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This situation complicates the continuing government budget crisis. Presently the Ministry of Finance has sufficient resources (including foreign credits) to meet current obligations, but the  conditions upon which this is based involve no attempt to reduce the size of the government securities market. All the same, the government’s appeal to investors to stop selling securities may have fallen on deaf ears, and moreover a liquidity crisis has developed.

Lastly, a basic question which arises in this situation concerns the potential development of Russia’s financial market, at least until the end of the current year. It seems clear that considering the current situation, neither a financial market nor a banking system can exist. In the event of a continuation of current trends, Russia will be hit with not only a banking crisis, but a general systemic crisis as well. As a result, measures of a market character are meaningless, and regulatory actions will assume a purely administrative character.

Two non-administrative scenarios are possible with respect to stabilization on Russia’s financial market. According to the first, stabilization is achieved by the effect of foreign capital; the flow of foreign capital into Russia strengthens. The second scenario envisions stabilization by means of domestic capital. Insofar as reserves in the economy no longer remain, a monetary emission by the Central Bank is possible. Such a measure is relatively risky in that all things equal, it may stoke inflation and put pressure on the ruble exchange rate. Therefore the notion of “all things equal” becomes crucial. The Central Bank’s refinancing of commercial banks through a deposit of government securities could relieve the ruble deficit and at the same time support the domestic debt market. Given a plan of action which includes additional mobilization of public savings (industry has no savings), tactical adjustment of monetary authorities’ activity on all segments of Russia’s financial market, and the strengthening of banking and currency regulation, such a strategy may result in considerable improvement in Russia’s financial sector.

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The latest wave of Russia’s ongoing financial crisis was of a slightly different character than that which was encountered before, but nonetheless resembled that of August 1995 - a crisis of the banking sector. Although the reasons underlying the current crisis are slightly different than those of three years ago, the consequences are rather similar: a decrease of banking limits to a point of total closure, a rise in interest rates on the GKO-OFZ market, and a sharp deterioration of the financial health of several credit organizations. Moreover, the situation in August 1998 exhibits a number of specific characteristics, particularly those concerning the currency market. If the banking crisis of three years ago had no effect upon the currency market (remember that three years ago the ruble was strengthening and the currency corridor in some respects merely aggravated the situation), the present crisis is unfolding under the threat of a ruble devaluation. Last week the interbank market came to a practical standstill, with submitted bids assuming a role as mere indicators. The exchange rate at times amounted to 6.4-6.5 rubles/dollar, and volumes on MICEX grew steadily. However the deficit of US dollars among commercial banks gave rise to a sale rate for dollars to the general public of about 8 rubles/dollar.
 

• The necessity of a number of large banks in the near future to meet redemption payments linked to syndicated loans denominated in foreign currency (currently, Russian banks owe to other banks and non-residents a total of over 10 billion dollars, a portion of which may be called in for immediate redemption). As of July 1 the banking system maintained an asset-liability deficit denominated in foreign currency equal to $2.8 billion.
• The danger of a ruble devaluation leads to an outflow of private capital from commercial banks. In June alone, private banking deposits decreased by more than 8%.
• Non-resident funds remain on Russia’s financial market, which may lead to a rise in demand for foreign currency. The volume of activity of foreign funds on the GKO-OFZ market is estimated at about $20 billion.
• A worsening of the foreign trade balance. In May, Russia ran a positive trade balance amounting to $300 million (in 1997 $1.1 billion). For the first quarter of 1998, the trade balance was positive but amounted to just $1.1 billion (compared to $6 billion during the same period in 1997).

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Having declined to issue new securities on the primary market, the Ministry of Finance placed on the secondary market only 1.5 billion rubles worth of securities with a maturation of one week. This only partially compensated for a redemption payment amounting to over 5 billion rubles.
 

The swift rise in interest rates and the almost total lack of demand for government securities last week exacerbated the problem associated with serving the government debt. Investors were seriously disturbed by the fact that the government was unable to meet its payment obligations. The government in the guise of the Ministry of Finance only strengthened this sentiment by suggesting that banks were obligated to fully re-invest proceeds following GKO-OFZ redemption back into the government securities market. However last week a number of banks encountered serious problems making payments on current obligations; the only source of funds is currently the market for government securities.

