bank Systems in DPR and LPR
Functioning of industry both in LPR and DPR is impossible without a banking system, even a hybrid one.
The so-called Central Bank of DPR was established in October 2014. Already in spring 2015 CB of DPR started opening accounts for natural and legal entities since for obvious reasons there are no commercial banks on unrecognized territories. In fact, it is a recreation of banking system model of former USSR but without specialized banks, for instance Savings Bank. In fact, it is a one-level model of early USSR. The technical basis for this hybrid is the Ukrainian bank network, which was seized and «nationalized», in particular these are branch offices of Savings Bank and Pryvat Bank which had a significant presence in the region. Not surprisingly, the main currency is Russian ruble as the unrecognized government can receive wireless and cash financial support only in this currency. Through CB of DPR and Donbas Post pension and other social payments are made. At present 257 branch offices are functioning in 24 towns, with more than half of them located in Donetsk-Makiivka agglomeration. The total number of opened accounts is 440,000, which includes 16,000 accounts for natural persons and 380,000 for legal entities. Other accounts belong to state-financed organizations.
Payment infrastructure includes 94 ATMs, 532 POS-terminals and 505,000 payment cards which are accepted only on uncontrolled territories.
Financial support is made through banks of Southern Ossetia. This republic, which was not recognized by the world, has found support of several countries-political satellites of Russian Federation: Nauru, Nicaragua, Venezuela, Vanuatu. And Russia itself which is not surprising. Such a simple system of recognition helps the banks of Southern Ossetia open accounts in Central Bank of DPR and simu-ltaneously have correspondent relations with Russian banks and in theory with banks from, say, Venezuela. In such a way National Bank of Southern Ossetia has legal correspondent accounts in Russian banks on the one hand, and in CB of DPR on the other. Moreover, the chain of transactions involves South Ossetian International Accounting Bank, which has branches in Moscow and in Donetsk.
With the help of such a scheme (which is also true for LPR once you replace the words «Central Bank of DPR» with «Central Bank of LPR») the quasi financial system of DPR may be supported and not only by Russian ruble but also by US dollar, both wirelessly and in cash. Total internal cash flow of such a system can be estimated at 10 bln RUR per month or 150 mln USD. Annual debit cash flow, which is thrown into the system from coal «trade cushions» and Russian charitable foundations, may reach 50-60 bln RUB.
At present «charitable foundations» are the only possibility for wireless transfer of money to Central Bank of DPR using Russian and South Ossetian bank institutions. It looks similar to this: raw materials and end products (coal, coke, metal) are transported to specialized plants located in Russian Federation where the product certificate of origin is replaced (from Ukrainian into English). Once the products are sold (e.g. coal), money is transferred to accounts of legal Russian enterprises and then sent to Russian charitable foundations offering aid to «government of DPR» on a non-refundable basis. As a result, the correspondent account of Central Bank of DPR has billions of rubles in non-cash form, which are used to pay pensions, salaries and make other payments.
Unfortunately, such schemes are practically not investigated by Ukrainian law enforcement bodies so they may be discussed only hypothetically.
In particular, it would be important to investigate the activities of such groups of enterprises: coke manufacturer Makiivkoks, CJSC and Yasinovskyi Coke Processing Plant, PJSC. These enterprises as well as Donetsksteel Iron and Steel Works, PJSC are entering the orbit of a famous oligarch Viktor Nusenkis (officially, Donetsksteel Iron and Steel Works belongs to a Cyprus company and the majority stake in above mentioned coke processing plants belongs to Donetsksteel Iron and Steel Works itself). It is known that a charitable Foundation DOBRO (Good) is registered in Russia (at the address: 109147, city of Moscow, 34 Marksystska Street, block 7), which has Viktor Viktorovych Nusenkis as its President and Founder. It is hard to tell how closely connected into one chain of transactions these companies are without a special investigation.
As to LPR banking system, its sum of annual debit flow, which is thrown into the system from coal «trade cushions» and Russian charitable foundations, may reach 30-40 bln RUB.
