No one is really standing in the way of Russia’s annexation of Crimea. Despite the tough talk from Western leaders, there are few obstacles on President Vladimir Putin’s path. His plan for the occupation of Crimea is going to be 100 percent realized. The March 16 referendum is now behind us, and the results were all too predictable. The Crimean parliament is now appealing to Russia with a formal request to join the Russian Federation. There is no doubt that such a request will be honored but it may take some time. For example, the Russian parliament will need to prepare and vote on relevant legislation. There is also a requirement to amend the Russian Constitution, which contains a list of the country’s components and regions.
But one thing that will happen fairly quickly is the deployment of additional Russian troops in Crimea.
Putting more troops on the peninsula is necessary not simply to protect it from a possible invasion by the Ukrainian army—hardly a realistic scenario at this point—but rather to incorporate Crimea into Russia’s financial infrastructure as soon as possible. The primary goal for the Russian army will be to launch the monetary system of Crimea.
Today, Crimea is effectively part of Ukraine, and the National Bank of Ukraine (NBU) is in charge of the organization of the functioning of the payment system as well as cash circulation. Ukraine almost certainly will not shut off supplies of water, gas or electricity to Crimea—such provocative moves will immediately affect the entire population of the peninsula. And Kyiv will likely avoid such a move in the vain hope that one of these days Crimea can be convinced to return Ukraine.
But as far as the monetary system of Ukraine is concerned, the authorities in Kyiv should cut off Crimea immediately (assuming there are people on staff who remember the process of disintegration of the USSR 1). The goal should be to isolate immediately the Crimean payment system in order to avoid uncontrolled currency emission by the Crimean authorities. By gaining control over the branches of the NBU on the peninsula, Crimean authorities, in theory at least, will be able to issue as much hryvnia as they wish simply by injecting seemingly legitimate payments into the payment system of the NBU.
If Kyiv is willing take such a step and assuming that Kyiv has the technical ability to stop the payment system in Crimea, on the very next day the entire financial system in the peninsula will grind to a halt. And this is where the Russian army might be used. Inside the Central Bank of Russia (CBR) there is a special department called "Field Services," which is designed to handle the accounts and organization of payments for Russian military units. It is the Ministry of Defense which decides when to create the new structural units and where to place them. Some of those units may by even mobile. Such units were used, for example, in Chechnya in 1995-1998 when the Russian civil service and central bank were unable to operate in this region.
It seems reasonable to assume that such units have already been established and that the necessary staff are being assigned to them 2, along with necessary technical equipment and security codes. If that is really so, then by the end of the first day an autonomous payment system can be established on the peninsula. And just one day later banks will be able to open their corresponding accounts. After a week or two, all organizations and business based in Crimea will be able to open new banking accounts.
This payment system will use the Russian ruble as a legal tender. The initial amount of rubles will arrive thanks to generous Russian financial assistance to Crimean government. And this amount should be enough to pay pensions and the salaries of public servants, not to mention all other expenses of the Crimean budget, including payments for water, gas and electricity supplied by Ukrainian companies.
If Kyiv is only able to block (that is, control) all monetary transfers from Crimea but does not retain the ability to hinder the functioning of the payment system, it is conceivable that for some short period of time there will be two disjoint payment systems in Crimea operating side by side—one denominated in rubles and one in hryvnia. But Russian authorities as well as Crimean banks and companies will be interested to stop the second system and limit payments to rubles as soon as possible.
Crimean authorities have already announced that for approximately six months they plan to allow parallel cash circulation of the Russian ruble and Ukrainian hryvnia on the peninsula. This is a reasonable transition period to organize a painless transition to the Russian ruble for cash circulation.
In early 1998, the CBR conducted a redenomination of the national currency (1000:1). And within six months all old banknotes were withdrawn from circulation. Moreover more than 95 percent of the old banknotes were withdrawn within theree months. All instructions of the CBR, which determined the rules of the parallel circulation of old and new banknotes, were of a high quality, and this template almost certainly will be used in Crimea.
That’s why there should no be any particular problems with the transition of cash circulation into rubles. During this period an official UAH/RUB exchange rate likely will be announced, most likely a fixed rate (a floating is possible, but it is technically more difficult and might lead to social discontent among those citizens who don’t move into ruble salaries right away). The fixed exchange rate will be used to convert monetary stocks (both of households and legal entities) during the transition period as well as for the dual prices nomination in stores—that is, quotations of prices for goods in rubles and hryvnia simultaneously. Households will be able to pay for goods and services in any currency since the prices should be equal. If the transition to the ruble payment system in Crimea is accomplished quickly there probably will not be any difficult paying salaries to 200,000 public sector employees and 524,000 pensioners. All the necessary databases are available in Crimea. If the Russian authorities allocate sufficient funds, the technical procedure of payment of salaries and pensions will not change. It is possible that in the early days such payments cannot be executed due to delays in establishing the right technical procedures. In such circumstances, one would expect Crimean authorities simply to pay salaries and pensions (wholly or partly), using cash as a transition mechanism.
The overall price of annexation of Crimea for the Russian budget is a topic worthy of an entirely separate discussion. Briefly, any estimates should be based on a set of basic assumptions (for example, the deficit of the regional budget and pension system will be financed by Russia; pensions and wages in the public sector will be increased to their average level in Russia). The costs of such moves would amount to at least 90-100 billion rubles per year (approximately 2.5-2.7 billion dollars). This amount does not include any future investment projects that might be implemented by Russian authorities (power generation, road construction, modernization of sea ports, construction of a Kerch—Taman bridge, etc.).
In any event, the overall Crimean expenditures likely will not create a heavy burden for Russia’s public finances. The federal budget of Russia for 2014 is 14,565 trillion rubles (400 billion dollars) on the expenditure side. Although the budget envisages a fairly small deficit for the year (390 billion rubles) it is still possibly that the budget will end in surplus. The devaluation of the ruble by 10 percent since the beginning of the year may yield another 350-400 billion rubles on the revenue side.
The challenges of integrating Crimea, economically speaking, are fairly modest. The political costs are another matter entirely, of course.
Notes
1 There were two well-known episodes of this type. One was called “the emission race.” As the Soviet republics started to undermine central authorities in Moscow, they were able to gain control over the units of the then USSR’s central bank (Gosbank), which was able to issue unlimited amount of rubles. That role became one of the sources for the hyperinflation that ravaged the country from the end of 1991 until 1992. This process was stopped only in August 1993 when the Central Bank of Russia issued new Russian ruble and separated Russian payment system from that of other republics. The second episode was called "Chechen avisos." During the first war in Chechnya in 1991-1994 criminal groups had obtained security codes for the payment units of the CBR. That allowed them to make false payment to other regions of Russia and to withdraw the funds.
2 Russian authorities might also assign migration officers to these units who would use simplified procedures to issue Russian passports to residents of Crimea. Technically speaking foreign nationals are obligated under current law to apply for Russian citizenship using special procedures and then wait for five years for approval. Presumably Russian President Vladimir Putin will issue a special decree, which will simplify the procedure. Moreover, Russian authorities have promised to pay Russian pensions to Crimean pensioners (although applying for a Russian passport may be a precondition).
Sergei Aleksashenko, the former deputy chairman of the Russian Central Bank, is a visiting fellow at Georgetown University.
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