Russia holds war games near Ukraine as Merkel warns of catastrophe
* Russia shows no sign of backing down on Crimea
* Merkel sees "catastrophe" unless Moscow changes course
* Kerry warns of "serious steps" if referendum goes ahead
Russia launched new military exercises near its border with Ukraine on Thursday, showing no sign of backing down in its 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 emotionally worded speech, German Chancellor Angela Merkel warned of "catastrophe" unless Russia changes course.
"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 said in a speech in parliament. "No, this would also cause massive damage to Russia, economically and politically."
U.S. Secretary of State John Kerry said a "serious series of 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 vice chancellor, Sigmar Gabriel, a member of the normally Russia-friendly Social Democrats (SPD), also struck a tough tone, saying it was up to President Vladimir Putin to decide whether he wanted to return to the Cold War.
Putin declared Russia's right to invade its neighbour on March 1, even as Russian troops were already seizing control of Crimea, a Black Sea peninsula with a narrow ethnic Russian majority and a Russian naval base.
The pace of events has moved rapidly on the ground, perhaps signalling an effort by Moscow to turn the annexation into a fait accompli before the West could coordinate a response.
Pro-Moscow separatist politicians, who took power in the province after armed men seized its parliament on Feb. 27, are planning to hold a referendum on union with Russia as soon as Sunday. Western countries say the vote is illegal.
Russia has taken territory from its former Soviet neighbours in the past with no serious consequences - most recently in 2008 when Putin invaded Georgia and seized full control over two breakaway regions with little international opposition. 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 once based as a KGB spy in Merkel's native East Germany - has had the closest relationship in the past.
Merkel was initially more cautious than other Western leaders in responding to Russia's seizure of Crimea, but has emerged in recent days as among the toughest critics of the Kremlin, pushing the European Union to match U.S. sanctions.
The 28 member bloc has agreed on a framework to impose travel bans and asset freezes on Russian individuals and firms. It is expected to implement the measure and announce the target list as soon as Monday, the day after the Crimean referendum.
EU action is critical because Europe does 10 times as much trade with Russia as the United States, buying most of Moscow's gas and oil exports. Brussels had been widely seen as far less likely to act than Washington, both because of Europe's closer economic ties with Russia and because of the 28-member EU's laborious process of decision making and internal divisions.
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 for this year down to just 1 percent from 3 percent on Thursday, blaming the political tension over Ukraine for fuelling capital flight that would cripple investment. It said $45 billion had already left Russia this year, mostly from Russians stashing money abroad because of uncertainty.
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 and is up by more than a third this month.
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 Paralympic Games he is hosting in Sochi that Russia was "not the initiator" of the crisis.
The Russian Defence Ministry said about 8,500 of its troops were taking part in new military exercises near the Ukrainian border, testing artillery and rocket launchers, practicing firing at a conventional enemy up to 15 km (9 miles) away.
It was the second big military exercise Moscow has ordered since the crisis began; the first, involving large infantry units, began days before Russian forces seized Crimea and ended three days after Putin declared his right to invade.
Among efforts by the West to isolate Russia politically, the Organization for Economic Cooperation and Development, a 34-member rich nations' club, announced on Thursday it was suspending membership talks with Russia, under way since 2007.
RESPOND IN KIND
Russia has pledged to respond in kind to any Western sanctions. China's ambassador to Germany warned of a "spiral" of sanctions hurting both sides.
But European leaders appear to be calculating that the damage to Russia would be far worse than to Europe. EU-Russian trade makes up 15pc of Russia's economy and just 1 percent of Europe's. Although EU countries, and Germany in particular, depend on Russian natural gas imports, winter is nearly over and storage tanks are full after a mild season.
German Finance Minister Wolfgang Schaeuble said on Wednesday he was not worried about serious damage to Germany's economy.
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.
The crisis over Crimea began after pro-Russian president Viktor Yanukovich fled power in Kiev and pro-European politicians took charge, following three months of demonstrations.
A Ukrainian businessman who had wide influence under Yanukovich, Dmytro Firtash, was arrested in Vienna at the request of the United States, which has been investigating him since 2006.