By Polina Devitt and Gabriela Baczynska
MOSCOW/KIEV (Reuters) - Russia fought back on Wednesday over new U.S. and EU sanctions imposed over Ukraine, where fighting between Moscow-backed rebels and government troops has intensified since a Malaysian airliner was shot down.
The confrontation between Moscow and the West entered a new phase this week, with the United States and European Union taking by far the strongest international steps yet against Moscow over its support for Ukraine's rebels.
New EU and U.S. sanctions unveiled on Tuesday restrict sales of arms and equipment for the oil industry, while Russian state banks are barred from raising money in Western capital markets.
Moscow said the sanctions were "destructive and short-sighted" and would lead to higher energy prices in Europe and damage cooperation with Washington on international affairs.
On Wednesday it banned imports of Polish fruit and vegetables and said it might expand the ban to the entire EU.
On the ground in Ukraine, heavy fighting between government forces and the separatists has been taking place near the site where Malaysian flight MH17 crashed into wheat and sunflower fields on July 17, shot down by what Washington and Brussels believe was a missile supplied by Russia.
Kiev accused the pro-Russian rebels on Wednesday of fortifying the area, including with land mines, to prevent the site from being properly investigated. The land mine report could not be independently confirmed. Ukraine is party to a treaty banning land mines; Russia is not.
The new Western sanctions mark the first time Washington and Brussels have adopted measures designed to hurt the overall Russian economy, after weeks of narrow steps targeting only specific individuals blamed for Russia's Ukraine policy.
"Russia's actions in Ukraine and the sanctions that we've already imposed have made a weak Russian economy even weaker," U.S. President Barack Obama said in Washington on Tuesday. "If Russia continues on this current path, the costs on Russia will continue to grow."
German Economy Minister and Vice Chancellor Sigmar Gabriel said the measures would hurt the European economy but would hurt Russia more. The price was worth paying, he added: "At a time of war and peace, economic policy is not the main consideration."
Even so, Russian markets rallied, as investors deemed the sanctions less severe than feared, with Russian stocks, bonds and the rouble rising.
The Russian Central Bank said it could support banks that were hit by sanctions. Russia's second-largest bank, VTB, said it would find funding outside of the EU and United States, using currencies other than euros and dollars.
But bankers said Russian firms had been effectively frozen out of global lending, not just in the West, leaving the Russian state as their only source of funding.
"Right now, all banks are acting the same. No group is any more cautious or sanctions aware: It's all too important. Asian banks are the same as European or U.S. banks in this respect," a London-based banker at an Asian bank said.
A banker said VTB had been unable to find a lender for a $1.5-$2.0 billion refinancing loan since a previous round of U.S. sanctions on July 16. VTB declined to comment.
The first European economic victims of the trade war were Polish apple growers, who sell more than half their exports to Russia. Moscow is by far the biggest importer of EU fruit and vegetables, buying more than 2 billion euros' worth a year.
Russia said the ban, covering most Polish fruit and vegetables, was for sanitary reasons and it would look into expanding it to the rest of the EU.
Poland's agriculture ministry called it "political repression in response to the sanctions", and said it would seek compensation from the EU.
Moscow denies Western accusations that it has armed and supported rebels who are fighting Ukrainian forces in eastern Ukraine. But Western countries say flows of heavy weapons across the frontier have only increased since flight MH17 was shot down on July 17, killing all 298 people on board.
Ukrainian military spokesman Andriy Lysenko said the rebels were digging in for battle near the crash site: "They have brought a large number of heavy artillery there and mined approaches to this area. This makes impossible the work of international experts trying to start work to establish the reasons behind the Boeing 777 crash."
Lysenko said 363 Ukrainian troops had been killed and 1,434 wounded since Kiev's "anti-terrorist" operation began.
Ukraine's fragile economy is also taking a battering. Parliament will consider austerity budget amendments on Thursday that are key to receiving IMF support and to assign more financing for the army.
Despite what the West says is an increase in armaments for the rebels, government troops have advanced since the start of the month, when they pushed the rebels out of their best-defended stronghold, the town of Slaviansk. Since then, Western countries say thousands of Russian soldiers have returned to the border from which they had withdrawn weeks ago.
