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Econometric Unit VEDI
Alexei VEDEV, Ph.D.
Econometric Unit "VEDI"

The key indicators of the Russian economic and financial spheres will be defined both by the governmental decisions and current trends. These trends were formed after the system financial crises in August 1998. The components of that crisis were currency, banking, external payments and financial markets crises. The measures to overcome these crises will be in the basis of the key trend in Russian finance in the year 2000 and in the medium-term.

Russian monetary authorities undertake the significant activity to solve foreign debt crises through the talks with IMF, Paris and London Clubs and foreign investors into domestic bonds. The volume of foreign debt payments is one of the main scenario parameters and will define the balance of payments condition, the essential volume of the foreign currency, which Central Bank of RF will buy on the market or transfer from the international reserves and, as a consequences, the money supply.

A currency crisis was liquidated in general through the administrative regulation introduction. The exchange rate control policy of the Central Bank of RF was targeted on smooth ruble rate dynamics, stabilization of the international reserves level (not less than $6-7 bln. excluded gold or 2-3 months of imports) and the necessity to buy foreign currency on the domestic market to serve external debt. Central Bank of RF bought $5.5 bln. on the domestic market and net purchases (including the operations with the ministry of finance of RF) was about $3.8 bln. Thus the money supply through the Central Bank's purchases of the foreign currency was 102 bln. RUB or 65% of the wide monetary base increment.

Note, that some tactic approaches, which the Central Bank of RF used for foreign currency purchases were quite dangerous. For example, during 1999 the monetary authorities used all tops and bottoms to intervene the market or to buy foreign currency. Moreover, sometime the Central Bank provoked such instability to stimulate the overbought position of market participants. Systematic use of such policy can create the situation of uncontrolled attack on the ruble.

Chart. Ruble Exchange Rate in 1999

Source: EU "Vedi"

Banking crises is still existing. Banking transfers system was recovered directly after crises at the end of 1998. The condition of the other banking services, low deposit growth and banking investment activity indicates the maintenance the crisis.

Banking reform can be conducted by the three basic direction (or on the combined scenario): the Russian commercial banks survive on them own, the government finance and control the banking reform or the liberalization of the foreign banks enter to the domestic market.

The realization of these scenarios has some limitation. The recovery of banking capital and the cover of the losses after financial crises 1998 will take a long time. Moreover, taking into consideration the low level of the banking managers, households mistrust to the Russian banks, depression of the financial markets, the revival of the Russian commercial banks by themselves can be consider as a long-term prospect.

The active participation of the monetary authorities in the banking reform assumes at least two components. First, this is the creation of the strategic program of the banking reform, including banking supervision, risk management and deposits' insurance. Second, this is the money for banking reform. All these components are staying out now.

The liberalization of the foreign banking access to the domestic market looks quite attractive. But there is an apparent collision in this scenario. Both Russian monetary authorities and foreign banks are interesting in accumulation the household's deposits - in rubles and foreign currency using the reputation of the western banks. Russian monetary authorities are interesting in using such liabilities as ruble investments on the domestic market. Contrary, the foreign banks are interesting in placement the assets abroad, taking into consideration all risks.

As the main scenario of recovering banking system appears the banking revival on them on. The realization of this scenario go along with high financial risks and keeping the losses on the significant level (accumulated losses of the banking system was 34.1 bln. RUB on December 1, 1999), low investment activity.

The condition of the financial markets have not been changed in principle within the last 18 months and as the features can be pointed high risks, wide set of the interest rates and low market turnovers. The recovery of the effective functioning of the financial markets should be connected with normalization of the financial condition of the commercial banks as the market operators, trade floors, equity issuers, risks and interest rates. But the Russian commercial banks could not recover their liabilities, the trade floors was partly reinstate (excluding derivative sections), the investments portfolio forming was random.

The equity and bonds issuers' policy was impure in 1999. Federal government finished the restructuring procedure of the state bonds (GKO/OFZ); the secondary market was recovered, but with high spreads and low daily turnovers. Local administrations, which had avoided the default on the municipal bonds (first of all, Sankt-Petersburg and Moscow administrations), continued to support the existing bonds and to issue the new ones. Some attempts was launched to issue corporate bonds (RAO "EES Rossii" - energy monopoly, RAO "Gazprom" - natural gas monopoly, Lukoil - one of the biggest oil company), nominated in foreign currency. High risks, depression on the financial markets and relatively low yield of return governed the failure of these attempts.

Thus high risks and low liquidity characterized Russian financial markets. Key risks were connected with market price fluctuations, low market turnovers, high inflationary and devaluationary expectations. As a result all set of the interest rates became segmented and information about these rates inadequate. Note that starting from 1992 it had been no discussion on the interest rates or effective rate management. Moreover the monetary authorities during last five years use interest rate only for exchange rate control or for maximization net budget revenues through state bonds issuing.

