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GKO/OFZ Market
Forecast

GKO/OFZ Market

he beginning of March 1998 was marked by further reduction of yields on government securities. Both Russian and foreign investors continued to buy GKOs, causing GKO prices to increase faster than usually. A characteristic weeklong cycles were observed on the market. On Mondays and Tuesdays, before a government securities auction, government securities prices grew slightly slower, while yields on GKOs increased slightly. On Wednesdays, a significant amount of funds accumulated in non-competitive bids made it possible for the issuer to carry out primary placements rather successfully. Strong demand for government securities which was not fulfilled at auctions was felt during secondary trading on Thursdays, which was confirmed by a significant growth of funds in market participants’ accounts. On the same day, the largest growth of yields on government securities was observed. By the end of each weak, the situation on the exchange usually stabilized.

GKO Turnover, Weighted Average Yield and Volume of Funds Reserved by Market Participants,

in Secondary Auctions in 1998

n the middle of March, yields on GKOs reached a new level. This was accompanied by the Central Bank’s decision to reduce its refinancing rate from 36 to 30% per year. Most market participants regarded the new refinancing rate as the upper limit on fluctuations of yields on GKOs during the next few months. However, this opinion changed soon because the mood of dealers changed noticeably. It should be pointed out that the beginning of spring is traditionally a difficult period for the GKO/OFZ market. Significant price and yield fluctuations were observed on the GKO/OFZ market during this period in previous years.

GKO/OFZ Market Development

hough in March 1998 the situation was not destabilized as significantly as in 1996 and 1997, the stability of the domestic debt market was upset during that period. After a six-week-long growth of securities prices, investors began profit taking and the average weighted yields on GKOs began to grow. A new turn in Russia’s political instability caused by the dismissal of the Russian government caused additional tension during trading sessions in the second half of March. Immediately after the dismissal of the Russian government was announced, the yields on "long" GKOs at maturity increased to 32% at secondary trading sessions, exceeded the refinancing rate for a short time. However, they began to decrease soon and amounted on average to 29% per year during the March 23 trading session.

Public Debt on Bonds and Its Growth Rates

s distinct from March 1997, when yields on GKOs increased from 27 to 36% per year within two weeks, the average weighted yield on GKOs at maturity practically did not change in March 1998. Stabilization and a slight increase in yields which followed during the reviewed period were explained mostly the fact that the issuer consistently refused to attract funds to the budget from the government bonds market. While in the first quarter of 1997 the Ministry of Finance’s net revenues amounted to 14.7 billion rubles (in new prices) and half of this amount was received in March, in the first three months of 1998 financing budget deficit through GKO/OFZ issue amounted to only 0.7 billion rubles. Moreover, net revenues turned out to be negative (-122 million rubles) in March. In the previous month, a record number of GKOs, nearly 4.7 million, were redeemed through the issue of coupon bonds, whose issue reached the maximum during the last five months.

Average Term of State Bonds Debt

owever, it should be explained that net revenues received in March were calculated without taking into account the interest paid on coupons of OFZ-PD with a maturity of several years, which are not circulating on the market and are kept in the Central Bank’s portfolio. A year ago, on March 15, the government’s 79.8-billion-ruble debt to the Central Bank, which arose in the first years of economic reform, was rearranged into 13 issues of OFZs with a 10-percent annual coupon to be redeemed in 2001 through 2013. The Central Bank managed to sell a part of the five "shortest" issues on the secondary market. Since only these OFZ issues are included in the calculation of the volume of government securities market officially updated by the Central Bank, FM experts took into account only coupon interest payments (3.07 billion rubles) for these five issues when they estimated the issuer’s net revenues in March.

Structure of Monthly GKO/OFZ Issues (March 1998)

s of March 31, the debt to GKO/OFZ holders amounted to 454.6 billion rubles, including 289 billion rubles (63.6%) owed to GKO holders, 80.9 billion rubles (17.8%) owed to OFZ-PD holders, 4.6 billion rubles (10%0 owed to OFZ-PK holders and future coupon interest payments amounting to 39.1 billion rubles (8.6%). The share of debt to OFZ-PD holders changed the most significantly in March. During that period, it grew by 16%.

