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The Current State of the Russian Financial Markets in 2002 and the Prospects for the Developments in 2003, May 20, 2003

1. Macroeconomic Developments

The Instable Stability of the Russian Economy: the Reality or Fortune? (the Prospects of the Oil Export Model Development)

The results of the Russian economic developments in 2002 can be access as positive. The growth rate of the produced real GDP was 4.3% (here and below we refer on the estimates of the State Statistic Committee - Goskomstat RF), industrial production - on 3.7%, capital investments - on 2.6%. The federal budget surplus was 1.44% GDP, households' real disposable income increased on 8.8% and consumer price index - 15.1%. The real growth of the key macroeconomic indicators was lower than expected and moreover much lower the planned level. Meanwhile the fact of the positive growth rates (which has been keeping during last four years) changes as the status of Russia in the world economy as the expectations of the domestic enterprises and households for the better changes.

Table. Russia's Key Economic Indicators

  1995 1996 1997 1998 1999 2000 2001 2002 2003*
GDP, real growth rates, in % YOY -4.0 -3.4 0.9 -4.9 5.40 9.0 5.0 4.3 3.8
Industrial Production, real growth rates, in % YOY -3.3 -4.5 2.0 -5.2 11.0 11.90 5.00 3.7 3.20
Capital Investments, real growth rates, in % YOY -10.0 -18.0 -5.0 -12.0 5.30 17.40 8.70 2.60 3.80
Households' Real Disposable Income, growth rates, in % YOY -16 1 6.3 -16.1 -12 13.4 9.8 9.2 7.8
Retail Turnover, real growth rates, in % YOY -6.2 0.3 4.9 -3.4 -6.1 8.8 10.7 9.1 7.50
Exports, $ bln. 82.4 89.7 86.9 74.4 75.6 105 101.6 106.9 102
Imports, $ bln. 62.6 68.1 72 58 39.5 44.9 53.8 60.5 64
Balance of Trade, $ bln. 19.80 21.60 14.90 16.40 36.10 60.10 47.80 46.4 38
Source: State Statistic Committee, CBR, * - EU "Vedi" forecast

The year of 2003, on the one hand, get the hope to the enterprises and the households of the positive national economy developments supported by the market reforms. Such positive movements should provide the households' real disposable income growth, the cut of the inflation rates, the improvement of the enterprises' financial positions. On the other hand, the probability of the external threats realizations is still high (as the foreign debt payments or the drop of the oil prices under the high dependency of the national finance from the external conditions), which potentially can change the state of Russian economy - up to the fall of production output and inflation acceleration. In any case the developments of Russian economy still will be determined by external factors and by unsolved domestic problems (the arrears of structural reforms and the weakness of the financial sphere).

Russian economy is still significantly oriented on the raw materials exports and the volume of export's revenues strongly determine the growth rates of domestic production and the financial welfare of the enterprises. The existence of the exports' oriented model of the national economy provides the steady revenues of the export-oriented companies, the positive foreign trade balance (under the real exchange rate control) and relatively high "financial reserve" for the economic reform realizations. Inside this model of the economic development the dependency of financial positions of the government and enterprises will be indefinite and depend on the external factors.

Formally (from the world economy and partly from the international investors' point of view) the major problems of the Russian economy in 2003 will be the timely serve of the external debt and the financial sphere stabilization (at least, to avoid the domestic financial crises). It means, that Russia has to be positive debtor on the world capital market, the stable raw material provider and should keep its financial and political stability. In case of stable external debt service payments (which is equal $17.05 bln. in 2003), providing the effective inflation and devaluation control, the avoiding of the possible defaults (maybe except on the corporative bonds) Russia will keep its own position as attractive country for the international investors. This means the keeping possibility for the sovereign credit rating increase, which will lead to the foreign investments growth - the volume of the foreign direct and portfolio investments and the decrease the rates of return on the external debt bonds.

It is naturally to expect no increase of the foreign investments under the conditions of listed above factors - they appear only as necessity ones. The sufficient conditions will be the providing of the structural reform (for example, the reforms of the natural monopoly, the creation of the competitiveness environment, the realization of the monetary policy targeted to the expansion of the domestic demand and others) as well as the recovery of the effective financial system.

