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In general one might suggest a “soft version” of economic development, never before addressed in a VEDI analytical report. This scenario envisions the execution of a monetary-credit oriented policy aimed at the support of domestic producers and a corresponding monetarization of the economy. This will lead to an acceleration of inflation to 2-5% per month (naturally, this level of inflation will be achieved merely as a result of last month’s stabilization measures). The ruble exchange rate is growing at the same pace as inflation, or perhaps a bit faster. The goals of such a policy are to decrease the volume of mutual debts, generally improve the financial health of enterprises, and decrease the share of barter operations. The inflationary growth of enterprise turnover and government finances will lead to the partial lowering of the population’s real income.

The strengthening of the government’s role may take the form of an imposition of monopoly control over alcohol production as well as significant state control over exports, particularly in terms of the repatriation of export revenues.

Of course, the new government will continue to cooperate with international financial organizations in order to receive further credits from the IMF and World Bank, as well as to attract direct and portfolio investment. Therefore the likelihood of a repeal of the moratorium on repayment of foreign debts as well as amendments to the domestic debt restructuring plan are rather high. One can expect the restoration of most segments of Russia’s financial market in the near future.

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Last week, the currency market experienced a decrease in the dollar rate, from a level of 25-30 rubles/dollar on Monday, September 7 to 10-11 rubles/dollar by the end of the week. This sharp fall in the ruble exchange rate was made possible as a result of low liquidity on the currency market as well as a growing ruble deficit (funds on account at banks remained at the rather low level of 9-10 billion rubles).

Under these conditions, the necessity of converting export revenues from a number of large enterprises inevitably should have led to a noticeable decrease in the ruble exchange rate. The activation of currency sales was partially the result of the preparation of a document calling for the mandatory sale of 50% of currency revenues on the official market (remember that up until recently exporters were permitted to convert received funds on the unofficial market).
 

The further course of events on the market for forward contracts remains uncertain. Remember that according to the Central Bank’s August 17 decision, payments on futures contracts were halted for a 90-day period. Therefore if the fulfillment of futures contracts comes due in the middle of November, then the date fixing the accounting rate (according to completed contracts) should remain unchanged (for most contracts, this date is the 15th of the month). Due to the fact that a majority of Russian financial market participants face losses related to completed forward contracts, the continuing decline of the ruble exchange rate (or at least its preservation at existing levels) will allow them to limit potential losses.

At the same time however, many experts do not consider the fall in the dollar rate over the period under consideration to mark the beginning of a new trend. According to the current opinion of VEDI experts, preconditions for a further strengthening of the ruble do not exist. The sharp rise in demand for foreign currency has been restrained due to the announcement of a moratorium on payments to foreign investors, the freezing of state securities, and the deterioration of most of the population’s standard of living (as a result of the rise in prices, the growth in unemployment (including hidden unemployment), and the difficulty in withdrawing money from a number of large banks).

New nominations to government circles (including a new Central Bank chairman) may lead to a situation where rumors of a repeal of decisions taken on August 17 may become reality as early as the beginning of next week. If this were to occur, a new spiral of demand for foreign currency is inevitable. In the presence of declining reserve assets (as of September 4, Russia’s gold and foreign exchange reserves stood at $12.3 billion) and uncertainty regarding when further funds from international financial organizations will be transferred to the Central Bank (now headed by a new chairman), the government will either be forced to impose new administrative measures or permit a new rise in the dollar rate.

The new chairman of the Central Bank and his relation to the commercial banking system will have an influence on the currency market. In this respect a softening of the Central Bank’s monetary-credit policy will inevitably lead to further depreciation of the ruble. As far as can be gathered from recent comments by Victor Gerashchenko, the Central Bank does not plan on fixing the ruble exchange rate.
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Last week saw virtually no changes in the situation on the GKO/OFZ market. Securities are still frozen, and only private individuals were able to receive redemption payments on time (about 187 million rubles) through a bank where direct accounts had been opened, or through Sberbank or Vneshtorgbank. Remaining investors continue to consider which type of portfolio to create with the restructured securities. The expiration date for the submission of applications for GKO/OFZs falling under the government’s restructuring plan is September 18.

As this date approaches, the voices of those challenging the legality of the government’s August 17 measures are heard more clearly. Last week, the Security Council and the Federal Securities Commission joined a number of commercial banks in a joint appeal regarding the necessity of freezing GKO/OFZs. It is possible that such a scenario is presently under consideration at the governmental level. However the basic problem (which has never been encountered before) is that the economic policy framework within which these decisions will be made remains unclear. It is clear, however, that the freezing of government securities today would largely represent an admission by the government of fundamental errors and the illegality of these steps. Meanwhile over the past several weeks, investor funds in GKO/OFZs have almost completely depreciated. During the first week of September alone, inflation reached 35% and even with a freezing of GKOs, the situation in the banking sector will not radically change. Funds received from the redemption of GKOs will not compensate banks for losses incurred as a result of the ruble’s devaluation.
 