For example, during 1995 - 1998 the yield of return on state bonds (GKO) defined the minimum opportunity to cost. This situation seemed to be quite natural, because this market was relatively liquid with daily turnover more than $1 bln. But that level of the minimum interest rate was extremely high and made unobtainable the banking loans to the enterprises.

Chart. Real Interest Rates in 1996-1998

Source: EU "Vedi"

There is a lack of information on the interest rates. Russian financial market is split on three segments. First segment includes the banking transactions with the foreign currency and with the Central Bank of RF. The banking investments in the foreign currency on the buy-and-hold basis return 30.75% per annum. Note that in some periods the investments were extremely effective (due to "saw-edged" dynamics of the exchange rate). Investments in foreign currency were in red, but with low risk and liquid.

Central Bank of RF suggested the market participants the deposits with different term - form overnight to 3 months deposits. Such deposits, taking into account the financial instability, were with the lowest risk, but real interest rates on them were negative. Commercial banks preferred overnight deposits (more than 60% from total). Interest rates on overnight deposits were 3%, on one month - 17%, on 3 months deposits - 20% per annum at the end of 1999. At the same time the interest rates on households' time deposits in Sberbank (State Saving Bank) were 28-30% (average term was 3-4 months). Moreover, according to the polls' data (Russian Economic Barometer) average interest rates on the liabilities were 23% per annum. Taking into account the required reserves transfers the banking operations on this segment brought losses.

Table. Interest Rates on Central Bank of RF Deposits, Inflation and Devaluation Rates (annualized) in 1999.

  Interest Rates on the Liabilities * Interest Rates on the Households' Deposits ** Overnight Deposits in Central Bank 30 days Deposits in Central Bank Loans to the Enterprises * Inflation Devaluation
January 24 40-45 18 - 52 102.0 113.32
February 24 40-45 10 25 53 49.2 13.81
March 27 40-45 3 25 53 33.6 68.24
April 27 40-45 3 23 52 36.0 0.00
May 23 40-45 3 20 48 26.4 13.91
June 22 40-45 3 20 47 22.8 -11.29
July 25 40-45 3 20 51 33.6 -0.99
August 24 28-31 3 20 51 14.4 30.76
September 23 28-31 3 20 47 18.0 11.61
October 23 28-31 3 20 47 16.8 47.90
November 23 28-31 3 18 47 14.4 22.11
December 23 28-31 3 17 47 15.6 21.26
1999           36.5 30.75
* - Polls data of the Russian Economic Barometer
** - State Saving Bank (Sberbank) data
Source: EU "Vedi", CBR

Second segment includes different parts of the Russian financial markets - interbank loans, federal and municipal bonds, equity market. The key point is that the yield of returns on this market could not be considered as the indicators of the interest rates for the economic agents due to risks and turnovers. The main risks connected with high spreads, the possibility of default, low liquidity.

For example, the Russian equity price index (RTS index) increased more than 200% in USD, but the $0,3-$0.5 mln. capital inflow or outflow could easily affect the price trend. The average yield of return on state bond was more than 70%, on Sankt-Petersburg municipal bonds - from 100% till 200% per annum. But the fixed income market was low liquid and with high spreads.

Yields of Returns on the most liquid shares in the Russian Trade System
(buy-and-hold approach) % per annum in USD.

Issuer Yield of Return in 1999,
% per annum
spread,
%*
Capitalization on 31.12 99,
mln. USD
Oil and Gas Industry
Gazprom** 128 - 6342
Lukoil 221 -2 9476
Lukoil (priv) 269 -9 456
Slavneft-MegionneftegazÁ 475 -257 123
Surgutneftegaz 396 -2 8067
Surgutneftegaz (priv) 498 -4 807
Tatneft 303 -5 768
Electricity
RAO EES Rossii 293 -1 4925
RAO EES Rossii (priv) 300 -12 104
Ircitskenergo 92 -15 388
Kubanenergo -13 -193 18
Kusbasenergo 165 -66 55
Mosenergo 120 -3 1126
Communications
Rostelekom 195 -5 1506
Rostelekom (priv) 186 -31 194
Sankt-Petersburgtelecom -4 -149 126
Sankt-Petersburgtelecom (priv) -33 -190 7
Machinery
GAZ 94 -15 158
Metallurgy
Norilski Nikel 1650 -15 1140
Norilski Nikel (priv) 2768 -53 107
* - Ratio of difference between the best bid and the best ask
** - Accordind MSE trades' results
Source: EU "Vedi"

Table. Yields of Returns on Sank-Petersburg Municipal Bonds in 1999
(buy-and-hold approach), % per annum in rubles.