The maintenance or accelerated the rates of growth of Russian production will be determined by the effect of following factors:

- The high level of the world prices on the crude oil and other raw materials;

- The growth rates of the international economy, which are determined the demand on the Russian exports (in physical and money terms);

- The widening of the internal demand and competitiveness of the domestic production.

Listed above factors determine the current state of the national economy, but the Russian government has no possibility to manage them. For example, the volume of the export revenues is strongly depended on external markets. Further, the provided fiscal, monetary policy, the state of national banking system and financial markets are also oriented on the external conditions (first of all, the world oil prices). The estimated world oil prices are put in the basis of state budget as the main scenario variables, which will be determined the volume of expected revenues and expenditures (the same situation has been observed during last four years). It means that the Russia financial sphere and the rates of production will be strongly depended on external factors also in 2003. Moreover, the changes of external factors can contradict the main goals of the Russian developments, but national economy will have to follow world these trends.

Financial Policy in 2002 and its Prospects for the 2003

The parameters of the financial policy in 2002 was formed on the governmental targets, which assumed the consume price index growth on 12-14% and the stable real ruble rate under the expected external and internal conditions. It means, that, on the one side, the high level of the world oil prices should provide the relatively high level of the positive balance of trade ($45 bln. in 2002 compare with $47 bln. in 2001). The supply of the foreign currency (as the export revenues and net foreign investments) significantly exceeded the demand. The exchange rate policy control (i. e. the limitation of the real ruble rate appreciation for the purposes of the imports restrictions and the support of the national exports) constrained the Central bank of RF to provide the open market operations through the purchase of the excess supply of the foreign currency.

Table. Key Indicators of the Russian Financial Sphere

  1999 2000 2001 2002 2003*
Money Supply
Monetary Base, in %, Dec. To Dec. 54.1 60.2 38.1 30.4 25.0
Wide Monetary Base, in %, Dec. To Dec. 64.8 69.5 28.5 33.0 28.0
Aggregate Money Supply (M2), in %, Dec. To Dec. 57.2 62.4 39.2 32.3 24.0
CPI, in %, Dec. To Dec. 36.5 20.2 18.6 15.1 15.0
CPI, in â %, average for the period 86.0 20.9 21.7 16.0 15.3
PPI, in %, Dec. To Dec. 67.3 31.6 10.7 17.1 15.0
PPI, in â %, average for the period 58.9 46.6 19.2 12.4 14.0
Exchange Rate, end of period, RUB/$. 27.0 28.2 30.1 31.8 32.9
Exchange Rate Growth Rates, in %, Dec. To Dec. 69.0 4.4 6.7 5.6 3.5
Average Annual Exchange Rate, RUB/$ 24.6 28.1 29.2 31.5 32.3
Average Exchange Rate Growth Rates, in % 250.0 14.2 3.9 7.9 2.5
Source: CBR, estimations of EU "Vedi"
Note: * EU "Vedi" forecast

Correspondingly, the Central bank of RF provided the significant purchases of the foreign currency to keep the real exchange rate on the acceptable level (in the sense of current economic conditions). Moreover the changes in exchange rate control policy (first of all, the decrease from 50 to 30% of compulsory sale of export revenues) in the second half of 2002 had no effect on the demand and supply balance of foreign currency on the open market. If the volume of the net purchases of the foreign currency of the Central bank RF was $15.7 bln. and the international reserves increased on $8.2 bln. in 2001, than these indicators equaled $17.3 and $11.6 bln. in 2002, correspondingly. Thus the "negative" year of 2002 as it expected in the context of the fiscal and monetary policy turned to be quite "good" contrary the expectations and due to the external factors. As a results the real ruble exchange rate to the USD increased on 6% (with the US inflation), the real ruble exchange rate to euro fell on 7% and the annual average real effective exchange rate (weighted on the volume of export and import operations) increased only on 2% (the real effective exchange rate December 2001 to December 2002 fell on 3%). In fact the real exchange rate has been on the stable level and some changes in the foreign trade structure determined by the demand from the external market on the national exports and on import - from the domestic demand.

Chart. The CBR Operations on the Open Market, $ bln.

