Russia holds war games near Ukraine; Merkel warns of catastrophe

By Stephen Brown and Timothy Heritage BERLIN/MOSCOW (Reuters) - Russia launched new military exercises near its border with Ukraine on Thursday, showing no sign of backing down on plans to annex its neighbour's Crimea region despite a stronger than expected drive for sanctions from the EU and United States. In an unusually robust and emotional speech, German Chancellor Angela Merkel warned of "catastrophe" unless Russia changes course, while in Ukraine a man died in fighting between rival protesters in a mainly Russian-speaking city. In Berlin, Merkel removed any suspicion that she might try to avoid a confrontation with Russian President Vladimir Putin, "We would not only see it, also as neighbours of Russia, as a threat. And it would not only change the European Union's relationship with Russia," she told parliament. "No, this would also cause massive damage to Russia, economically and politically." U.S. Secretary of State John Kerry said serious steps would be imposed on Monday by the United States and Europe if a referendum on Crimea joining Russia takes place on Sunday as planned. Merkel, a fluent Russian speaker who grew up in Communist East Germany, has emerged in recent days as a leading figure in threatening tough measures against Moscow. Her foreign minister, Frank-Walter Steinmeier, said European states would draw up a list over the weekend of Russians who will face visa restrictions and asset freezes. Putin declared Russia's right to invade its neighbour on March 1, as Russian troops were already seizing control of Crimea, a Black Sea peninsula with a narrow ethnic Russian majority and a Russian naval base. Events have moved rapidly, perhaps signalling an effort by Moscow to turn the annexation into a fait accompli before the West could coordinate a response. In the Ukrainian city of Donetsk, a young man was stabbed to death and more than a dozen people were in hospital after pro-Russian and pro-European demonstrators clashed. The violence was the worst since last month's overthrow of Moscow-backed president Viktor Yanukovich. But in an apparently conciliatory move, Russia backed deployment of an OSCE monitoring mission in Ukraine, including Crimea, the Swiss chairman of the European rights watchdog said. ARMED MEN The leader of pro-Moscow separatist politicians, who took power in Crimea after armed men seized the regional parliament on February 27, predicted a strong vote in favour of union with Russia in Sunday's referendum. "We have a survey by renowned Ukrainian and Crimean polling experts showing clearly and plainly that more than 80 percent of people in Crimea are ready to join the Russian Federation," Crimean prime minister Sergei Aksyonov told Reuters. Aksyonov, whose election in a closed session of the regional parliament is not recognised by Kiev, dismissed opponents' accusations that he will fix the referendum on Moscow's orders. "We guarantee that all aspects of European law will be followed, including security for voters," he said in an interview. Western countries dismiss the vote as illegal. "The referendum on Sunday will have no legitimacy, no legal effect, it can have no moral effect. It is a piece of political theatre that is being perpetrated at the barrel of a gun," Daniel Baer, the U.S. ambassador to the OSCE, told reporters in Vienna. Russia has taken territory from its former Soviet neighbours in the past with no serious consequences - in 2008 it invaded Georgia and seized two breakaway regions. But if Putin was hoping for a similarly tepid response this time, he may have misjudged. In particular, he seems to have alienated Merkel, the Western leader with whom Putin - a German speaker who was once a KGB spy in East Germany - has had the closest relationship. Merkel was initially more cautious than other Western leaders on the Crimean crisis, but in recent days she has pushed the European Union to match U.S. sanctions. EU action is critical because Europe does 10 times as much trade with Russia as the United States, buying most of its gas and oil exports. The prospect that EU measures could be implemented as soon as Monday has weighed down the Russian economy. STASHING MONEY ABROAD Goldman Sachs revised its prediction for Russian economic growth this year down to 1 percent from 3 percent, blaming the tension over Ukraine for capital flight that would cripple investment. It said $45 billion had already left Russia this year, mostly Russians stashing money abroad. The Russian stock market hit a four-and-a-half-year low on Thursday and is down 20 percent since mid-February. The cost of insuring Moscow's debt against default rose to its highest level in nearly two years. The crisis has already forced several Russian firms to put plans on hold for public offerings to raise cash abroad. Yet none of that appears to have slowed down Putin, who told officials of the Winter Paralympic Games he is hosting in Sochi that Russia was "not the initiator" of the crisis. The Russian Defence Ministry said 8,500 troops were taking part in new military exercises near the Ukrainian border, testing artillery and rocket launchers. It was the second big exercise Moscow has ordered since the crisis began; the first, involving 150,000 troops, began a few days before Russian forces seized Crimea. In a gesture of support for NATO's eastern members, U.S. F-16 fighter jets landed at Poland's Lask air base on Thursday. Among efforts by the West to isolate Russia politically, the Organization for Economic Cooperation and Development, a 34-member rich nations' club, announced it was suspending membership talks with Russia, under way since 2007. RESPOND IN KIND Moscow has pledged to respond in kind to any Western sanctions. The prime minister of Lithuania - a former Soviet republic that is now an EU member state, said Russia had suspended food product imports through its port of Klaipeda. But European leaders appear to be calculating that the damage to Russia would be far worse than to Europe. EU-Russian trade makes up 15 percent of Russia's economy and just 1 percent of Europe's. Although EU countries depend on Russian gas imports, storage tanks are full after a mild winter season. Diplomatic lines have been open between Russia and the West throughout the crisis: U.S. Secretary of State Kerry and Russian Foreign Minister Sergei Lavrov spoke on Thursday as they have nearly every day. They are due to meet in London on Friday. Russia's top general discussed Ukraine with the chairman of NATO's Military Committee by telephone on Thursday, the Interfax news agency said. The crisis over Crimea began after Yanukovich fled Kiev and pro-European politicians took charge, following three months of demonstrations. In Strasbourg, the European Court of Human Rights warned Russia and Ukraine that any military action that harmed civilians would violate an international convention signed by both countries. (Additional reporting by Lina Kushch in Donetsk, Aleksandar Vasovic in Simferopolm, Fredrik Dahl in Vienna, Andrius Sytas in Vilnius, Gilbert Reilac and Alexandria Sage in Paris; Writing by Peter Graff; Editing by Giles Elgood and David Stamp)

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