Structure of State Bonds Debt

t the March auctions, the Ministry of Finance followed the same primary placement pattern which it had already used earlier. Every Wednesday, it offered one OFZ-PD issue and one issue of "long" GKOs to investors. The total issuance of the first type of securities amounted to 4 to 4.5 billion rubles at nominal value, while the total issuance of the second type of securities amounted to 8.5 to 10 billion rubles. In March, the issuer placed four new issues of twelve-month GKOs, one issue of OFZ-PDs and three additional tranches of coupon bonds issued earlier. It seems that such a scheme of holding double auctions is optimal for the Ministry of Finance. It will most probably continue to use this scheme in the future, provided that market conditions are favorable for the issuance of "long" securities. The share of OFZs in the total amount of securities issued will gradually grow and replace an even larger number of discount bonds.

ealers were slightly more active during secondary trading sessions in March than in February. The total transaction volume grew by 20% to 78 billion rubles, while the average daily transaction volume grew from 4.1 to 4.6 billion rubles. The distribution of transaction volumes at trading sessions in the reviewed period was more even, compared to the previous month. If we do not pay attention to a brief livening of market operators on the last Thursday of March (total transaction volume exceeded 9 billion rubles on that day due to additional placements and ahead-of-schedule redemption) a trend towards a decrease in government securities transactions volume was clearly visible during that period.

Weighted Average GKO and OFZ Yield in Primary Auctions

s distinct from February, the structure of traded government securities issues practically did not change in March. Transactions with GKOs with maturities shorter than three months accounted for 10-40% of daily transactions volumes in March, reaching their maximum on Tuesdays before a regular redemption. A share of transactions with six- and twelve-month GKOs also increased slightly in March, from 25-30% during the first weeks of the month to 35-40% at the end of the period under review. Simultaneously, the share of transactions with coupon bonds decreased slightly. Of all government securities issues, the issues closest to maturity or the GKO issues that had just been placed showed the greatest transaction volumes in March. At the end of the month, the dealers’ preferences shifted in favor of the former.

Trade Volume of GKO (for Maturity Date) and OFZ in 1998

n March, the issuer became more active on the secondary market. Moreover, the character of orders issued by the Ministry of Finance to its GKO/OFZ agent, the Central Bank, changed significantly. Additional placements of government securities had been the only type of transactions carried out by the issuer on the secondary market for more than six months. They were needed either to attract additional funds to the budget or to fulfill high demand for government securities. In March, the Ministry of Finance began to effectively use another way of the management of the government debt - the ahead-of-schedule repurchase of GKOs.

Bond Auctions (March 1998)

ields on GKOs with different maturities changed gradually in March. The average yield on six- and twelve-month GKOs did not decrease below 24% per year, while yields on shorter GKOs did not exceed this level. When analyzing changes in government securities prices in March, one can notice that the index of prices for government securities with longer maturities behaved more erratically, while prices for these securities moved in different directions. Nonetheless, the level of GKO/OFZ prices grew significantly in March, as in February.

Price Index of GKO (for Maturity Date) and OFZ in 1998

Yields on GKOs and OFZs at Maturity (for Maturity Date) in 1998

hile GKO prices increased on average by 3.5%, the 114th GKO issue placed in late February ensured the maximum monthly yield on investments (nearly 5.4%). Successful speculations on weekly GKO prices could earn investors 7.5% in March, with more than two-thirds of the amount earned in the first half of the month. Issue 26002, which ensured a yield amounting to more than 10.7%, led the growth of prices for coupon bonds. It should be mentioned, however, that it was difficult to realize this profit through the purchase and sale of these securities due to very low volumes of transactions with these securities. OFZ-PD prices grew on average by 6% in March, with the first week of the month accounting for most of this growth. During the rest of the month, yields on coupon bonds fluctuated. As the supplied chart shows, the index of prices for these bonds was tied to 1 in the third decade of the month. Counting of government securities indices began from 1 at the first trading session in January. This shows that those who bought OFZ-PDs at the beginning of January and held them until the end of the first quarter only retained their funds and earned no profit.