Source: CBR, EU "Vedi" estimations Notes: the foreign currency interventions of the CBR equal the volume of purchases of the foreign currency by Central bank of RF on the open market (including the compulsory sales of the export revenues, the operation on the interbank market and on the Moscow Interbank Currency Exchange). The Net Conversion Operations were calculated as foreign currency intervention minus the volume of foreign currency sales to the Ministry of Finance minus the sales of the foreign currency on the auctions for the owners of the "C" accounts. The increment of the international reserves (gold excluded) was practically fully determined by the volume of the net conversion operations (plus the interest income on the international reserves and other income)

The high level of the world market oil prices and other energy resources provided the positive Russia's balance of trade ($59.8 bln. in 2002 compare with $58.1 bln. in 2001). The activity of the Central bank of RF boiled down only to the real ruble rate control - due to the inflation rate control and in the support of the domestic producers. But the money supply increase had happen through the international reserves growth. The volume of the net purchases of the foreign currency by the Central bank of RF was about $9 bln. and the international reserves of RF (gold excluding) increased on $11.6 bln. The differences between the net purchases and the international reserves increment was insignificant and due to interest income on reserves, the fluctuation of the world currencies and other factors (including the REPO operations with the reserves).

Contrary the wide monetary base increased only on $3 bln. in 2002 (using the market exchange rate for the recalculations) and monetary base - on $6 bln. Taking into consideration the fall of the net domestic credit all the increment of the money supply was connected with the growth of the international reserves. In this sense the monetary policy (as in 2000-2001) was fully determined by the external factors. The high level of the oil price and other mineral resources keep the Russian foreign trade balance strongly positive, the excess supply of the foreign currency over the demand and finally the increase of the internationally reserves.

On the other hand, the keeping crisis in the national finance impedes the control on the exchange rate and inflation. The real ruble rate control was connected with the high purchases of the foreign currency by the Central bank of RF on the open market and the high level of the money supply. The high growth rates of the money supply form the inflation potential. (As the example, the inflation acceleration in January-February 2003 was mainly determined by the monetary factors).

One of the key consequences of the weakness of the national banking system and financial markets was the high level of the liquid components in the aggregate money supply. The share of the cash money in circulation exceeded the 35% from total money supply by the end of 2002. This indicator has been on such high level during last decade, except the 1997 when it decreased due to the high development of the bond market. It is evident, that the fall of this indicator can be happen due to the growth of the households' savings in the national banking system and will be stimulate the recovery of the financial market. But the structure of the money supply is still on the same level and, other things equal, the increase of the M2 provoke the threat of the inflation.

Chart. The Structure of the Money Supply, in % to the total (M2)

Source: CBR, EU "Vedi" estimations Notes: the share of the cash money in total money supply has been remained stable and even grew in the last years. Opposite, the share of the banking deposit of the households and enterprises has been cut. The keeping of the share of the liquidity components forms the inflationary and devaluationary potentials. In case of sharp ruble rate depreciation it is possible to expect the growth of the inflation rates.

The position of the Central bank of RF toward inflation regulation has been changed in last year. Central bank of RF in its official documents (for example, in the official presentation of the monetary policy prospects for 2003) divided inflation into two components - monetary and non-monetary inflation. According to the official position the monetary components of inflation will be defined by the money supply and exchange rate growth. The set of these factors should provide the price increase (according to the official estimates) on 8.5% in 2003. The non-monetary components (i. e. the cost-push inflation, connected with price growth on the natural monopoly products and other services) should be in the boundaries defined by the government. The total price growth will not exceed the 10-12% in 2003 according to the official plan. This official target is strongly criticized by the independent analysts, who expected inflation rates at least on the level 14-15% per annum in this year.

Chart. The Growth rates of the Inflation, Devaluation and Wide Monetary Base, % per months.

Source: CBR, EU "Vedi" estimations Notes: the domination of the monetary components of the domestic inflation forms the dependency of the consumer inflation from the exchange rate and money supply growth rates. Analogous the monetary authorities regulate exactly the level of exchange rate and money supply (depending on the external and seasonable factors) for the inflation control.

The prospect of the national finance developments in 2003 will be traditionally determined by the possibility of the two scenarios realization - inertia and optimistic. The contents of the inertia scenario consist of the absence of the crucial changes in monetary sphere. Thus such scenario seems to be the most probable. The realization of the reform envisages the mobilization of the political will and financial resources of the monetary authorities, but such probability is quite low.

Thus we expect that the Russian financial sphere development will traditionally follow the inertia scenario, which is assumed the high dependency of the national finance from the volume of export and the existing problems with the national banking system and financial markets. The low probability of the reforms providing in banking sector and financial markets (or even the absence of the program of such reform) makes the inertia scenario as the most probable for the 2003.