By October 1 the Ministry of Finance will have to redeem over 40 billion rubles worth of government securities, 11 billion of which falls in August alone. The only way to meet these redemption payments is through an inflow of new capital. Two sources exist for such funding, either foreign credits or a ruble emission through the purchase of government securities by the Central Bank. In current crisis conditions it is unreasonable to count upon an inflow of funds from private foreign investors. Even if such money did appear, it would be for purely short-term speculative purposes. This obviously would not provide the market with real stability. This leaves a final possibility, that of loans at the inter-governmental level. It is possible this question has already been discussed by the so-called “Group of Seven” industrial nations.

The position of the Central Bank with respect to the increase of government securities in its portfolio throughout the entire crisis was negative, insofar as it was seen as a threat to the stability of the ruble rate. It is likely that the Central Bank will maintain its current position. The problems of liquidity among large banks will probably be decided according to credit, including deposits of government securities.

It is today virtually impossible to provide forecasts regarding the GKO-OFZ market. Moreover, in our opinion it is possible to consider only the most extreme options: either a normalization of the situation as early as next week (in the event of an inflow of new funds) followed by a decrease in interest rates to lower than 100%, or the freezing or restructuring (by now involuntary) of the government’s ruble debt. The only thing which seems clear is that the current situation is untenable and decisions must be taken as soon as possible.

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Last week, the situation on the MinFin market was characterized by a decrease in liquidity for all financial instruments circulating on the market as well as a sharp decline in securities prices. The major reasons for such changes include the following.

The first is the failure of most Russian counteragents to fulfill obligations arising from transactions on the MinFin market. This resulted in virtually the complete closure of credit limits on operations with Russian counteragents by foreign and Russian market participants.

The second reason is a shortage of working capital, which compelled many resident companies to hurriedly sell their securities. Under conditions of low demand for Russian debt securities, this resulted in a decrease in securities prices. It is also possible that this decrease was prompted by the desire of some large Western market participants to speculate on a fall (at present, market conditions for such actions are favorable) in order to buy MinFin bonds later at undervalued prices. Naturally, such strategies are based upon expectations of stabilization on Russia’s financial markets in the medium term.
 

 

One can say that the MinFin market reached a qualitatively different state last week in which MinFin prices (unlike MinFin bonds which show the amount of funds that must be invested in order to conduct operations on the market) became major reference points for market participants. This caused the difference in prices for “long” MinFin issues (the 5th, 6th and 7th issues) to fall to a minimum, fluctuating around 20 to 23 percentage points.

By the end of the week, MinFin prices reached a support level (70 percentage points for the 3rd issue, 30 percentage points for the 4th issue, and 20 percentage points for other issues). As a result, foreign traders became more active on the market. In our opinion, the liquidity of the MinFin market and MinFin prices are unlikely to increase next week.

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The visible lack of confidence in Russia’s government in the middle of August due to the government’s inability to service domestic and foreign debt, along with a catastrophic decline in the liquidity of the Russian banking system and turmoil on international financial and commodity markets, produced consequences that were serious but cannot accurately be described as a true financial crisis.

Trends that developed on Russia’s financial markets (with the exception of the foreign exchange market) in the second week of August were completely beyond the control of Russia’s regulatory authorities. The rapid withdrawal of funds from Russian financial instruments (GKOs, OFZs, MinFin bonds and corporate shares) rendered Russia’s financial markets lifeless. Trading volumes on the MinFin market decreased to a minimum after MinFin prices decreased to a level corresponding to yields of 166% per year in US dollars (3rd MinFin issue) on August 13. On the same day, yields on “short” GKOs issues exceeded 210% per year in rubles.
 

Prices for Gazprom shares decreased to 22.6 cents per share on August 13 despite an official announcement that non-residents’ stake in Gazprom (Russia’s largest share issuer) would increase from 9% to 14%. The most significant fall in Gazprom share prices (-16.8%) occurred on August 11. On that day, equity market capitalization amounted to about $23 billion, compared to its maximum of about $130 billion reached in August and October of 1997.

A significant upward price adjustment occurred on the last day of the week (the RTS index increased by 13.7% on August 14). This was largely the result of foreign traders’ interest in Russian oil company shares (according to market participants this interest grew due to rumors of a forthcoming ruble devaluation, which would be profitable for exporters). Yet despite this rise, the situation on Russia’s equity market is unlikely to improve in the near future.

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