Ukraine to cut financial ties to rebel-held Donbass

By bne IntelliNews November 17, 2014

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Ukraine's president Petro Poroshenko has ordered all state institutions to withdraw from the rebel-held Donbass and to stop paying salaries and pensions from the state budget to residents of the region.

In a decree signed on November 15, Poroshenko ordered the National Bank of Ukraine to cut off all banking services in the rebel-held territories of Donbass within  a month, both to legal entities and to the population.

He also ordered state organisations and local administrations in the rebel-held area to close and for personnel to be evacuated with in a week, together with property and documentation where possible. He declared that all remaining institutions, based on what he said were illegal elections of November 2, would be regarded as illegal.

The move follows what Poroshenko calls the breakdown of the Minsk peace accords signed on September 5, which ended fighting between pro-Kyiv forces and pro-Russian forces in Donbass. As part of the peace agreement, Kyiv introduced a law according special status to the rebel-held territories of the Donbass region, envisaging regional elections to be held jointly with Ukraine. But the decision by the Russian-backed rebels to hold independent elections on November 2 prompted a furious response from Kyiv, leading to the repeal of the law.

Since the start of the conflict in Donbass in the spring of 2014, Kyiv has continued to transfer funds to Ukrainian state organisations in rebel-held territories, as well as pay pensions and salaries, in the hope of retaining some loyalty among the local population, and strengthening Kyiv's claim to be the legitimate power on the territory. But despite the continuing transfers, many locals have turned away from Kyiv, because of what they regard as indiscriminate Ukrainian military aggression against civilians in Donbass in a conflict in which more than 4,000 have died, many of them civilians.

With Ukraine's economy in free fall and the government facing a ruinous budget deficit, Kyiv can no longer afford the transfers to the rebel-held regions, while receiving little or no tax payments in return. Kyiv has previously said that all pensions and salaries would be payable at a later date, on reintegration of Donbass in Ukraine.

However, Ukraine has said it would continue to supply gas, heat and power to the rebel-held territories, despite currently receiving no payment for doing so, for humanitarian reasons. Thus cutting off social payments and salaries will compensate for the losses on supplying energy, Ukraine's government hopes. "We've got enough funds for more than six months so that the money which hasn't been paid as compensations, social welfare, subsidies and pensions could be transferred as payment for the gas and electricity," Ukraine's prime minister Arseny Yatsenyuk said, as quoted by Interfax.

Around half of the civilian population of the rebel-held region have fled, according to a number of estimates, and a large proportion of the remaining are pensioners, who will now be left without income. It is not yet clear whether they will be able to draw their benefits or salaries by travelling to regions held by Kyiv.

The move will force the rebel leaders to think seriously about sources of funding, likely prompting them to appeal to Russia for financial support, say analysts. This in turn will force the Kremlin to decide how far it can go in financing the rebel authorities in Donbass, at the risk of incurring further sanctions

In comments at the G20 summit in Brisbane, Australia, Russia's president Vladimir Putin criticized the Ukrainian decision, but made no commitment for Russia to step in with funding.

"I believe this is a big mistake because they are cutting off these regions with their own hand," Putin said of Poroshenko's decision, as quoted by Interfax. "One can understand that they are saving money, but this is not the time or case to economise," he added, reminding that even during the Chechen war, Russia's government  never stopped budget transfers to Chechnya. At the same time Putin called for " a single political space," in an interview with the German TV on November 13.

Coal to Ukraine

Ukraine has also decided to stop buying coal from the rebel-held territories, after revelations that around $150m had been paid from the state budget to mining companies in the Donbass since the start of the conflict for coal supplies needed to fuel power stations across Ukraine. 

Given Ukraine's parlous financial state, the coal purchases from the Donbass - one of the world's leading mining areas - made sense, since they were denominated in hryvnia and substantially cheaper than coal sourced from abroad. 

But the state budget's transferring of large sums of money to Donbass structures possibly supporting pro-Russian rebels, aroused a storm of controversy. This prompted Ukraine's energy ministry to source more expensive coal from South Africa, but the move in turn has prompted allegations of corruption regarding the deal, implemented by obscure intermediaries. Ukraine's prosecutor general has said it has initiated a criminal investigation of the energy ministry in connection with the deal.

As a result, Ukraine has finally gone for the not less controversial option of buying coal from Russia. Along with Poroshenko's decree on November 15 cutting off financial support to Donbass, was a decree on securing Ukraine's energy security, stipulating among other measures state purchases of coal and electric power from Russia. 

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