Inside the inertia scenario the set of the factors, which is determined the state of the national finance, will be the same. First of all, the inflation rates will depend on the monetary and non-monetary factors, contents of which fully correspond with the previous years. The monetary factors' impact will be as the extension of the money supply, which structure will be very liquid (due to the low level of banking savings of the households and enterprises). The growth of the money supply will be fully depended on the increase of the international reserves, which is determined by the oil prices, increase the income of the enterprises and households and finally the inflation rates (as it was seen at the beginning of 2003).

The realization of the optimistic scenario demands the politic will and financial resources from the monetary authorities - these components are absent due to the forthcoming elections, the necessity to serve the foreign debt and keeping the social payments from the state budget on at least stable level.

Thus the monetary policy in 2003 will be in fact determined by the external factors. Such parameters as inflation and devaluation rates will be depended on the external factors - as it has been observed during the last three years. Note that the external factors have been the favorable for the financial stabilization in Russia and formed some financial reserve (about $6 bln. in 2002) for the banking and financial market reforms. Russian monetary authorities missed this possibility for the reform realization, but used high budget revenues only for the purposes of the external debt payments and the support of the current social expenditures.

Keeping the world oil prices on the high level is favorable for the financial stability of the Russian economy and the slight real output rate. There is no base to expect the acceleration on the output growth, because there were no changes in structural and fiscal reforms. There is no base for the inflation rates cut expectations - there were no changes in financial sphere. The inertia scenario will copy the previous year (up to the basic points of the key indicators). The worsening of the situation is possible, but the improvement one will be with the probability near nil.

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2. Financial Market Developments

2.1. Foreign Currency Market

The ruble exchange rate as well as the state of foreign currency market was stable in the year 2002. As the result the nominal exchange rate appreciated on 5.5% (under the CPI growth on 15.1%) and the international reserves (including gold) increased on 30%. The set of factors manipulated the exchange rate remained the same compare with 2001 - the external factors (high oil prices) stabilized the ruble rate and the domestic factors (weak banking system and financial markets) kept the devaluation or revaluation risk.

Inaction of the monetary authorities in financial sphere recovery and its further development formed the content of foreign currency policy in 2002. The gist of such policy was the support of the real ruble rate on the stable level or its even slightly appreciation. The low real ruble rate appreciation was targeted on the limitation of the imports and the support of the exports, the stimulation of the foreign investments and the decrease of the inflation rates. The supply of the foreign currency was greater than demand in 2002, which provoke the sharp appreciation of the real ruble rate. For the real ruble rate stability the Central bank of RF had to buy the significant volume of the foreign currency on the open market and proportionally issued new money. The base money increased on 30.4% and money supply - on 32.3% in 2002, which is quite dangerous for the anti-inflation policy.

Table. Selected Indicators of Russian Foreign Currency Market

Years Exchange Rate, end of period, RUB/$. Annual Changes of Exchange Rate, % Annual Changes of Real Ruble Rate*, % Annual Changes of Real Effective Ruble Rate*, % Current Accounts Balance, $ bln. International Reserves (including gold), end of period, $ bln. Annual Changes of International Reserves (including gold), % Monetary Ruble Rate**, end of period, RUB/$ Sufficiency of the International Reserves***, end of period, months Annual Average Oil Price (Brent type), $/bar.
1999 27.0 30.0 1.4 - 25.30 12.50 2% 34 2.40 17.80
2000 28.16 4.3 11.9 18.0 46.29 28.0 125% 26.0 4.3 28.4
2001 30.14 7.0 8.5 9.0 31.70 36.6 31% 25 5.0 24.9
2002 31.78 5.5 6.3 -3.0 34.80 47.8 31% 26.0 8.1 25.0

Source: Central Bank of RF, EU "Vedi" assessments

* - sign "+" - real ruble rate appreciation, sign "-" - real ruble rate depreciation

** monetary exchange rate - the ratio of wide monetary base and international reserves

*** Sufficiency of the international reserves - the ratio of international reserves to the volume of imports (goods and services). The minimum sufficiency level is regarded as 3 months

Chart. Nominal Exchange Rate in 1999-2002, RUB/$

Source: Central Bank of RF

The main targets of the Russian foreign currency policy in 2003 are the same as in 2002 and determined by the necessity of monetary authorities to solve the following tasks:

  • to support the positive production growth rates;

  • to stimulate the foreign investments inflow (direct and portfolio);

  • to provide financial stability, first of all decreased the inflation and interest rates through the real ruble rate appreciation.
  • The listed above tasks are presented indirectly in official documents, but their importance for the national economy developments are evident. These tasks are quite inconsistent for the monetary policy in 2003. On the one hand, the current Russian economic conditions suggest the increase of the exports, mainly of the raw materials. Export of raw materials in less extent depends on the real ruble rate level than the final goods and the effect of the real ruble rate control will be insignificant on the export volume.