NATO military commander General Philip Breedlove said the number of troops along the border was now "well over 12,000", and weaponry was also building up.
Valentyn Nalivaichenko, the head of Ukraine's SBU security service, said arms including Grad multiple rocket launchers were flooding across the border.
"Grads come in from Russian territory, take pre-agreed positions and fire on the Ukrainians. This is hundreds of rocket launches. They come in, shoot around like in a safari. This is serious military aggression," he told a news conference.
The rebels are mainly holed up in the cities of Donetsk and Luhansk, which they have declared capitals of two independent "people's republics", as well as in the surrounding countryside.
A team of Dutch investigators say fighting has prevented them from reaching the crash site. Most bodies of victims were shipped out in refrigerated train cars days after the crash and flown to the Netherlands, but some human remains are still believed to be lying untended in the fields.
The UN Secretary-General called for an immediate halt to hostilities so international teams could access the site.
The sanctions are intended to persuade President Vladimir Putin to back down from a months-long campaign to seize territory and disrupt his neighbour, an ex-Soviet state of 45 million where a pro-Russian president was toppled by street protests in February.
But Putin, whose popularity at home has surged since he annexed Ukraine's Crimea peninsula in March, has shown no sign of backing down from support for the rebellion in parts of Ukraine that he has referred to as New Russia.
The EU had been reluctant to agree tighter sanctions - it has 10 times more trade with Russia than the United States does, and all 28 members must agree EU decisions - until the downing of the plane en route from Amsterdam to Kuala Lumpur.
Two thirds of the victims were Dutch, turning the Netherlands - the biggest importer of Russian oil bound for the rest of the EU - into a strong supporter of tougher measures.
The EU sanctions have nevertheless been crafted so as to inflict the minimum hardship on Europe: Russia's oil industry has been targeted but not the natural gas that fuels European industry and lights its cities. Existing contracts are excluded from the arms embargo, allowing France to move ahead with delivery of a warship it has already sold for the Russian navy.
Still, big Western companies, especially in the energy sector, will feel pain. Britain's BP, the largest foreign investor in Russia with a near 20 percent stake in oil company Rosneft, said its business could be hurt.
French oil major Total, which owned 18 percent of Russian joint venture partner Novatek at the end of June, said on Wednesday it had halted buying Novatek shares the day of the plane crash. In April, Total had predicted the Novatek venture would make Russia its biggest source of oil and gas by 2020.
"We stopped buying shares in Novatek the day of the plane accident, considering all the uncertainties that this event could lead to," Total Chief Financial Officer Patrick de La Chevardiere said. Novatek, which was hit by U.S. sanctions the day before the Malaysian plane crashed, said it was examining the impact of sanctions on ventures with foreign partners.
A statement from Russia's foreign ministry highlighted what is among European leaders' principal concerns.
"By going on a sanctions spree, Brussels, by its own will, is creating barriers for further cooperation with Russia in such a key sphere as energy. This is a thoughtless and irresponsible step. It will inevitably lead to an increase in prices on the European market," it said.
Although Europe buys huge amounts of oil and gas from Russia, its exports to Russia are far more limited. Nevertheless it is vulnerable to pressure in particular sectors, such as German manufacturing and British financial and legal services.
According to European Commission figures, the EU sold 28 percent of its fruit exports and 21.5 percent of its vegetable exports to Russia in 2011, totalling more than 2 billion euros.
Tomasz Solis, deputy head of the Polish Fruitgrowers Association, told Reuters the trade war was no surprise: "The political situation in Ukraine would sooner or later have affected our relations with Russia."
(Additional reporting by Tessa Walsh in London, Elizabeth Piper, Vladimir Soldatkin and Thomas Grove in Moscow, Aleksandar Vasovic in Donetsk and Natalia Zinets in Kiev, Wiktor Szary and Jakub Iglewski in Warsaw and Julia Fioretti in Brussels; Writing by Peter Graff and Will Waterman)