Terms to maturity January February March April May June July August September October November December Effective Yield of Return, % per annum*
Less than 1 month 73 68 58 36 36 23 23 22 29 29 15 20 42
Less than 3 months 200 170 129 63 86 46 34 24 41 49 25 30 104
Less than 6 months 221 311 170 60 227 69 74 30 91 62 34 37 194
Less than 9 months 142 415 101 60 258 78 48 45 105 138 85 32 219
Less than 12 months 142 415 35 67 258 78 5 61 41 113 112 51 188
Maximum Yield of Return 221 415 170 67 258 78 74 61 105 138 112 51 284
* - On actual monthly interest rates (assuming recapitalization of interest)
Source: EU "Vedi"

The third segment of the Russian financial markets includes the loans to the enterprises, promissory notes and the banking debt trading. This segment can be characterized as with high risks and lack of adequate information, but with extremely high interest rates. The high level of the risk connected with the different kind of defaults.

In spite of investment growth in 1999, fixed by Russian Statistical Agency - Goskomstat RF) the significant increase of the banking loans to the enterprises have not been observed. The volume of the banking loans increased on 38% during the first 11 months of 1999 while the loans to the real sectors in foreign currency fell on 25%. Thus the amount of the ruble loan grew on 112% due to the listed factors:

  • Significant command the growth of the wholesales prices (67.3% in 1999) compare with consumer prices - only 36.5%. This means, that the producers could obtain the loans for increase the working capital, which was effective in the nominal terms;
  • Enterprises participation in the banking system recovery. Legal entities as shareholders in the most banks use their resources to provide the loans to the other enterprises.

As a result the volume of the loans to the real sector grew on 38% during the first 11 months. It means, that in real terms the banking loans increased on 3.5% (according to the CPI), but it is more reasonable to recalculate the loans to the PPI - in this case the real loans to the enterprises fell on 25% in 1999.

Chart. The Volume of the Banking Loans to the Enterprises in nominal terms

Source: EU "Vedi"

Note that the scatter of the interest rates was significant. According to the polls data (Russian Economic Barometer) the average interest rates on the loans to the enterprises were 51% and the average loans' term was 4.3 months. The same data source pointed out, that the interest rates decreased till 34% per annum at the end of the previous year. Data collected by the EU "Vedi" shows that the interest rates on the loans to the enterprises were 23-24% per annum in USD. It means, that the interest rates in rubles were on the level of 55-60% per annum, but the risk of devaluation was transferred from banks to the enterprises.

The money supply (M2) increased on 57.2% in 1999. Wide monetary base grew on 65%, the cash in circulation outside of the banking system - on 46%. The money supply growth was due to improvement to the enterprises financial conditions and, as consequences, increasing of the legal deposits. At the same time the households' deposits grew insignificantly and fell in real terms.

The dynamics and structure of the money supply testify to keeping the liquidity preferences of the economic agents. The most forecasts assumed that the real money supply fell and it would be anti-inflationary factor. But the money supply grew in real terms and the money multiplier was stable - 2.13 on the 01.01.99 and the 2.17 on the 01.01.2000. Such liquid structure of the money supply suggests the possibility of inflation and devaluation potential forming. The crucial point for financial stability in 2000 is the households' savings stimulation.

Conclusions

The full recovery of the Russian financial system after the system crises had not happen - the banking crises is still exist, the financial markets are in depression, the money supply structure is liquid. In the case of keeping the current trends in financial sphere the most optimistic (and as "inertia") scenario will be inflation rate on the level of 25%, the exchange rate will be 34-35 RUB/USD. The realization of such scenario will face some threats. First of all, this is instability of the Russian banking system, which decrease the possibility of savings accumulation. It means, the disposable income growth will make some pressure on the inflation and devaluation rates.

The recovering of the national banking system is issuing very slowly. The key problem is the creation of the reform's program and introducing some measures for the agents' trust revival. The banking reform should reanimate the wide set of banking services, savings accumulation and the investment activity.

There is no adequate market information on the interest rates, which enforce the financial instability and enforce the financial instability and denude the enterprises to provide medium-term planning. The creation of the special governmental agency with indicative functions can change such situation.

The recovering of the financial markets can facilitate the changes in issuer's policy, the management of the secondary market. As a first step it should be the federal bonds introduction. Moreover, it should be different kinds of the bonds. After that the municipal and corporate bonds can be issues. This agenda is also actual because of the steady gap between the disposable budget revenues and the necessary budget expenditure in the medium term.


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