Fig. 44 shows the top 10 problem areas in the Russian economy according to the global competitiveness index issued by the World Economic Forum in 2009-20101. The principal The figures in Fig 44. signify Russia’s ranking for each of the scoring criteria among the 133 countries rated.
Section Monetary and Budgetary Spheres obstacles to Russia’s competitiveness belong to three main groups: product market inefficiencies (complicated customs procedures, high trade barriers, the low level of foreign direct investment and a significant number of restrictions on foreign property ownership); the unfavourable institutional environment (infringement of minority shareholder rights, the heavy burden of government regulation, insufficient protection of property rights, and the limited application of International Financial Reporting Standards); and weakness of the financial system (bank instability and restrictions on capital movements). It is obvious that most of the above factors that detract from the competitiveness of the Russian economy according to the World Economic Forum coincide with the low score areas in the Russian financial market according to CalPERS.
Source: Calculations based on World Economic Forum ratings (www.weforum.org) Fig. 44. The 10 principal shortcomings of Russia measured by the global competitiveness rating in 2009-2010 (aggregate 63rd position among 133 countires scored) Fig. 45 shows the scorecard for a more specialised World Economic Forum rating that was published in late 2009 and assessed the financial system in 55 countries with the largest financial markets. In this list Russian ranked 14th out of 55 countries. Fig. 45 also shows the worst score is received by Russia under this rating. Three groups of issues can be distinguished, including, once again, the unfavourable institutional environment as demonstrated by the limited application of international financial reporting standards, the infringements of minority shareholder rights at joint stock companies, weak stock market regulation (due to the presence of the bank of Russia among the owners of one stock exchange), corruption, barriers to entry of foreign entities into the financial markets, lack of independence in the judiciary system, difficulties in law enforcement, and breaches of property rights. Another issue of the RUSSIAN ECONOMY IN trends and outlooks Russian financial system is the weakness of banks, where Russian ranks last among the participant countries. Finally, the third issue is to do with the restrictive tax administration.
Source: calculations based on World Economic Forum ratings (www.weforum.org).
Fig. 45. Russia’s ten principal drawbacks under the Financial Development Index, 2009–2010 (aggregate 40th position among 55 participants) The events of 2009 leave a contradictory impression regarding the readiness of Russian authorities to radically change the investment climate in the country. On the one hand, the Russian president, D.A. Medvedev, has initiated an appeal for modernization of the society, read regearing the economy to developing value added sectors, and promoting innovation. This appeal translated into changes in the structure of government agencies, in the legislation, in decisions taken regarding the allocation of government finances.
The government opened dialogue with foreign investors regarding amendments to the Federal Law On Foreign Investment aimed at mitigating the restrictions for the access of foreign capital to strategic sectors and simplifying the procedure for approving investments into companies in these sectors1. The President of Russia has instructed the government to develop an action plan for improving the investment climate in Russia in 2010, including the simplification of customs procedures, the privatization of significant government stakes in state owned companies, changes to the tax legislation aimed at promoting innovation. 2.
On the other hand, civil society and foreign investors are increasingly perplexed by the legal proceedings in the Yukos case. The death of the chief legal counsel of the Hermitage Capital Management hedge fund has triggered a strong international reaction. Crimes against A. Gudkov, the Government has disappointed foreign investors // Kommersant, February 4, 2010.
P.Netreba,. the Investment climate is to change in the spring// Kommersant, February 12, 2010.
Section Monetary and Budgetary Spheres journalists are pervasive, the opposition is repressed, the situation of small and medium enterprises continues worsening, the activities of state-owned companies and corporations are becoming less and less transparent.
The issue of the degree of modernisation of society that may be required by modernisation of the economy remains open. We can only stress here that an indication of the resolution of this issue will be shown by the readiness of foreign portfolio investors and other large investors involved in FDI to change their attitude to the Russian financial market by investing large amounts of long-term funds, as well as making technology investments in the country. This “miracle” failed to happen in 2.4.8. The role of the stock market in economic modernisation and promoting innovation The current crisis revealed significant problems and contradictions within the Russian economy, demonstrating its lack of readiness to the challenges of globalisation. By the end of 2009, the government and the public as a whole adopted the focus on economic modernisation. The financial market must play a crucial role in the implementation of these plans, however, the question remains of whether it is ready to tackle the challenge.
Financial crises always result in increased risks and uncertainties for entrepreneurs regarding future investment projects, in the lack of trust between creditors and debtors. For these reasons it would be unrealistic to expect effective results from the financial market at the peak of the crisis. However, an analysis of financial market functioning prior to and during the crisis gives us grounds to believe that the domestic financial market is not yet prepared to fully tackle the issues of economic restructuring, accelerating innovation, and providing social support to the public.
This is due to a number of reasons. First, within the current regulatory framework, the return on investment from pursuing speculative strategies in the financial market, such as carry trading or using debt leverage in repo transactions, is higher than the return on investment in new production facilities. Second, the refocusing on many banks away from lending into investments in corporate bonds results in the loss by such banks of project financing skills in the real sector, while the ruble denominated bond market that allows to attract short-term investment funds cannot serve as a means of the replenishing real company capital. The banking system is weak and incapable of large-scale lending to the economy. Third, the Russian market does not have the traditional innovation vehicles such as private equity funds and venture capital funds. Finally, the system of mobilizing long-term retail savings does not function in Russia. The low effectiveness of the domestic financial markets is exacerbated by the unfavourable investment climate for attracting foreign direct investment and long-term portfolio investment.
