KALININGRAD, Russia (Reuters) - The Baltic Sea outpost of Kaliningrad was once touted as Russia’s future Hong Kong: separated from the mainland, with a special status that would allow it to thrive through trade.

A general view shows the Baltic Sea port of Kaliningrad, Russia, July 18, 2015. Picture taken July 18, 2015. REUTERS/Maxim Shemetov/File Picture

But for Igor Pleshkov, who employs 300 workers in a cement factory in this region of 1 million people wedged between EU members Lithuania and Poland, the future now looks dark.

He has watched his business wither in recent months, brought low by protectionist measures imposed by Moscow in retaliation for Western sanctions.

“The Russian economy has hit bottom, but who would have thought the Russians would start digging?” Pleshkov, 46, says, quoting a line he says he first heard from a German engineer who had come to work in Kaliningrad.

The medieval port of Koenigsberg, once a center of Protestant learning and trade on the Baltic coast, was in fact part of Germany until World War Two, when it was bombed to rubble by the allies, besieged by the advancing Red Army and captured in the final months of the war.

Its entire German population fled, died or was expelled, and the region known as North Prussia was annexed by the Soviet Union, renamed Kaliningrad, rebuilt with stark housing blocks and repopulated by Russians.

The breakup of the Soviet Union left it separated from the rest of Russia, its crumbling roads now clogged with second-hand Volkswagens and Skodas bought cheaply in Europe, rather than Russian Ladas and Volgas.

While the region was heavily militarized and largely closed to outsiders during the Soviet period, it grew the shoots of prosperity in recent years. Kaliningrad now has some 80,000 small and medium-sized firms, many involved in manufacturing, thanks in part to special trade status with its EU neighbors.

Companies like Pleshkov’s Thomas-Beton were permitted to import raw materials duty free to make products that could be sold back in mainland Russia.

But that status was allowed to lapse on April 1 this year. And that followed a series of other moves to restrict trade since 2014, when Russia seized Ukraine’s Crimea, the United States and EU imposed punitive financial sanctions, and Moscow responded with counter-sanctions of its own.

DIFFERENT SITUATION

Kaliningrad is hardly the only part of Russia that is hurting. Throughout the past two years, a collapse in global prices for energy exports have created a grinding economic crisis. The rouble has fallen, raising the price of imports.

But while some parts of Russia have been partly shielded from the pain by the fall in imports, which has boosted consumption of home-made goods, Kaliningrad’s close ties to its EU neighbors means it has suffered more than other areas.

Since 2014, Russia’s overall trade volume has fallen by a third, but Kaliningrad’s has plummeted by nearly half. Industrial output, which had previously outpaced the rest of Russia, fell more than anywhere else.

Russia’s counter-sanctions included a ban on most EU food imports, wrecking an industry of processing imported meat into canned lunch meat for sale across Russia, which had accounted for nearly a fifth of Kaliningrad’s manufacturing.

In the case of Pleshkov’s cement company, the situation became worse in recent months when the government squeezed his supply of inexpensive cement by demanding complicated certificates for imports.

The reform was intended to protect Russian companies but had the opposite effect in Kaliningrad, Pleshkov says.

“They are closing off markets, but they do not understand that the Kaliningrad region is in a little bit of a different geographical situation,” said Pleshkov.

NOT SPECIAL ANYMORE

The Moscow government speaks of refocusing eastwards on trade with countries like China. But that is small comfort here on Europe’s doorstep.

“Cooperation with Australia looks as likely to yield success as the current model at this point in time,” gloomily quipped Ilya Shumanov, a former director of Kaliningrad’s Transparency International office.

Many locals blame the region’s government for not having a plan to support business after the end of the special status regime, beyond relying on government subsidies, set at 66 billion rubles ($1.02 billion) for this year.

Anton Likhanov, the region’s newly appointed prime minister, an energetic young politician from Moscow, said there were some “rough edges” that needed smoothing out.

“We need to change the structure because we have depended too much on import components,” Likhanov told Reuters.

Kaliningrad should not aim to become a manufacturing hub assembling products from imported EU materials, which would only be sustainable if workers stay low paid, he said.

“I don’t want Kaliningrad to become an appendage to the EU with cheap labor and low costs -- that would be some kind of neo-colonialism,” said Likhanov. Instead, it should focus on high-quality manufacturing using Russian raw materials.

GOOD TIMES OVER?

For years, Kaliningrad residents enjoyed special permission to travel back and forth across the Polish border. But Poland suspended that pact in July, citing security concerns, and says it won’t renew it anytime soon.

That hurts shops in Kaliningrad, many of which have long passed off smuggled Polish meat as local meat. Consumers are demoralized.

“I am certainly a patriot, but I would go from time to time to Poland,” said Vladimir Kuzin, a former Kaliningrad city official. “Because what they call cheese in our stores is not cheese.”

Vadim Khlebnikov, editor of local news portal rugrad.edu, said everything had become more expensive last year, apart from potatoes and cheap frozen fish.

Russian tourists still come in summer to enjoy Kaliningrad’s sandy coast. But statistics show restaurants have been closing. Many are empty.

Meanwhile, Moscow has been busy turning the already highly militarized region into a fortress, beefing up its military presence amid heightened tensions with NATO. Some locals say that will only isolate Russia further.

Pleshkov, who calls himself an optimist, says he fears the region’s best times are behind it.

“The government tried to cover up the problems with the help of quasi patriotism, suggesting it wasn’t those fools who didn’t know how to manage their own country, but those evil people abroad who drove us into this situation,” he said.

($1 = 64.8653 rubles)