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Forecast

udging by the redemption schedule that existed on April 1, redemption volumes will be distributed evenly in the nearest weeks (7 billion rubles a week on average), which is lower than the March level. However, sharp fluctuations in the volumes of payments (from 9.3 billion rubles in the middle of the month to 5.5 billion rubles at the end of the month) became visible in the second half of May. The schedule of redemption for later periods is also uneven. It makes it possible for the issuer to issue additional tranches of relatively "short" GKOs with maturities at the end of July or in the middle of October. The shortest term for which the issue could place a significant GKO issue (larger than 7 billion rubles) decreased to seven an a half months by April. This was because in March the Ministry of finance did not issue securities with maturities in the middle of November and a corresponding date remained vacant. In the next few months, the Ministry of Finance will have to pay the following amounts to securities holders: 35 billion rubles in April, 29 billion rubles in May and 33 billion rubles in June. The debt transferred to the second half of 1998 amounts to 160 billion rubles.

Weekly Schedule of Coming Repayments

t was announced at the beginning of April that the Ministry of Finance would continue to pursue a tough policy on the domestic debt market in the second quarter of 1998. This meant that government securities would be issued only in the amount needed to refinance previous borrowings. Under such conditions, the development of the GKO/OFZ market will be determined by two major factors. The first factor will be the behavior of non-residents. Their share in the market grew noticeably in February through March. According to some estimates, by the beginning of April it non-residents accounted for more than 30% of the debt to securities holders. This meant that non-residents’ share of the market returned to the pre-crisis level of the late summer and early autumn of 1997. The comparison of the current situation with that in the similar period last year shows that non-residents’ share of the market may grow to 40% by the beginning of July if the inflow of non-residents’ funds into the market will be as intensive in the next few months as it was a year ago. In this case, yields on GKOs will decrease at the same rate at which they decreased a year ago and will eventually drop to 14-15% per year. Moreover, the net inflow of non-residents’ funds into the government securities market will amount to $5.5 billion in the second quarter of 1998, according to estimates of FM experts.

The second factor that will determine the situation on the GKO/OFZ market in 1998 will be the behavior of Russian market participants. It is evident that the above-described scenario, which is oriented towards government securities purchases by non-residents, is too optimistic, especially in view of political uncertainty in Russia caused by the dismissal of the Russian government. Last year’s experience shows that inflow of non-residents’ funds is necessary for making yields on GKOs to decrease. However, the opposite statement s incorrect: an increase in yields on government securities can be caused by a change in the mood of Russian market participants alone, even if non-residents’ refrain from large-scale transactions. The reasons that can make Russian investors sell government securities may include their worries about slow growth of Russia’s foreign currency reserves or a disparity between Russia’s foreign currency reserves and non-residents’ share of the domestic debt market. These circumstances periodically increase Russian investors’ expectations of faster devaluation of the ruble. If the exchange rate do increases, the domestic debt market may be in serious trouble.

Taking into account the above considerations, it can be assumed that a relatively calm scenario will be the most acceptable one for the majority of market participants. Evidently, If no external factors, such as inflow or outflow of non-residents’ funds and the flight from the ruble, affect the GKO/OFZ market in the near future, yields on GKOs will probably remain at the end-of-march level of 27% per year for a long time. It is evident that such yields will be acceptable to both Russian and foreign market participants under conditions of low inflation and a forecasted 7- to 11-percent annual growth of the dollar rate. Nonetheless, there will still be a potential for further reduction of yields on GKOs to 22-24% per year. Such yields can be achieved in as soon as May 1998, provided that the government crisis is resolved, political situation in Russia is stabilized and non-residents’ gradually resume purchases of government securities.

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