The return on financial and non-financial investments In the long term, stock market growth follows the trends in fundamental indicators, such as net company earnings and gross domestic product (GDP). For example, the author’s estimates of the relationship between stock market growth and the key economic indicators in 12 developed capital markets over the past 50 years shows that the average growth rates of stock mar RUSSIAN ECONOMY IN trends and outlooks ket indices are generally in line with the average nominal GDP growth rates1. In emerging markets, stock market growth rates tend to outstrip nominal GDP growth rates due to attracting foreign portfolio investments.
Fig. 46 Shows the relationship between the growth rates for the RTS index, GDP, and the earnings of Russian companies. It demonstrates that prior to both Russian crises the stock market index growth rates differed significantly from GDP growth rates. As markets recovered, stock market indices sought to catch up with industrial production and earnings indicators.
Source: RTS and Russian Statistics Committee data.
Fig. 46. Stock market index growth compared to fundamental indicators The greatest issue in the Russian stock market is the fact that the return on financial investments substantially exceeds the return on investments in industrial assets, both capital assets and working capital. As a result, instead of attracting investments in new industrial capacity, the securities market periodically functions as a “pump” funneling resources away from the real economy. The high return on investment in this market is ensured primarily by the influx of new investor funds rather than by the growth in issuer earnings. Meanwhile, in underlining the relationship between investment and economic growth, Economics Nobel Prize laureate Paul Samuelson, follower of the Neo-Keynsian model, noted that “investments… are only made by and real capital is being created”. 2 In other words, real capital NAUFOR report, Section 1.3. The Russian stock market and the creation of an international financial hub. The ideal long-term development model for the Russian stock market (through 2020) Moscow, 2008. Published at www.naufor.ru Paul E. Samuelson, William D. Nordhouse, Economics /Translated from English, 16th edition. Williams publishing house, 2005, page 389.
Section Monetary and Budgetary Spheres serves as the driver of economic growth, but the Russian stock market does little to promote the accumulation of such capital.
Fig. 47 shows data regarding the return on investment in equities as exemplified by an RTS index portfolio and the return on investment in industrial capital assets, which can be used as a proxy criterion for taking investment decisions based on the return on investment in incremental industrial capacity.
Source: proprietary calculations based on RTS and Statistics Committee data Fig. 47. The return on investment in equities and in economic assets.
In the 14-year period from 1996 to 2009, only three years (1998, 2000, and 2008) saw substantially lower rates of return for investments in equities compared to investments in capital assets. 1 Despite the fact that the linear trends for the rate of return in the RTS index and the rate of return in production assets are getting closer, the gap between these indicators remains significant, which creates a substantial risk of the flight of domestic capital from the real economy into short-term financial market investments. This risk is also evidenced by the higher growth rates for bank investments in bonds compared to corporate loans (see Fig. 30).
Issues in the corporate bond market The development of the ruble-denominated bond market was a surprising phenomenon in the 2000s (see Fig. 48). The total value of the ruble-denominated corporate bond market grew R.K. Vardanian, the founding manager of one of the major Russian companies, the Troika Dialog investment banking group, comments on the rate of return of financial markets operations as follows: “Frankly, it was excessive in Russia; in our sector, rates of return of 30-35% were considered the norm …” P. Rushailo, R. Vardanian: we must expect high volatility in the absence of significant growth // Kommersant Dengi, No. 6 (February15—21, 2010), page 16.
RUSSIAN ECONOMY IN trends and outlooks 8.2 times in ten years, from RUR 0.6 trillion in 2000 to RUR 4.9 trillion in 2009. Of all ruble denominated bonds, the corporate bond market segment showed the highest growth rates.
Their total market value grew 54.3 times, from RUR 46 billion in 2000 to RUR 2.5 trillion in 2009.
Source: Russian Ministry of Finance, Cbonds.ru.
Fig. 48. Ruble-denominated bond volumes The rapid growth of the corporate bond market was due to both internal and external growth mechanisms. As shown earlier in Figs 15, 16, and 20, the basis for this growth from early 2004 to July 2008 was provided by carry trading strategies used by Russian banks and foreign hedge funds. Starting from August 2008 until now, the growth of the rubledenominated bond market is due to the excess liquidity accumulated by banks as a result of government support measures during the crisis given the lack of loan portfolio growth. The market for direct repo transactions involving the Bank of Russia and of interbank repo transactions, which enabled the banks to borrow short term funds for long-term investments in bonds, played a significant role in the growth of the ruble-denominated bond market starting from the mid-2000s.
Most corporate bond issues have featured an issuer guarantee by way of an offer that gave bondholders the right to present these bonds to the issuer for early retirement 1-3 years following placement. Such offers de facto altered the nature of long-term bonds, converting them into short-term Financial Instruments. The funds raised by bond issues were used by issuers to finance merger and acquisition transactions, refinance loans, expand business, and fulfill other relatively short-term objectives. Due to this relatively short-term character of bond financing and the low rates of return for investments in new capital assets and other productive assets, the role of bonds in financing capital assets has been, and still is, minimal.
Table 6 shows the key indicators for the ruble denominated corporate bond market in 2000–2009, expressed in dollar terms. Despite the fast growth of corporate bond placement volumes, from US$1.1 billion in 2000 to US$29.2 billion in 2009, the amounts channelled Section Monetary and Budgetary Spheres into capital asset financing were very low. Thus, of the total bond placement volume of US$29.2 billion in 2009, only US$0.1 billion, or 0.27% of the total placement volume, was used to finance capital asset acquisitions. The overall share of corporate bond placement volumes used to finance capital assets ranged from 0% to 3.43% throughout the 2000s.
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