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The data presented in the Table demonstrate that the total amount of financial aid to be granted to regions in 2003 is planned at 2.58 per cent of GDP, what is somewhat below the amount targeted in the law on the federal budget for year 2002 (3 per cent). Transfers from the Fund of Financial Support of Regions made the bulk of the expenditures for financial aid to budgets of other levels (60 per cent). The aggregate share of resources distributed in accordance with formalized methods (transfers from the Fund of Financial Support of Regions and INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru subventions and subsidies from the Compensatory Fund) made about 75 per cent of the total amount of financial aid. As compared with the targets set forth in the law on the federal budget for 2002 across all types of financial aid to regions, the more pronounced decline was detected in relation to such items (in per cent of GDP) as subsidies from the Fund of Reform of Regional Finances (78 per cent of the figure registered in 2002), subventions and subsidies from the Compensatory Fund (80 per cent), transfers from FFSR (82 per cent). The financing of road networks remained at the level targeted in the law on the budget for 2002.

Basing on the results of the analysis of characteristics of the law on the federal budget for year 2003 concerning interbudgetary relations, the following conclusions may be derived:

1. Changes in proportions of apportionment of revenues generated by federal taxes planned for 2003 should, on the whole, result in more even distribution of tax revenues among budgets of different levels, what would allow regions to partially compensate for losses borne in relation to the abolishment of the tax on users of motor roads (by transferring certain excises in the budgets of regions where excisable products are consumed), and generate additional revenues of the federal budget due to centralization of excises on tobacco products, the base of which is unevenly distributed across the national territory.

2. The system of federal financial aid to regions on the whole answers the principles set forth in the Program of reforming fiscal federalism until 2005 (the amounts of financial aid and methods of its apportionment will be presented at the second or third reading); however, certain types of financial aid to regions present in the budget rises questions. For instance, it does not seem feasible to assign about Rub. 20 billion (an amount equal to the planned amount of financial reserve for the next year) for implementation of federal targeted programs of development of Republics of Tatarstan and Bashkortostan in the situation where federal budget is stretched to meet external debt obligations and compensate for losses resulting from the lighter tax burden.

2.4. Russias financial markets 2.4.1. The public debt market Internally held public debt. As of the beginning of 2003 the internally held public debt in from of securities accounted for 654.5 bln roubles, that is about 6% of the GDP. Of this the basic sum of the debt (up to 90%) was held in federal bonds (OFZ) with a permanent or fixed yield, and amortization federal bonds, that is securities with a circulation period exceeding one year at the time of issue. The share of short-term government securities (GKO) did not exceed 3%.

The past year can be characterised first of all by an unprecedented decrease in dividend yields with low sales during the most part of the year (see fig. 27). The nominal average yield of the GKO-OFZ when redeemed decreased to 13.5-14% per annum, while the secondary market turnover in certain weeks went down under 1 bln roubles. Thus at the beginning of the year monthly sales became minimal since the spring of 1999, when the market was only starting to function after the 1998 crisis.

RUSSIAN ECONOMY in trends and outlooks The Dynamics of the GKO-OFZ Market in 7500 18% 17% 16% 15% 14% 13% 5000 12% 11% 10% 9% 8% 7% 2500 6% 5% 4% 3% 2% 1% 0 0% Turnover of secondary GKO-OFZ market. Average weighted GKO-OFZ yields.

Source: Information agency Finmarket, calculations by the IET.

Fig. The average yield level at the internally held public debt market in the Russian Federation grew in March and May of 2002. The average yield of the GKO-OFZ when redeemed reached 16.5-17.5% per annum, which was the highest peak since July August of 2001. At the same time it should be noted that taking the downtrend in the inflation rates into consideration the real value of debts at the domestic market in that period became positive and accounted for 3-3.5% per year.

By the middle of 2002 a sales growth was registered. A greater interest to the GKOOFZ can be explained as we see it first of all by currently lower inflation rates, which made investments into bonds at their present yields more attractive. Secondly, the Ministry of finance of the Russian Federation increased its additional distribution of bonds (in certain days these additionally floated securities accounted for as much as 50% of the total secondary market turnover). In the third place there appeared a new big player at the market in April the Pension Fund of the Russian Federation.

But already in June July the securities yield dropped again to its historical minimum 13.5-14.5% per annum. An essential point should be noted here, though, the one that adds to the negative assessment of the market situation in the past months the Pension Fund has become one of the principal market participants that ensure a high demand for bonds, while private investors have practically lost their interest to this type of investments. According to its chairman M. Zurabov the Pension Funds monthly investments plans exceeded 3.5 bln roubles.

In 2002 on the whole the Ministry of finance held 29 auctions to float securities. The supply accounted for 180 bln roubles, including 29 bln roubles worth of securities to be paid off in 6 months, 19 bln roubles in one year, 26 bln roubles in two years, 23 bln roubles in years and 95 bln roubles from 3 to 10 years. Total demand on the part of investors reached 134.9 bln roubles, there were floated bonds for a total sum of 86.2 bln roubles, that is less % a year bln. rubles 3-9.6.1-7.7.8-14.4.6-12.5.9-15.9.11-17.2.11-17.3.25-31.3.22-28.4.20-26.5.17-23.6.15-21.7.12-18.8.23-29.9.7-13.10.4-10.11.25.2-3.3.29.7-4.8.26.8-1.9.14-20.01.21-27.10.18-24.11.28.01-3.02.31.12.01-6.1.INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru than 48% of the total securities supply. The average yield at the auctions was 15.28%. The Ministry of finance of the Russian Federation sold securities for 80.9 roubles.

