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The corporate bond market appears low concentrated, with its HHI index value being nearly twice as low as the one of the equity market at MICEX-RTS. This can be ascribed to the fact that in the conditions of an insufficiently liquid OFZ market, corporate bonds are used largely as an interbank lending mechanism. It is vigorously employed by all banks, which is why the circle of participants in trading in corporate bonds at the exchange is a very broad one. By contrast, the market for regional bonds in 2010-11 was moderately concentrated, with its monthly HHI values fluctuating within the band between 800 and 1,800. It was only in November 2011 that HHI on transactions hit above the 1,800 mark and the market for a while became highly concentrated. There are a few players on the market (Sberbank, VTB, Bank of Russia, Centrocreditbank, among others), and it is used at least as a platform for interbank lending.

Fig. 32 displays data on the number of transactions and the value of an average transaction with corporate bonds on the order-driven market at MICEX-RTS. In contrast to the market segment with trading in stock (Fig. 16), the number of market transactions with corporate bonds has been in decline between 2009 and mid-2011, with the average per-transaction volume being on the rise. This evidences that in contrast to the market deals with equity, this particular segment of the market exhibits a lesser degree of advancement of high-frequency trading. The fall in the number of transactions and the value of the average market deal in H2011 is explained by the effect of dying trading activity in the segment of order-driven transactions in the period of exacerbation of the problem with liquidity.

jul jul jul jul jul jul oct jan oct jan oct jan oct jan oct jan oct jan oct jan jun jun jun jun jun jun feb feb feb feb feb feb apr apr apr apr apr apr sep sep sep sep sep sep sep dec dec dec dec dec dec dec aug aug aug aug aug aug aug nov nov nov nov nov nov nov mar mar mar mar mar mar may may may may may may Section Financial Markets and Financial Institutions 7000 40 35 30 25 20 15 10 5 0 2005 2006 2007 2008 2009 2010 2011 Value of transaction, Rb Thos Transactions, pcs Source: by data of MICEX-RTS.

Fig. 32. Market Transactions with Corporate Bonds at MICEX Findings of an analysis of the segment of repo transactions with corporate bonds at MICEX-RTS presented in Fig.33 evidence that in contrast to the market regime of transactions, in the period of aggravation of the situation with liquidity in 2011, the number of transactions and the average transaction value in the repo segment were on the rise, which apparently mirrored the banks increasing demand for loans against corporate bonds. The value of an average repo transaction proved to be roughly twice as high as the value of a market deal with corporate bonds. That is hardly surprising, as the amount of a bank loan extended to a financial company cannot be small.

120000 45 40 35 80000 30 25 20 40000 15 10 5 0 2005 2006 2007 2008 2009 2010 2011 Value of transaction, Rb Thos Transactions, pcs Source: by data of MICEX-RTS.

Fig. 33. Repo Transactions with Corporate Bonds at MICEX As concerns placement of corporate bonds, the drivers of expansion of the respective market for several years have been large, primarily state-owned, corporations. Table 6 demonsrates that the proportion of issues placed by Top-24 largest issuers in the aggregate value of corporate bond issues in 2009 was 87.7%, in 2010 - 60% and in 2011 - 59%. In 2007, of the Rb Thos Number of transactions jul jul jul jul jul jul jul jan oct jan oct jan oct jan oct jan oct jan oct jan oct jan feb jun feb jun feb jun feb jun feb jun feb jun feb jun apr apr apr apr apr apr apr sep sep sep sep sep sep sep dec dec dec dec dec dec dec aug aug aug aug aug aug aug nov nov nov nov nov nov nov mar mar mar mar mar mar mar may may may may may may may Rb Thos Number of transactions jul jul jul jul jul jul jul jan feb apr oct jan feb apr oct jan feb apr oct jan feb apr oct jan feb apr oct jan feb apr oct jan feb apr oct jan sep dec ma r jun sep dec ma r jun sep dec ma r jun sep dec ma r jun sep dec ma r jun sep dec ma r jun sep dec ma r jun aug aug aug aug aug aug aug nov ma y nov ma y nov ma y nov ma y nov ma y nov ma y nov ma y RUSSIAN ECONOMY IN trends and outlooks overall volume of placement of corporate bonds worth a total of Rb 476.7bn the share of their issues accounted for just 42.1%, while all other issuers 57.9%. In the 2009 and 2010 lists, out of the top ten corporations therein 6 ones were state-owned, while in 2011 there already were 7 of them.

Table The Largest Issuers of Rb-Denominated Corporate Bonds in 20092011 .

