KRAMATORSK, Ukraine—The military observers from the Organization for Security and Cooperation in Europe taken hostage by pro-Russia militants in eastern Ukraine will go free only in exchange for prisoners tied to the anti-Kiev uprising, the self-appointed head of the armed activist movement in the country's southeast said.

Denis Pushilin, head of the pro-Russia militant movement in the southeast Donetsk region that has seized government buildings and demanded a referendum on the territory's future, made the announcement in...