    The transfer of the national economy from the model, oriented on fuel-energy export, to the model of the production contains high share of the value added is one of the prior task of the Russian government. In such context the low real ruble rate level turns to be key instrument of the macroeconomic regulation. The relatively low real ruble rate will increase the competitiveness of domestically produced goods, stimulate production and limit the volume of import. (In spite of the real ruble rate appreciation to USD the effective real ruble rate grew only on 2% and the Euro appreciation toward USD was the main factor of import limitation in 2002 - the biggest part of Russian import was from Europe.) Even if the volume of Russian export will be stable in 2003 (and will be on the level as in 2002) the keeping real ruble rate on the same level will in some extent stimulate the domestic production, limit volume of imports and keep positive balance of trade.

    On the other hand, the foreign currency policy targeted on the real ruble rate appreciation has some advantages. Firstly, real ruble rate growth stimulates the increase of foreign investment inflows - direct and portfolio. Current interest rates and the profitability of the industrial enterprises even being real negative in ruble term turn to be the relatively high in foreign currency (for example, in US dollar due to real ruble rate appreciations). Secondly, the real ruble rate appreciation stimulates import of capital goods, which will create the basis for the future economic growth. Thirdly, the real ruble rate increase is the strong and effective anti-inflationary measure and helps the monetary authorities to cut the inflation and the interest rates. Listed above arguments toward strong Russian ruble are quite sensible - the realization of such foreign currency policy allows to keep financial stability, widening the volume of foreign investments and in some sense to form the platform for the future economic growth. The Russian government as the main for the year 2003 chose this scenario - the goal of the monetary policy is the real ruble rate appreciation to USD on 4-6% in the year 2003.

    The disadvantages of such policy are a) the impossibility of Russian monetary authorities to realized all the possible revenues from the strong real ruble rate, which connected with the weakness of the national banking system and financial markets and the result of such policy can be poor - the worsening of the balance of trade and still low investment activity and b) the low dependency of the national fuel-energy export from the real ruble rate, which will keep the volume of export unchanged along with the import increase.

    Auxiliary risk factor can be the possible changes in the Law of foreign currency control and regulation. Three projects of this Law circulated now in Russian Parliament and each of them presents some suggestions of the foreign policy liberalization. The common parts in presented projects are the suggestions of the foreign currency regulations liberalization, which differ only in some parts, but in general they include the proposals for the monetary authorities to liberalize the regulation and control for the current and capital foreign operations. These projects reflect sooner the palsy of the Russian monetary authorities to resists the positive external shock connected with the high oil prices and impossibility to accumulate the high revenues from the foreign trade for the economic development purposes. Logically the foreign trade liberalization should follow by the steady improvement of the real sector and of fundamental indicators of financial sphere. Thus the appointment by the Russian Parliament one of existed project of the Law concerning foreign activity regulation will create the additional threat for the currency crisis in case of changing the foreign situation (first of all, the drop of world oil prices). Last case assumes the cut of the foreign currency supply, the increase of the demand on it and further destabilization on the domestic foreign currency market.

    Thus the realization of any kind of foreign currency policy in Russia will face the objective obstacles connected with the existed problems in the national finance - the dependence of the Russian economy from the raw material exports, weakness of the banking system and financial markets, the impossibility to use the interest rates as the regulation instruments and other problems.

    As a target of the providing foreign currency policy in 2003 the Russian government will oriented on moderate real ruble rate appreciation - on 4-6%. At the same time the key indicator of the federal budget was the annual average exchange rate on the level of 33.7 RUB/$ under the condition of the average oil price level 21.5 $/bar. for the contract price for the Urals type. This target means, that the nominal ruble exchange rate should not exceed the 34 RUB/$ by the end of 2003.