2009 2010 Issuers Rb bn. % Issuers Rb bn. % Issuers Rb bn. % 1 Russian Railways 145 15.8 FSK UES 50 5.8 Rosselkhozbank 62 5,2 Transneft 135 14.7 Rosselkhozbank 35 4.1 FSK UES 55 5.3 VEB 60 6.6 Rosnanotech 33 3.9 Uralkaliy 50 4.4 Lukoil 50 5.5 Evrazholding 30 3.5 Rostelecom 39 3.5 Atomenergoprom 50 5.5 AHML 29 3.3 AHML 35 3.6 Bashneft 50 5.5 VEB 27 3.2 Rosnano 33 3.7 AFK Systema 39 4.3 Alrosa 26 3 VEB 30 2.8 MTS 30 3.3 MTS 25 2.9 Gaspromneft 30 2.9 AHML 28 3.1 Mechel 25 2.9 Rusal Bratsk 30 2.10 VTB ( VTB 24) 23 2.5 Wimm-Bill-Dann 24 2.8 Veb-Leasing 25 2.11 SIBMETINVEST 20 2.2 VTB ( VTB 24) 20 2.3 Mechel 25 2.12 Gaspromneft 18 2 Gaspromneft 20 2.3 Oboronprom 21 1.VTB-Leasing 15 1.6 VympelkomInvest 20 2.3 Mortgage agent 20 1.Finance AHML 14 Mechel 15 1.6 Russian Railways 15 1.8 Gasprombank 20 1.15 MMK 15 1.6 Severstal 15 1.8 NLMK 20 1.16 Gasprom 15 1.6 Globex Bank 15 1.8 RusHydro 20 1.17 NLMK 15 1.6 Norilsk Nickel 15 1.8 AFK Systema 20 1.18 Severstal 15 1.6 Unicredit 15 1.8 NK Alliance 17 1.19 NIA VTB 001 14 1.6 EBRD 14 1.6 Uranium One Ink 17 1.Bank Petrocom- 11 1.2 MMK 13 1.5 Gasprom Capital 15 1.merz MBRD 10 1.1 Bank Saint Peters- 13 1.5 EvrazHolding 15 1.burg Rosbank 10 1.1 Aeroflot 12 1.4 Kuzbass-Energo 15 1.Finance 23 Rosselkhozbank 10 1.1 Transcreditbank 12 1.4 MMK 15 1.VympelkomIn- 10 1.1 Atmoenergoprom 10 1.2 Moscow Credit 13 1.vest Bank Other issuers 113 12.3 Other issuers 342 40.0 Other issuers 448 41. Total 917 100 855 100 1089* * - including non-public offering.

Source: by data of www.cbonds.ru, www.rusbonds.ru and MICEX-RTS.

The corporate bond market has increasingly shaped up as a process locked between public structures: state-owned corporations borrow funds from their peers, while it is mostly stateowned banks in tandem with the Bank of Russia which steer the secondary market. More than this, it also is public investment banks which become underwriters and investment consultants in the course of corporate offerings. This is evidences by data of Table 7. In 2007, state owned banks rendered underwriting services to 36.3% of bond issues (value-wise); in 2008, their proportion surged 46.8%, in 2009 62.4%. In 2010 it slid to 46.0%, but in bounced back to 62.4%.

The situation with investment banking services on the market for regional bonds appears different. In 2008 and 2009, the share of state-owned banks in the value of these bond issues rose from 14.2% in 2007 up to 58.7% and 85.6%, respectively. But in the next two years, 2010 and 2011, it slid first to 75.4% and then to 14.4%. The cause behind such a drastic decline in the proportion of state-owned structures in regional offerings in 2011 lies in the terSection Financial Markets and Financial Institutions mination of Mosfinagencys operation - once a key player on the market for regional loans, the Moscow City Hall has revised its budget strategy priorities.

Table Proportion of State-Owned Investment Banks in Volumes of Rb-Denominated Bond Issues on the Domestic Market 2007 2008 2009 2010 share, share, share, share, share, Rb mn Rb mn Rb mn Rb mn Rb mn % % % % % Corporate bonds Total 467 970 100.0 469 792 100.0 994 022 100.0 855 035 100.0 994 844 100.Public invest- 169 668 36.3 219 892 46.8 620 044 62.4 393 743 46.0 620698 62.ment banks Other 298 302 63.7 249 900 53.2 373 978 37.6 461 292 54.0 374 146 37.Regional bonds Total 53 032 100.0 71 943 100.0 155 836 100.0 114 901 100.0 53 944 100.Public invest- 7 551 14.2 42 227 58.7 133 325 85.6 86 613 75.4 7767 14.ment banks Other 45 481 85.8 29 716 41.3 22 511 14.4 28 288 24.6 46 177 85.Source: by data of ratings of organizaers of bond placements www.cBond.ru over 20072011.

3.5. The Main Risks on the Financial Market The main risks of the financial market are related to the following factors: stagnation of the equity market due to a halt of the growth in prices on energy carriers; risks related to the outflow of foreign capital; depreciation of the ruble; advanced growth in external borrowings by banks and the non-financial sector; growth in the volume of trading on the term market with insufficient level of surety of deals; growing risks on the REPO market and low capacity of the financial services market which hindered growth in financial intermediaries.

