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Stabilization on Russia’s financial markets in the first week of June was prompted both by optimistic expectations on the part of foreign investors and concrete measures implemented by monetary authorities. Despite the fact that the government continued to insist that there was no need for foreign loans, rumors about foreign financial aid spurred price rises by the middle of the week. Furthermore, expectations of the receipt of funds through the Wednesday issue of $1.25 billion in Eurobonds and the approval of the next tranche of the IMF’s loan were major factors behind an increase in government securities prices.

Nonetheless, unfavorable macroeconomic conditions (such as decreases in industrial production and capital investment and a worsening of the balance of payments) continue to make investment in Russia overly risky. Since Russia’s GDP is stagnant and the budget deficit has yet to decrease, Russia’s state debt will inevitably grow. Servicing of domestic debt will amount to about 100 billion rubles in 1998 and grow further in 1999.

The government has yet to improve tax collection, and the largest monopolies still remain the largest tax debtors. But according to preliminary data, real federal budget revenue increased by 8-9% in the first five months of the year, compared to the same period last year. A planned 74 billion ruble reduction in spending will make it possible to shrink the budget deficit in 1998 and consequently to reduce future interest payments.

The amount of money raised through the Eurobond issue is not enough to bring about complete stabilization and the return of yields to pre-crisis levels. Next week, average weighted yields on GKOs will amount to between 40% and 60%. Future developments will depend on the establishment of a reserve fund for the support of Russia’s financial markets.

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Throughout almost all of last week, the ruble rate remained within the limit set for exchange rate fluctuations by the Central Bank (6.139-6.191 rubles/dollar at the beginning of the week and 6.14-6.198 rubles/dollar at week’s end). This indicates that the situation on the foreign exchange market improved at the beginning of June.

Tension remained on various segments of the financial market at the beginning of the week. On Monday, the RTS index fell by 10% while yields on GKOs amounted to 60-80% per year in the first two days of June. However, restrained by high lending rates on the interbank market (on June 1 and 2 INSTAR rates amounted to 86% and 66.5% per year respectively), the dollar rate did not exceed its upper fixed limit of 6.16-6.19 rubles/dollar.

Improvement on Russia’s financial markets by the end of last week was accompanied by a decrease in demand for foreign currency. For instance, the dollar rate fluctuated between 6.14-6.17 rubles/dollar on the interbank market on June 3. Although the dollar rate grew to 6.18-6.19 rubles/dollar by the end of the week, there was no large demand for foreign currency during that period.

Futures contract prices decreased during the first days of June. Prices for “long” futures contracts decreased by 5-7% on MICEX. At present, December contracts are priced at less than 7.2 rubles/dollar on MICEX (a 30-percent increase in the yearly dollar rate) and 7.3-7.35 rubles/dollar on the Chicago Mercantile Exchange (a 33% to 35% yearly increase). The May crisis was accompanied by growth in trading on the futures segment of MICEX. The monthly trading volume grew from $1.1 billion in April to $1.7 billion in May. The total value of open positions increased from $563 million at the end of April to $855 million at the end of May.

How stable is the market equilibrium and when might it be upset? July is likely to see relative calm on the foreign exchange market. The next tranche of the IMF’s loan is likely to be disbursed at that time and funds from the Eurobond issue will be received. This will make it possible for the Central Bank to replenish its foreign exchange reserves and bring about a positive effect on the foreign exchange market. At the same time, it is unlikely that significant investment will be forthcoming before the end of the year. This, along with a worsening trade balance, will increase pressure on the foreign exchange market in periods of growing demand for foreign currency (such as Autumn).

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The situation on the GKO/OFZ market stabilized last week. Panicky sales of government securities ended in the first half of the week, and yields stabilized at 65-70% per year. However, it only became possible to speak about the end of Russia’s latest financial crisis on June 4, when a significant amount of funds remaining after the primary auction caused a rapid decline in yields, by 20 points within a single trading session. As a result, yields on GKOs decreased to a little less than 50% per year by the end of the week.
 

Significant fluctuations on government security yields are likely until the end of the year. It can be safely assumed that the present situation on the GKO/OFZ market is largely influenced by speculative capital. Under such conditions, the market remains rather sensitive to many different factors. The exploitation of both favorable and unfavorable events, including those that do not specifically relate to the market but are interpreted accordingly, allow speculators to earn additional profit. Under conditions of uncertainty regarding the long-term prospects for yield fluctuations, non-speculative investors in effect become involved in speculation and thus boost the existing trend.