    Presented above governmental guides reflect the key parameters of the monetary policy for the year 2003. These parameters (including the exchange rate, inflation rate, the money supply growth and others) will have the direct impact on the real sector, the balance of revenues and expenditures of the main economic agents (government, enterprises, households and rest of the world) and as the result - on the output growth rates and the condition of the national finance.

    The official forecast of the exchange and inflation rates seem to be inconsistent, because all of the major indicators depend on external factors - the last ones will finally determine the parameters of the Russian economic developments in 2003. For example, we expect, that the officially forecasted annual average exchange rate will be lower than the presented one in the federal budget project (33.7 RUB/$). The command of this level can be happen only due to the sharp drop of the oil prices - in practice it may lead to the deep crisis on the domestic foreign currency market and moderate devaluation of the national currency rate due to negative external shock. Such shock along with the expected liberalization of the foreign currency regulation can provoke the ruble devaluation, because Russian monetary authorities could not resists the negative influence through the open market operations, but only through the administrative control (due to the weakness of the national banking system and the shortages of the existed financial instruments). In the case of the stable and relatively high oil prices the annual average ruble exchange rate will be lower than the officially forecasted level (i. e. about 32.0-32.3 RUB/$) and this level will not exceed 33 RUB/$ at the beginning of the year 2004.

    2.2. The Federal Bonds Market (GKO/OFZ)

    The role of the government is traditionally high under the export-oriented model - the state owned natural monopoly influence the cost of production and monetary authorities near fully determine the national financial sphere. In this sense the domestic debt market developments traditionally define the inflation rates, interest rates, the condition of the banking system and financial markets. Under the export model the financial regulation had been provided through the ruble exchange rate and the interest rates level is not defined by refinancing rate but by the rates of return on the federal bonds. As a result the federal bonds market (beside the goal of the budget deficit financing) has stimulated the savings growth, decrease of the liquid components of the money supply, which create the basis for the capital investments increase and the cut of the inflation rates.

    Thus the domestic debt market has played the key role in Russian financial system in the last decade. Being the most liquid and the less risky instruments the federal bonds defined the minimum level of the financial resources cost in the national economy - the bonds' yields regulations provided the direct effect on the interest rates of the banking loans to the real sector and of banking deposits of households and enterprises.

    The federal bond markets had been in crisis up to the year 2002 that was determined by the consequences of the financial crisis in August 1998 and the absence of the monetary authorities in the financial sphere recovery. As a result the aggregate turnover and liquidity of the existed financial instruments sharply decreased. The financial sphere was characterized by the shortage of the financial instruments and the excess of the free financial resources, that determined the existed gap between the level of savings and investments and provoked the capital outflow, limited the excess of the enterprises to the banking loans and affected the possibility of the national monetary authorities to control the inflation and devaluation rates. The keeping of such situation will limit the capabilities of the Russian government to control inflation (we see no roots for the inflation rates cuts in the current year compare with the previous one, cause no principal changes had been done in financial sphere).

    The further developments of the national financial markets are strongly depended on the federal bonds, first of all, from their liquidity and rates of return. The relatively full recovery has been observed only in the year 2002 (after the financial crisis in 1998), when under the existed market infrastructure the growth of the domestic public debt was fixed (the federal budget revenues on bonds' issue exceeded the redemption payments). The stable exchange rate, relatively low inflation rates and federal budget surplus allow the Russian monetary authorities to sharply increase the volume of the federal bonds' issues.

    The significant bonds' emission, the yield of which had been lower than the inflation rates, was determined by the keeping the high volume of the free financial resources in national banking system and by the appearance of the new government owned market participant - State Pension Fund. The role of the State Pension Fund could be dominated in 2002, taking into consideration the volume of the disposable assets and the size of the domestic debt market. But the State Pension Fund active invested their resources into federal bonds only in the first half of 2002 (about 14 bln. RUB), after that the Russian monetary authorities limited such activity (to support narrow domestic debt market) and the investment activity of the State Pension Fund was switched on the Russian external debt bonds.

    Table. The Federal Budget Revenues from the Domestic Bonds' Issue (GKO/OFZ) in 2002, bln. RUB.

