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Cut Off: What Does the Economic Blockade of the Separatist Territories Mean for Ukraine?

Brian Milakovsky
Cut Off: What Does the Economic Blockade of the Separatist Territories Mean for Ukraine?

Ten months have passed since Ukraine imposed a full economic blockade of the part of the Donbas under Russian and separatist control. What has it meant for Ukraine’s economy and for the prospects of the territories’ economic and social reintegration?

The policy caught many Western observers off guard. President Petro Poroshenko initially opposed the railroad blockade by army veterans to end the “bloody trade” in coal and other materials from the separatist-held territories, claiming it would “destroy Ukraine in the Donbas.” But fearing the political blowback from sending police to disperse the veterans, he let them continue the blockade. As the crisis mounted, the separatist authorities in Donetsk and Luhansk announced the “nationalization” of forty-three large industrial enterprises previously within Ukrainian jurisdiction. Poroshenko answered by effectively legalizing the blockade, abruptly ending the surprisingly active economic relations between Ukraine and the occupied territories.

According to the political scientist Andrey Buzarov, the blockade is the new reality. Poroshenko’s main condition for lifting it, return of control of the nationalized enterprises, is fundamentally unacceptable to the separatists. And there is practically no lobby in Kyiv willing to openly advocate restoring trade under any other condition.

The blockade had relatively high public support, but it also inspired dire warnings from many economists and opposition politicians. They claimed that the lost supplies of anthracite coal would cause huge energy shortages and the demise of the crucial metallurgy sector. They also warned that lost trade and tax revenues from the seized industries would drag down Ukraine’s growth rate, which is slowly recovering from the disastrous war years of 2014–2015.

A Dodged Bullet

For Ukraine as a whole, and for the government-controlled portions of the Donbas, the impact appears muted. In October the Ukrainian Institute of Strategic Research released modest figures showing that between U.S. $98 million and $151 million had been lost to Kyiv in personal taxes, corporate taxes, and the value-added tax (VAT). A further $222 million in back taxes accrued before the blockade were moved to the “hopeless” category for collection. The governor of the government-controlled part of Donetsk oblast cited a loss of around $44 million in provincial taxes.

It is important to note, however, that these losses reflect a drop from an already severely reduced level. For instance, in Luhansk oblast, corporate taxes dropped from $45 million in 2016 to a predicted $12 million after the blockade, but in the prewar year of 2013 revenue from corporate taxes had amounted to $355 million. So much revenue had already been lost in three years of war and plundering that the blockade had little to finish off.

Most concerning of all, the National Bank estimates that the blockade has worsened Ukraine’s balance of trade by $1.8 billion, though the record grain harvests and strong metal prices abroad helped compensate. 

The Institute of Strategic Research cited larger long-term economic issues caused by the loss of the forty-three enterprises, such as a gaping hole in the pension system and destabilization of the currency as a result of the reduced inflow of foreign currency. Most concerning of all, the National Bank estimates that the blockade has worsened Ukraine’s balance of trade by $1.8 billion, though the record grain harvests and strong metal prices abroad helped compensate. But the overall fiscal impact did not stop Standard & Poor’s from specifically noting that Ukraine had overcome blockade-related difficulties to attain a 2.2 percent growth rate in 2017.

Metallurgy (Ukraine’s most important export sector) and energy production also bore the shock better than expected. According to data from Volodymyr Vlasyuk of Ukrainian Industry Expertise, due to the enterprises seizure of Ukraine lost around 17% of its cast iron, 15% of metal cable and 22% of coke production. Coke is needed by the majority of the country’s metallurgy plants. If we consider the coke plant in government-controlled Avdiivka, which is frequently shut down due to shelling, then fully 50% of the production of this essential product in Ukraine is disrupted by the conflict. Immediately after the blockade was imposed, the Avdiivka plant and two large eastern metallurgy plants shut down, seemingly confirming the darkest predictions. But they all quietly reopened several months later after reconfiguring their supply chains.

The massive mining, metal, and energy holding Metinvest Group, owned by the Ukrainian oligarch Rinat Akhmetov (which had seventeen enterprises seized in Donetsk and Luhansk) was able to soften the blow by importing anthracite coal from Akhmetov-owned mines in America, and by shifting power plants to gas-grade coal from Akhmetov’s remaining mines in government-controlled areas. The government has followed suit for many state-owned plants.

