By Darya Korsunskaya

SIMFEROPOL, Crimea Mon Mar 31, 2014 12:06pm EDT

(Reuters) - Prime Minister Dmitry Medvedev flaunted Russia's grip on Crimea by flying to the region and holding a government meeting there on Monday, angering Ukraine and defying Western demands to hand the peninsula back to Kiev.

The Ukrainian government denounced the visit, a few hours after the latest round of crisis talks between Russia and the United States ended inconclusively, as a "crude violation" of the rules of diplomacy.

Russia said it had pulled some troops back from near Ukraine's eastern border, a move that could ease tension in the worst East-West standoff since the Cold War. The Defence Ministry said a motorized infantry battalion was being withdrawn from the region. A battalion numbers between 300 and 1,200 men.

However, Medvedev's visit taunted Western leaders by underlining their inability to force President Vladimir Putin to relinquish Crimea, seized after the overthrow of Russian-backed Ukrainian President Viktor Yanukovich and annexed on March 21.

Accompanying Medvedev, outspoken Deputy Prime Minister Dmitry Rogozin - targeted by Western sanctions - left no doubt about the symbolism of the trip, saying on Twitter: "Crimea is ours. Basta!"

Putin and German Chancellor Angela Merkel discussed by telephone ways of stabilizing Ukraine and another former Soviet Republic, Moldova. A Kremlin statement quoted Putin as calling for a comprehensive solution that would a "blockade" on Moldova's breakaway region of Transdniestria.

Soon after landing in Crimea's main city of Simferopol with many members of his cabinet, Medvedev held a government meeting attended by Crimean leaders and outlined moves to revive the region's struggling economy.

"Our aim is to make the peninsula as attractive as possible to investors, so that it can generate sufficient income for its own development. There are opportunities for this - we have taken everything into consideration," he said, sitting at a large desk with Russian flags behind him.

"And so we have decided to create a special economic zone here. This will allow for the use of special tax and customs regimes in Crimea, and also minimize administrative procedures," he told the meeting, broadcast live on Russian state television.

In comments that made clear Russia had no plans to give back the region, he set out moves to increase wages for some 140,000 state workers in Crimea, boost pensions, turn the region into a tourism hub, protect energy links, end reliance on Ukraine for water and improve its roads, railways and airports.

The visit appeared aimed to cement and celebrate Moscow's acquisition of Crimea, which has a narrow ethnic Russian majority and was transferred from Russia to Ukraine by Soviet leader Nikita Khrushchev in 1954.

NO AGREEMENT AT TALKS

Ukraine sent a protest note to Moscow over Medvedev's trip, declaring that "the visit of an official person to the territory of another state without preliminary agreement is a crude violation of the rules of the international community."

Medvedev landed in Simferopol hours after U.S. Secretary of State John Kerry met Russian Foreign Minister Sergei Lavrov in Paris late on Sunday and reiterated that Washington considered Russia's actions in Crimea "illegal and illegitimate".

Kerry said resolving the crisis over Ukraine depended on a Russian troop pullback from Ukraine's borders. The United States has put the number near the eastern border at up to 40,000.

Russia has described the troop buildup as part of war games. Ukrainian Major-General Oleksandr Rozmaznin, told journalists in Kiev that the number of troops near the border had been reduced but that might just reflect a scheduled rotation of conscripts.

German Foreign Minister Frank-Walter Steinmeier said the slight reduction in troop numbers was a small signal that the border situation was becoming less tense.

The United States and European Union have imposed sanctions on Russian officials since a March 16 referendum in which Crimea voted for union with Russia. The West says the vote was a sham as Russian forces had taken control of the region.

Russia has shrugged off the sanctions, though the absorption of Crimea and its 2 million residents creates a new financial burden as Russia struggles with slow growth, rising inflation, a weak currency and unusually high capital flight this year.

Medvedev indicated he hoped Crimea, which he said had "colossal prospects" for tourism income, would become self-sufficient.

A senior local economic official said the impoverished Black Sea peninsula hopes for an economic leap forward with large-scale investments, state subsidies and tax breaks from Moscow.

"We have underdeveloped infrastructure and poor people. Now all this has just come to an end and we will finally start dynamic development," Rustam Temirgaliyev, Crimea's First Deputy Prime Minister, told Reuters.

The Crimean economy generates some $4 billion a year but is highly dependent on energy supplies from Ukraine and suffered widespread blackouts last week, which Temirgaliyev denounced as a plot by Kiev.

Boosting the local economy and tourism faces big obstacles, not least a decision by the European Union this month to impose heavy tariffs on goods from the annexed region.

Of the 6-8 million tourists a year who visited Crimea before Moscow intervened, more than 60 percent were from Ukraine, many who came by train on state-funded holidays for public sector workers, and only one-quarter from Russia.

Finance Minister Anton Siluanov said last week that Russia would spend up to 243 billion roubles ($6.82 billion) in Crimea this year, to be financed from the budget reserve.

The ultimate cost of its action in Crimea is likely to be far higher: analysts in a Reuters poll last week slashed their forecasts for Russian economic growth.

Crimea, home to Russia's Black Sea Fleet, has an estimated 55-billion-rouble budget deficit, and has relied on Ukraine for 85 percent of its electricity, 90 percent of its drinking water and much of its food.

It biggest industry is tourism as one of the former Soviet Union's few warm seaside resorts but making it an attractive destination for Russians will be more difficult, since most travel by air and have a wider choice of holiday destinations.

Crimea would have to compete with Bulgaria, Turkey, Greece and Egypt, as well as Russia's own brand new $50 billion Black Sea Olympic resort in Sochi.

A young woman in Simferopol who gave her name only as Yulia welcomed Medvedev's visit: "It's always good when top figures pay us visits because they usually bring money and this is what we need."

(Additional reporting by Gabriela Baczynska in Simferopol, Steve Gutterman in Moscow and Richard Balmforth, Natalia Zinets and Pavel Polityuk in Kiev; Writing by Timothy Heritage; Editing by Peter Graff and Paul Taylor)