      GKO Issued by Auctions GKO Issued on the Secondary Market OFZ-FD Issued by Auctions OFZ-FD Issued on the Secondary Market OFZ-AD Issued by Auctions OFZ-AD Issued on the Secondary Market Total GKO/OFZ Issue
    January 2.817 0.431   0.178     3.426
    February 4.189 0.446 2.291 0.377     7.303
    March 3.779 0.008 1.867 0.379     6.032
    April   0.183 3.861 7.157     11.200
    May 1.907 1.309   8.942 2.326 1.471 15.956
    June   1.358 3.847 4.717 2.440 2.789 15.151
    July 3.439 0.604 3.230 3.059   2.539 12.871
    August 2.721 0.105 2.197 0.085 0.731 0.355 6.194
    September 3.258 0.197 3.710 2.585 1.165 4.089 15.006
    October 3.258 0.059 5.116 1.767 3.331 6.901 20.433
    November 1.675 0.170 5.142 0.217 3.792 0.671 11.667
    December 2.593     0.007 4.574 1.468 8.642
    Total 29.637 4.869 31.260 29.471 18.360 20.283 133.880

    Source: Ministry of Finance of RF, EU "Vedi" estimates

    Note: GKO - short-term federal bonds, OFZ-FD - medium-term federal bonds with the fixed coupon

    The high level of the free financial resources in the national economy along with the steady surplus of the federal budget deficit allow Russian monetary authorities to provide the emission of the federal bonds in April-June and in September-November - in the volume of more than 10 bln. RUB per month (in October 2002 this indicator reached 20.43 bln. RUB). Compare with the year 2001 Ministry of Finance of RF increased its share on the secondary market - the additional sale on the secondary market exceeded the 40% from the total issue. The total issue of the federal bonds in 2002 was 142.59 bln. RUB (on the face value or on 2.7 times higher than in 2001), and the net federal budget revenues equaled 133.88 bln. RUB.

    Table. The Federal Budget Expenditures on Bonds' Payments (GKO/OFZ) in 2002, bln. RUB

      GKO Redemption OFZ-PD Redemption and Coupon Payments OFZ-FD Redemption OFZ-FD Coupon Payments OFZ-AD Coupon Payments Total on Market Circulated GKO/OFZ Payments on the Non-market OFZ-PD
    January 4.732     1.412   6.144 0.141
    Fabruary 2.182   9.542 1.743   13.467 1.111
    March 3.000 0.190   1.623   4.813 1.043
    April 1.508     1.412   2.920 1.043
    May     9.542 2.081   11.623 1.025
    June     9.542 2.345   11.887 1.043
    July 8.271     1.412   9.683 0.534
    August 8.255     1.529 0.491 10.275 0.467
    September     9.542 2.268   11.811 0.577
    Octomber     9.542 0.954   10.497 0.615
    November 9.864 0.189   1.913 0.918 12.884 0.401
    Desember       1.838 0.262 2.100 0.762
    Total 37.812 0.379 47.712 20.531 1.670 108.104 8.763

    Source: Ministry of Finance of RF, EU "Vedi" estimates

    Note:OFZ-PD - medium-term federal bonds with the float coup payments, non-market OFZ-PD bonds - the federal bonds in the Central bank of RF portfolio.

    Beside the traditional short-term federal bonds (GKO) with the term to maturity around 5-8 months and medium-term bonds (2.5-3.5 years) with the fixed coupon payments (OFZ-FD) the Ministry of Finance of RF suggested the investors in 2002 the new instrument - amortized federal bonds (the redemption will be provided partly during the last two years of their circulation). Being the most “long-term” bonds OFZ-AD met with the relatively high demand from the investors and the share of such bonds rapidly reached 20% from the total market. Central Bank of RF also introduced new instrument in 2002 - the medium-term bonds (OFZ) from its portfolio with offer (the right of buy back through the some months on the face value). The volume of sales and turnover of such bonds were insignificant because of low rates of return.

    The existence of the wide set of the bonds was reasonable in the period of the market recovery, but now different types of federal bonds provoke only the arbitrage deals between the professional market participants and misleading other investors. Cutting the types of the federal bonds and emission the so called indicative bonds will stimulate the investment activity on this segment in greater extent, will structured the interest rates on the financial market (at least for the more clearance of the information)

    Chart. Federal Bonds’ Secondary Market Turnover 9left scale, bln. RUB) and Rates of Return on Medium-turn Bonds (OFZ, right scale, % per annum) in 2002.