Conclusion
Russia will continue to subsidize the territory of the ORDLO, taken into account the sum of subsidies currently does not exceed $ 500 million per year (excluding military expenditures). Creating a new quasi-industrial model (to launch surviving production capacities) will require Russian Federation to withdraw from the Minsk process, annual capital investments of $ 1-2 billion for two to three years, and up to $ 1 billion annually in internal price subsidies for goods manufactured in the DNR / LNR for an indefinite period. In addition, recognizing the «nationalization» of Ukrainian enterprises, «provisional administrations», local certificates of origin of goods and unrecognized customs declarations is required. Steps like these though will probably put Russian Federation at risk of new international sanctions, including its financial sector. In this model, LNR is doomed to inevitably be absorbed by the DPR. Perhaps the unrecognized territories will initiate launching Alchevsk Iron and Steel Island under the Ukrainian fiscal and banking jurisdiction. Without it LNR functioning and life prospects will remain dubious.
This scenario is least beneficial for the Russian Federation. The most comfortable option for it is the removal of a trade blockade and the restart of coal transportation from unrecognized territories to Ukraine. In this case, Russia will only have to pay for paramilitary local formations (the «People's Militia») costs, and the bulk of social payments (pensions, subsidies) and the public sector will be financed through purchase of coal by Ukrainian enterprises, as well as legal exports of metal produced by LNR / DNR, through the Ukrainian customs.
Therefore, at present, Russia's main objective is the LNR / DNR inculcation into the political body of Ukraine. The formation of a Transnistrian (unrecognized) or even South Ossetian (partially recognized) model on their basis is not yet discussed. In this regard, the industrial potential of the region is preserved, keeping up to 20-30% of its initial level.
In addition, the Russian Federation has a plan B handy. It provides for a very fast relaunch of industrial capacities remaining in the region and implanting them in domestic Russian market with subsidies provided. Russian Federation will adopt this option in case of the definite scrapping of the Minsk process and rejection of the active military phase. In this case, the purpose of the new project will be to build a paternalistic ersatz-state economic model in ORDLO that resembles the times of the late USSR. Simply put, it will be about creating an industrial showcase for residents of southeast Ukraine. In this context, forming Ukrainian industrial policy for the full development of the Donetsk-Pridneprovsky economic region, especially for such cities as Dnipro, Zaporizhya, Kamiansk, Mariupol, Kramatorsk, Toretsk, Severodonetsk, Lisichansk, becomes vital. In addition, strengthening of the Ukrainian information, cultural and humanitarian policy regarding such pro-Ukrainian enclaves as Alchevsk becomes extremely important. Such a comprehensive program, designed for the next three to five years, will help, on the one hand, to minimize the infiltration of Russian politico-economic projects in the cities of southeast Ukraine. On the other hand, it will provide conditions for the de-occupation of uncontrolled territories by strengthening there sentiments, directed against DNR / LNR policy. Over time, such negative attitudes will inevitably transform into sustainable pro-Ukrainian local movements.
The main estimates and projections are summarized in the table:
As a new means of de-occupation of territories of Donetsk and Lugansk regions, a mechanism of demilitarized free economic territories (DeFET) can be used. Principles of their creation:
DeFETs are created in the rear parts of the Donetsk and Luhansk regions beyond Ukrainian government control.;
The DeFET zones are completely demilitarized: the illegal armed groups and heavy military equipment are withdrawn;
Local authorities legitimate as of December, 2013 are restored within DeFET zones;
To enforce law and order within DeFET areas reinforced OCSE monitoring missions and local militia under OCSE officials command are deployed;
Within DeFET territories enterprises registered according to Ukrainian legislation and the Ukrainian banking system are relaunched;
Within DeFET territories, cargo transportation is renewed;
Within DeFET territories state fiscal service stations start functioning issuing Ukrainian certificates of origin for manufactured goods.
A number of factors taken into account, at present, the highest chances to create the DeFET are in the Alchevsk industrial region, Yenakievsko-Makeyevka agglomeration, Khartsyzsk, and in coal mining sites: Antratsyt, Rovenki, Sverdlovsk.Creating DeFET can become a new hybrid form of de-occupation of uncontrolled territories, a transitional step to their full integration into the economic and political space of Ukraine.
In a sense, the Kaesong Industrial Park, created jointly by the DPRK and South Korea could be considered the international analogue of the DeFET model. Just a reminder: The Kaesong Industrial Park is located on the territory of the DPRK, 10 km north of the Demilitarized zone. Until recently, 120 South Korean small and medium-sized companies and 15 large corporations had operated within the industrial park area. The trade turnover of the zone was an average of $ 2 billion per year, with over 50 thousand people employed (mostly from North Korea).
Otherwise, if the state continues mechanically cutting off uncontrolled territories and is unable to stop industrial stagnation in controlled ones, it will not be possible to avoid the infiltration of Russian influence in the southeast of Ukraine.
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