In so far as the slight strengthening of the ruble that took place last week cannot be considered stable, ruble funds received from the redemption of GKO/OFZs (the volume of late payments between August 17 and September 9 being about 18 billion rubles) are likely on September 16 to flow into the currency market.

The fact that today’s investors are not prepared to work with ruble instruments was confirmed by the almost total lack of interest in the Central Bank’s securities (OBR’s). Last week, the Central Bank managed to place only 117 securities with an interest rate of 68-70% (the overall volume of the planned issue was 1 billion rubles with a redemption date of September 16, and not a single security was placed on the secondary market). It is likely that today’s investors would only be interested in securities with interest rates indexed to reflect both the inflation and ruble exchange rates.

In terms of quote orientation, one might accept interest rates on government securities (MinFin or Central Bank) equal to those for sub-federal debt, although with some conditions. A majority of regional administrations continue to service domestic debt in accordance with obligations taken upon themselves. The interest rate for the most liquid municipal obligation (St. Petersburg) stands at between 200% and 500%, with an average daily trading volume of about 20 million rubles.

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The situation on Russia’s financial markets last week was determined by the expectation of a resolution of the political crisis brought about by the second rejection of Victor Chernomyrdin for the post of prime minister. The threat of political chaos resulting from this situation became real enough to force the “party of power” (Our Home is Russia) to strike a compromise with the opposition and support the nomination of Yevgeny Primakov, a candidate who appealed to all interested parties. One of the main virtues of the new prime minister is said to be his reputation in international political circles, leading one to hope that he can maintain Russia’s good relations with world powers and leading international creditors.

In terms of the MinFin market’s direct relationship with Russia’s foreign debt market, no changes occurred last week. Current quotes remain only indicative, deals are not occurring, and the price level of OVVZs fluctuates by 5-35 percentage points.

Recently the main topic of discussion among market participants has been the possibility of default on Russia’s foreign debt. On September 11 it was announced that Russia was unable to make timely interest rate payments on 1998 yearly (former Soviet) debt to a number of countries comprising membership of the Paris Club of creditors. Nevertheless, Germany’s Ministry of Finance stated that it was confident that Russia would meet all outstanding payments (800 million DM) by the end of 1998. A similar attitude was expressed by the treasuries of other country creditors because it is likely that a decision will be taken to postpone planned payments due by the end of the year (it is possible that this subject was discussed at the meeting of representatives from the G-7, which took place September 12).

In general, experts are joining in the conclusion that Russia will only avoid default on its foreign debt obligations through the approval of the IMF’s next loan tranche. The date when these funds might arrive remains unknown, and the new government will have to make a great effort to achieve a positive IMF decision.

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In the middle of the week, the lively discussion in Russia’s economic community regarding the idea of an “economic dictatorship” announced by Victor Chernomyrdin and Boris Fyodorov’s improvised suggestion of a currency board did not affect the investment mood on the part of market participants; the equity market continued its slow crawl. From September 8-9 the average market value of corporate securities decreased by 3%, and trading volume on RTS on September 9 reached a minimum over the past 32 months ($645,000). RTS’s all-time local minimum was set on December 27, 1995 ($78,000).
 

The greatest amount of activity last week was registered on Thursday, September 10 but was followed by the market’s continued deterioration. The achievement of a compromise between various branches of power (following Victor Chernomyrdin’s removal of his candidacy for the post of Prime Minister) enlivened the mood of market participants and led to positive changes in average market indicators. The rise in the RTS index (the first in over three weeks) turned out to be rather laughable- almost 5%. The September 10 inauguration of the RTS’ institute of primary dealers (having been postponed from September 1 by the Federal Securities Commission) was greeted by an almost five-fold increase in trade volume to $3.1 million.

Meanwhile the quality characteristics of the equity market as expressed in ruble equivalents continue to closely correspond to the dollar rate on SELT in having shifted from a clear upward trend to one in the opposite direction. The depreciation of the US dollar led to a correction in the branch arrangement of power on the equity market. Accordingly, the position of issuers oriented toward ruble revenues improved, while that for issuers receiving oil dollars worsened. Between September 7-10, corporate securities for RAO UES appreciated by 11%, Irkutskenergo by 16%, and Mosenergo by 5.6%. Prices for preferred shares for the oil company and main exporter of hydrocarbon raw materials Surgutneftegaz fell by almost 10%. Quotes for Gazprom equity assets over the course of the week did not undergo any fundamental changes. On September 11 they traded on MFB at 1.53 rubles/share.

Unfortunately the new Prime Minister Yevgeny Primakov has not yet announced his program for bringing the country out of crisis. Therefore this program will likely be the main topic of discussion all of next week. The equity market at present will likely remain indifferent to all of this and maintain its stagnating character.
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