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The disbursement of a long-awaited $670 million tranche did not improve Russia’s financial situation because this amount is too small to help resolve all the problems in the Russian economy. The present macroeconomic situation is much worse than in 1997 and early 1998. Investors are reluctant to invest in Russia because of the possibility of a ruble devaluation and the government’s inability to redeem its securities. It is possible however that the approval of a $10 to $15-billion loan from international financial institutions will calm investors and help stabilize Russia’s financial markets.

Last week, the government approved an anti-crisis program which provides for an increase in the tax base, tighter control over exports/imports, and centralized control over the production and sale of alcohol. Unfortunately, the development of a good program is not sufficient for an improvement in Russia’s macroeconomic situation. It must first pass through the State Duma with minimal amendment and ultimately be implemented.

In the near future, the situation on Russia’s financial markets will be determined by the results of negotiations regarding a $10 to $15-billion loan for Russia and how the State Duma treats the government’s anti-crisis program.

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Last week, developments on the foreign exchange market were accompanied by continued debate regarding the possibility of a ruble devaluation. Attention was focused on negotiations regarding the disbursement of the next tranche of the EFF loan to Russia. A favorable decision regarding this tranche was made only on the evening of June 25. In addition, the market paid attention to governmental attempts to negotiate additional financial aid (about $10 to $15 billion) from international financial institutions.
 

Last week, the dollar rate grew by 0.15% (which corresponds to a 7.5-percent yearly growth). Since the beginning of the year, the dollar rate has grown by 4.2% (8.4% yearly). Ruble stability was maintained through the Central Bank’s intervention on the foreign exchange market (according to official forecasts, the dollar rate is expected to increase by 7% to 9% in 1998). This helps explain the discrepancy between amounts raised through the June Eurobond issue ($3.75 billion) and the increase in Russia’s gold and foreign exchange reserves to $16 billion, an increase of only $1.5-2 billion.

Traders’ interest in futures transactions continued to grow. Last week, members of the MICEX futures section concluded futures contracts worth $115 million daily. The total amount of open positions exceeded $900 million by the end of the week. The greatest demand centered around contracts to be executed from August through October 1998 (the total amount of open positions regarding such contracts grew by nearly 50%). At the same time, the rate of ruble devaluation on which futures contract prices were based remained high, amounting to 40% per year on MICEX and 50% per year on the Chicago Mercantile Exchange.

The probability of a ruble devaluation did not lessen even after an announcement that the next $670-million tranche of the EFF loan to Russia would soon be disbursed. The fear of a devaluation will continue to plague investors next week. In addition to high interest rates on the money market, promising news regarding additional financial additional aid to Russia and stabilization on other markets (particularly the GKO/OFZ and equity markets) may have a positive effect on the foreign exchange market over the next few days.

However, any negative information regarding the prospect of a stabilization loan and the continuation of this week’s trends (increasing yields on government securities and declining share prices) will keep the dollar rate at the upper boundary of the Central Bank’s currency corridor. In this case, the Central Bank will continue to implement measures aimed at ruble stabilization.

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In the period under review, yields on government securities (on “long” issues) grew from a little more than 50% to 75% per year. A significant increase in yields occurred immediately after the June 24 primary auction. Market interest in government securities decreased despite the fact that GKO/OFZ market participants regarded the results of the auction as positive. However the market stopped responding to separate bits of favorable news due to the overall negative background. Moreover, investors began to doubt that the stabilization measures announced last week would prove effective.
 

It is clear that funds withdrawn from the GKO/OFZ market created significant pressure on the foreign exchange market and consequently created problems for the Central Bank, which continued to refrain from active open market operations. Moreover, a significant reduction in government securities prices continues to occur on low trading volumes. This means that even small purchases of government securities by the Central Bank can reverse the downward trend currently dominating the market.
 

If the Central Bank starts buying government securities at the beginning of next week and thus creates favorable conditions for primary placements, the yield on government securities will likely decrease below the refinancing rate (60% per year) at the end of next week. Otherwise, unstable market conditions observed at the end of last week will likely develop into a new crisis and new emergency measures will be needed to overcome it.

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A downward trend dominated the MinFin market last week. During that period, MinFin prices decreased on average by 3.85 percentage points. According to market participants, a decrease in MinFin prices accompanied by a slight increase in the spread between MinFin purchase and selling prices occurred because a number of Western traders decided to sell a significant number of MinFin bonds during that period.

Most probably, such behavior is explained by the fact that many Western traders believed that Russia would soon issue new securities with higher yields. It should be pointed out that such expectations are justified. The Russian government’s policy of tight control over the financial market (which provides, among other things, for a reduction in domestic debt through foreign borrowing) is based on the assumption that the inflow of foreign capital into Russia will increase in the near future.
 

The second source of funds is the sale of government stakes in certain companies, such as Rosneft and Svyazinvest. The first such auction is planned for the middle of July 1998, involving the government stake in Rosneft. This will be the second time this stake has been put up for sale. Taking into account the low level of international oil prices, one can expect that the government will again be unable to sell its stake in Rosneft.

The third source of funds is the issue of Eurobonds. Observers believe that Eurobond issues are the most effective way to raise funds at present. However, taking into account the limited amount of money intended for investment in Russian securities and large Eurobond issues over the past few months, one can assume that yields on newly-issued Eurobonds will remain above average market levels. This, in turn, will lead to an increase in yields on MinFin bonds.

News regarding the possibility of attracting additional foreign funds is likely to determine changes in MinFin prices next week. MinFin prices are likely to continue to fluctuate significantly (?1 percentage point) while the general market trend will be downward.

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A liquidity crisis continues on Russia’s equity market. On June 22-26, this crisis manifested itself in an extremely low volume of investment in Russian shares. The weekly trading volume on the organized equity market amounted to $110.4 million. On Tuesday, June 23, the daily trading volume amounted to a mere $10.9 million, the lowest amount over the last year and a half.

During the period under review, the behavior of the equity market was determined by the following two factors:

Yields on financial instruments providing alternative investment opportunities (GKOs/OFZs and MinFin bonds). A steady increase in yields on investments in these securities (73-93% per year in rubles and 15-17% per year in US dollars) made it impossible for Russian share prices to increase. The RTS index (reflecting the attractiveness of shares in 64 Russian companies) decreased by 6% to the level of October 1996 by the end of the week.
 

 

The equity market will remain characterized by low trading volumes in late June and early July. A lull in activity due to traders on vacation will be an additional factor behind a decrease in transaction volumes. Trading will be conducted only with the most liquid shares in four or five Russian companies, while the number of active traders will be insignificant. Share prices will most probably continue to decline. Oil company shares, which depleted their potential for growth last week, will also continue to decrease in price.

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