3.5.1. Halt of the Growth in the Equity Market Due to the Pricing Factor As shown in Section 3.2.1. (Fig. 6 and 8), the Russian stock market is dependent on oil prices. That price is an indicator of the state of the global economy, stability of the financial system and the level of cash liquidity in it, political stability in oil exporter countries and other factors. The current forecasts of the Ministry of Economic Development and international financial institutions which forecasts all point to the fact that in the mid-term prospect no growth in oil prices is expected reflect concerns over both the slowdown of the global economic growth and risks to stability of the global financial system due to the outstanding problem of sovereign debts, Euro-zone crisis, insufficiently stable banking system and other factors.

If an equation of correlation between the price on oil and the index shown in Fig. 6 is applied to the short-term forecast of oil prices of the Ministry of Economic Development in the 20122014 period there will be a stagnation of the equity market as shown in Fig. 34. The RTS Index will be volatile, but its average value will stop at the level of 1900 points. To renew the stock markets growth, new ideas of economic growth are required and even if they are implemented it is unlikely that they start working at once1.

In different versions of Strategy-2020, such ideas include a radical change in the business climate, a new industrial policy and innovations.

RUSSIAN ECONOMY IN trends and outlooks 2 500 120,100,2 000 1748,65 80,1 500 73 62 1842 60,1 40,28 20 24 Forecast 19 17 500 20,195 97 81 0 0,Average annual RTS index (left axis) RTS index as of the year-end (left axis) Annual average Brent oil price, the 2010-2020 forecast of the Ministry of Economic Development (hand axis) Source: calculated on the basis of the data of the forecast of the Ministry of Economic Development and MICEX-RTS.

Fig. 34. The forecast of the RTS index until 2014 on the basis of the forecast of oil prices of the Ministry of Economic Development On the basis of the equation of correlation between the RTS index and prices on oil, in the 2009 report1 in 2010 the annual average value of the index was expected to be at the level of 1503 points, while the actual one was equal to 1510. When analyzing the market results of 2010, the average annual oil price per barrel was expected to grow in 2011 from $80 to $1052.

Actually, it grew more to nearly $111 per barrel. However, instead of the expected growth in the annual average value of the RTS index to 2017 points in 2011, that index actually grew merely to 1748 points. Furthermore, as of the year-end the RTS index fell from 1770 points in 2010 to 1381.87 in 2011 (a decrease of 21.9%). The factor behind the difference between the actual data and the expected one is a more sizable capital outflow from Russia than it was expected.

According to our evaluations, in 2012 with an insignificant drop in the average annual prices on oil the average annual value of the RTS index will grow from 1748 points to (an increase of 5.4%). Multidirectional dynamics of average values of oil prices and the index will be explained by a slowdown in volumes of the capital outflow from Russia.

3.5.2. The Risks of the Outflow of Foreign Capital In Section 3.2.2., correlation between the Russian equity market and the flow of cash funds of foreign investment funds which invest in Russia was analyzed. As was shown with reference to the IMF survey, investment decisions of portfolio investors are based on the dynamics and volatility of the GDP growth rates forecasts of international financial institutions, evaluations of volatility of foreign exchange rates and indices of the expected volatility of the developed and emerging markets.

As was shown in Fig. 9, the outflow of capital from foreign funds specializing in investments in Russia which outflow was registered in May-December 2011 was replaced in January 2012 by a trend of inflow of resources to those funds. It remains to be seen if a The Russian Economy in 2009. Trends and Prospects. .: IEP, 2010, p.154.

The Economic and Political Situation in Russia. 2011, No.7, Trends and Prospects. .: Publishing House of the Gaidar Institute, 2011, p.154.

points $ per barrel 2012e 2013e 2014e Section Financial Markets and Financial Institutions change in the trend of portfolio investors behavior took place. In our opinion, there are no prerequisites for that so far. In particular, in the latest Report on the State of the Global Economy whose update was published on the Internet site in January 2012 the dynamics of the IMF forecasts as regards the GDP of the worlds largest economies point to that fact, too. In that Report, as compared to the forecast of September 2011 the IMF revised downward the forecasts of the GDP growth rates in 2012 for the global economy from 4.0% to 3.3%, Japan from 2.3% to 1.7%, Germany from 1.3% to 0.3%, the UK from 1.6% to 0.6%, China from 9.0% to 8.2% and Russia from 4.1% to 3.5%.

Developments of 2011 point to the fact that there is a correlation between downward revision of GDP dynamics forecasts and behavior of investors of investment funds. As shown in Fig. 35, in April 2011 the IMF revised downward the 2011 forecasts of the GDP growth rates in the USA, the UK and Japan. In subsequent quarters, the forecasts of economic growth were revised downward as regards Germany, China, Russia and the world as a whole. Not surprisingly, according to the data of EPFR in May 2011 portfolio investments started to leave steadily the Russian equity market as a kind of response to the growth in uncertainties in the global economy.

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