But again, the good news for Ukrainian metallurgy is only relative. Collapse was staved off, but production is nearly halved compared to the best post-Soviet year of 2007. Industry experts are comparing the wartime levels of production to those experienced during the worst years of the 1990s. And the blockade came at a time when steel prices were high globally. Had it occurred during a price slump, the darker predictions of critics might have come true.

Toxic Assets

Unsurprisingly, the separatist “people’s republics” have been much harder hit by the blockade. The Ukrainian government (and the residents of occupied territories I spoke with for this article) claim that management of many seized enterprises was handed over to a firm based in the breakaway republic of South Ossetia and run by the Ukrainian oligarch-on-the-lam Sergey Kurchenko. This firm is struggling to deal with lost export markets and inputs from suppliers in government-controlled areas, and also with an outflow of qualified workers after the enterprises were seized. Reports regularly appear in the Ukrainian media about mine and factory closures, “unpaid leave,” and sharp reductions in working hours in enterprises located in the occupied territories.

Sergey Sakadinsky, a separatist journalist from Luhansk, wrote, “The majority of Donbas industrial enterprises will never reopen.… Take the train car factory in Stakhanov. The raw metal was Ukrainian, the cars went to Russia. But now they can neither import the raw material nor export the finished product.… We can bring in Russian products with no problem, but the Russian market for our products is practically closed.”

Some residents worry that the coal sector will be ruthlessly “optimized” as it was over the past decade in the Russian Donbas, leading to extended protests by miners in the neighboring Rostov region. But despite the severe cutbacks at mines in the “people’s republics,” Russia appears to be laundering coal from these territories through its own Black Sea ports to Turkey and other markets. High-grade coal exports from Rostov rose nearly by 50 percent since the start of the blockade, and by 100 percent from the port of Azov.

Furthermore, Russia is greatly increasing coal exports from its own territory to capture markets formerly served by the recently seized mines. Absurdly, Ukraine has doubled imports of Russian anthracite since the start of the blockade. Despite well-publicized imports of anthracite from the United States, Poland, and South Africa, 91 percent of Ukraine’s imports of this valuable coal were from Russia (valued at U.S. $70 million).

Some Ukrainian politicians supported the blockade as a means to shift the economic burden of maintaining the occupied territories to Russia. But the strategy is questionable in light of Ukraine’s stated goal of reintegrating the Donbas.

Some Ukrainian politicians supported the blockade as a means to shift the economic burden of maintaining the occupied territories to Russia. But the strategy is questionable in light of Ukraine’s stated goal of reintegrating the Donbas. Russia can extract resources from these territories in the short term, and then acquiesce to their return to Ukraine when their economic potential has been practically destroyed by the blockade and mismanagement of the “nationalized enterprises”. The separatist commander turned internal critic Aleksandr Khadakovsky has even accused Moscow of deliberately wrecking Donbas industry “so that it won’t be left to the enemy.”

Lost Islands

The costs of the blockade for Ukraine should not be measured just monetarily. In his initial criticism of the blockade, President Poroshenko claimed, “The enterprises were an anchor that held these territories to Ukraine.… We intended to use them during reintegration, during the return of Ukraine to the Donbas and the Donbas to Ukraine.” The governor of Donetsk oblast put it more bluntly: “Before, people who received a salary from a registered Ukrainian company were inclined to feel more loyal to Ukraine, but now things are much more complicated.”

Larissa, an internally displaced person who worked in the mining sector, told me about the blockade’s impact on hearts and minds in her occupied hometown: “Working for a ‘Ukrainian’ company was some kind of a connection to our country. Now they feel as if their livelihoods are undermined. They feel entirely abandoned.”

About the Author

Brian Milakovsky

Brian Milakovsky

Independent Analyst
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Kennan Institute

The Kennan Institute is the premier US center for advanced research on Eurasia and the oldest and largest regional program at the Woodrow Wilson International Center for Scholars. The Kennan Institute is committed to improving American understanding of Russia, Ukraine, Central Asia, the South Caucasus, and the surrounding region though research and exchange.  Read more