The long-term prospects (until year’s end) for the GKO/OFZ market are rather pessimistic. There are only two ways to retain control over the state debt market, through the redemption of securities with either tax revenues or new foreign borrowings. The first way is highly unlikely in the near future, while the second would entail switching from relatively short-term ruble borrowing to relatively long-term foreign currency borrowing. However the efficiency of this method is disputable. One associated problem is the release of ruble resources, including those of Russian banks, which were previously invested in government securities. The purchase of foreign currency is no alternative to investment in government securities because the Central Bank’s ruble devaluation rate target of 7% per year appears realistic. The purchase of more risky assets and lending to industry in particular is impractical under present conditions.
 

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Last week was characterized by significant growth in prices for instruments circulating on Russia’s financial markets. The government’s resolute measures aimed at overcoming the crisis, which were supported by the international community (particularly the announcement at the beginning of last week that Russia would receive additional financial aid from ether foreign lending institutions or G7 governments), had a favorable effect on financial market participants. As a result, the downward trend on the Russian securities market reversed on June 2.

The MinFin market was no exception. During the period under review, MinFin prices grew on average by more than one percentage point. At the same time, a speculative mood dominated the MinFin market the entire week. As a result, daily fluctuations of MinFin prices amounted to 1-1.5 percentage points. According to observers, such behavior reflected general instability on Russian financial markets and should be considered a natural reaction following such a serious crisis.

The US dollar-denominated Eurobond issue was an additional factor prompting an upward trend on the MinFin market. The issue is worth $1.25 billion, its maturity is five years, the coupon rate is 11.75% per year and the spread over US T-bills is 650 basis points. The fact that this Eurobond issue occurred without the traditional road show and with a coupon rate higher than initially suggested indicate that the government is very much in need of additional foreign financing. In view of this, it is highly likely that new Russian borrowing on international capital markets (for instance, an increase in the Eurobond issue or the raising of a syndicated loan) will be announced soon.

The situation on the MinFin market is likely to remain unstable next week. MinFin prices will likely continue to fluctuate (± 1-2 percentage points), while the general trend will be upward (+0.7-1.5 percentage points during the week).
 

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Of the last few weeks, the first week of June was the most successful for Russia’s equity market. A speculative mood dominated the equity market during this period, confirmed by the fact that the majority of transactions involved shares in 6 to 10 Russian blue chips. Significant price fluctuations in the first half of the week were regarded as intentional “heating” of the market.

Despite a 10-percent fall in the majority of share prices on Monday, share prices grew rapidly over the next two days. This growth more than compensated for Monday’s losses. For the week, the RTS index increased by 8.55%, passing the psychologically important 200-point threshold. A slight downward price adjustment at the end of last week was natural following such rapid growth. Gazprom led the Russian equity market last week with a gain of 33.5%.

When trying to forecast future developments on the Russian equity market, we should first consider the potential causes of last week’s price rise.

The first cause is largely emotional. Investment in the equity market is primarily long-term investment in cheap shares in a generally stable financial environment. This increase in share prices as the result of psychological factors now has a good chance to become a steady trend that will later find support through more objective factors.

This growth is likely to be stimulated by 1) stabilization credit lines provided to the Russian government by international financial institutions and commercial banks, 2) a decrease in tension on international stock markets, 3) a steady trend toward further reduction of yields on government securities, and 4) the resolution of corporate problems and other factors likely to stimulate such growth. In this case, share prices will probably reach pre-crisis (early May) levels in the next two to three weeks and the January 1 level by the Autumn of 1998.

The second cause is one of rationality. Investors want to recoup losses incurred over the course of Russia’s recent financial crisis. It seems clear that in this case investment resources will be mostly speculative and investors will begin to withdraw funds from the market when share prices reach pre-crisis levels (+20 to +25%).

Those Russian commercial banks currently encountering liquidity problems will be the first to begin withdrawing funds from the equity market. Large individual shareholders who lost more than half of their savings over the past six months will be the second group to sell their shares, while the third wave of sales will be provoked by foreign investors. It is quite possible that these sales will cause a significant decline in share prices. It can be assumed that by the middle of Autumn the main stock-market indices (the RTS and MT indices) will decline to 100 points.