    Source: Ministry of Finance of RF, EU “Vedi” estimations

    Thus if the net revenues of the Ministry of Finance of RF from the federal bond issue in 2001 was -54.7 bln. RUB, than this indicator was positive and equaled 25.8 bln. RUB in 2002 due to large-scale bond emission. The volume of the debt on federal bonds grew on 57.9 bln. RUB (or on 36%) and reached 217.0 bln. RUB on January 1, 2003. Note that the volume of the short-term (GKO) and medium-term (OFZ-FD) bonds had been stable and all the increment had been provided by the new type of bonds OFZ-AD (amortized bonds).

    According to the Law of the Federal Budget for the year 2003 the Ministry of Finance of RF will have the surplus on the domestic bond market (volume of the issued bonds will exceed the redemption payments). Such position is determined by the necessity of the widening the domestic debt market (in the context of sterilization the free financial resources in the national economy and of stimulating the recovery and developments of the other segments of the Russian financial market). In addition the large-scale external debt payments also turn to be the stimulus of the domestic debt market developments - at least as the insurance from the negative shocks. As at the beginning of the year 2003 the Ministry of Finance of RF will provide the redemption payments as the 91.14 bln. RUB on the OFZ and GKO on the face value and also pay the coupon income on 20.5 bln. RUB. Due to the new planned issue the payments may increase on 15-30 bln. RUB in 2003. Moreover, the domestic debt market can be widening through the cut of the state property and reserves sales.

    It is evident, that the federal bond market (GKO/OFZ) will be stable in 2003 and the Ministry of Finance of RF will face no problem with the redemption payments. The rates of return on the federal bond will insignificant fluctuate with the main downward trend. If the yields on these bond were 14-18% per annum in 2002, than they will fall up to 11-15% in 2003. The greater fall of the rates of return seems to be risky due to state of the national banking system (first of all, State Saving Bank - Sberbank as the main investor on the federal bond market). In case of the problem with the issue procedure of the new bonds the Russian monetary authorities have the reserve as the State Pension Fund, which resources can be invested into state bonds, balance the demand and supply of the bonds under the acceptable rate of return.

    Under such conditions the main task of the Ministry of Finance of RF will be the increase of the maturity date of the issued bonds. The Russian government will be able to issue 10 years or even longer bonds due to the presence of the state strategic investors and the shortage of the financial instruments on the domestic market. As the result of the new issue will be the monopolization of the domestic debt market by the government, which will liquidate the competition on this segment. Such “virtual” stability can affect the changes on the external markets or domestic political instability, but the consequences will be less hard, than in 1998 due to the narrow federal bond market.

    Municipal Bond Market in 2002

    The full recovery of the Russian municipal bond market was realized in fact only in 2002 - the four year since the system financial crisis in August 1998. More intensive recovery of the financial markets was affected by the weakness of the national finance, mainly keeping the banking and financial crises. Lack of the support from the monetary authorities (legislative and financial) determined the realization of the scenario, according which the national banking system and financial markets recovered by themselves. As a result the Russian banking system reached the pre-crisis level only due to some indicators in the middle of 2002, but some others were significant below that level (for example, the banking own capital was below pre-crisis level on near $5 bln., or on 30%). The volume of secondary market turnover on federal and municipal bonds were much lower than in 1997-1998 as well as their liquidity and real return (see the table below).

    The favorite state of the world raw material market provided the stabilization of Russian finance (for example, the steady surplus of the state budget, increase of the international reserves and others). Moreover, the internal political stability and positive production real growth rates conduced the improvement of the Russia’s international credit ratings and formed the basis for the foreign investments inflow.

    Listed above factors provided the increase of the demand on the municipal bonds. Only banking investments into municipal bonds increased from 8 bln. RUB on 01.01.02 to 17 bln. RUB. on 01.01.02 and the volume of the banking loans grew from 16 to 27 bln. RUB.

    The total volume of the municipal bonds’ issue in 2002 was about 20 bln. RUB (here and below we referred to the data of the municipal bonds circulated on Moscow interbank currency exchange - MICEX and S.-Petersburg currency exchange - SPCE), which twice exceeded the same indicator in 2001. The large market issues have been provided except Moscow and S.Petersburg, by Republic Bashkortostan, Khanty-Mansiisk region, Republik Komi, Leningrad region, Ufa city and others. Quite solid looks the list of the Russia’s region, which was fixed the prospect of the bonds’ emission in ministry of finance of RF on 2002 - 46 (only 26 in 2001).

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