External debt. The total external public debt of the Russian Federation (according to the internationally accepted calculation methods and data provided by the Central Bank of Russia) in nine months of 2002 decreased by 7 bln US dollars from 113.5 to 106.5 bln dollars.

The securities part of the debts in the first three quarters got reduced from 28.8 to 28.0 bln dollars, first of all due to the pay off of a part of European bonds floated within the framework of the second restructuring of debts of the former USSR to the London Club of creditors. During the whole of the year there were circulated at the market 6 tranches of the OVVZ and 10 tranches of the European bonds.

In 2002 a quick growth of quotations of all Russian securities continued (see Fig. and 29). In particular, the yield of the OVVZ when redeemed decreased from 9-12.5% to 4.58.0 per annum, of the European bonds to 3.5-9.5% par annum. Thus the income derived from holding Russian securities (not counting bond coupons payments) reached 38.2% for the European bonds (the issue with pay-off in 2030) and 43.2% for the OVVZ (the 7th tranche, pay-off in 2011, they are referred to as debts of the Russian Federation).

Dynamics of OVVZ yields in 13% 12% 11% 10% 9% 8% 7% 6% 5% 4% 4 tranche 5 tranche 6 tranche 7 tranche 8 tranche Source: Information agency Finmarket.

Fig. Such a growth of prices on Russian securities as we see it is predominantly explained by a greater demand for them on the part of international investment funds. The stabilized economic situation in Russia, good showings in economic growth, a low probability of default on external debts made it possible for the investors to review their limits for Russian securities and to increase them. In one year the national ratings of the Russian Federation climbed several steps and by the end of the end reached the BB+ level (in national currency) and BB (in foreign currencies, Standard & Poors) and Ba2 (Moody's), that is got really close to the investment ratings category.

% annualised 03.01.17.01.31.01.14.02.28.02.14.03.28.03.11.04.25.04.09.05.23.05.06.06.20.06.04.07.18.07.01.08.15.08.29.08.12.09.26.09.10.10.24.10.07.11.21.11.05.12.19.12.RUSSIAN ECONOMY in trends and outlooks Dynamics of Russian Eurobonds yields in 12% 11% 10% 9% 8% 7% 6% 5% 4% 3% USD-03 USD-05 USD-07 USD-Source: Information agency Finmarket.

Fig. It should be noted that in January February 2002 the Ministry of finance of the Russian Federation was paying off the OVVZ of the 4th series at the secondary market, which (together with payments by the Bank of Russia to the International Monetary Fund performed before due time) allowed unburdening the federal budget for 2003. At present the default bonus for the 4th tranche of the OVVZ (obligations of the former USSR, which are traditionally viewed by the investors as the most risky ones; to be paid off in 2003) is assessed by the investors as 1 per cent point per annum, the yield of the European bonds to be paid off in the near future taken into consideration).

In addition to technical factors (a correction after the period of quick growth of quotations) the profitability of Russian securities in March was influenced by a number of other important factors. First of all, all the positive information about Russias economic growth outlooks in 2002 had already been taken into account in the bonds prices, as well as Russias higher national credit ratings by international agencies. At the same time the real sector showings in the last months of 2001 and in the beginning of 2002 were clearly negative. Secondly, in March the Ministry of finance was probably not pursuing the policy of repurchasing its securities, which decreased the total demand for Russian securities. Hence, one can assume, that the yield reduction by 1-1.5 per cent points in January February of 2002 was due to debts pay-off operations, and in March bonds ratings returned to the level corresponding to the risk assessments by the investors. Thirdly, in March there appeared expectations about a soon increase of rates by the US Federal Reserve System, which influenced rates of all assets in US dollars to grow.

In April 2002 the foreign debts market of the Russian Federation witnessed contradictory tendencies. When yields of the European obligations continued to decrease during the whole of the month and reached the lowest level in their history, the OVVZ ratings moved in the opposite direction. Yields of the 4th and the 6th issues of OVVZ, which dropped at the very beginning of the month got stabilized. At the same time prices on the 5th and the 7th issues remained at the same level as in March or even got slightly diminished. These changes in rat % annualised 03.01.17.01.31.01.14.02.28.02.14.03.28.03.11.04.25.04.09.05.23.05.06.06.20.06.04.07.18.07.01.08.15.08.29.08.12.09.26.09.10.10.24.10.07.11.21.11.05.12.19.12.INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru ings of Russian securities as we see it can predominantly be explained by lack of significant news from Russia and a relatively quiet situation at the developing markets on the whole (the persistent crisis in the Argentine has now practically no influence on other markets).

In June July 2002 the Russian external debts market witnessed a new fall in securities ratings caused first of all by the developments in Brazil. The menace of a foreign debt default in this Latin American country, which is one of the largest loan securities issuers led to an overall revaluation of investment risks for bonds of developing markets. In this way the yield growth influenced also Russian bonds in spite of clearly expressed positive trends (gold and foreign currency reserves growth and the fact that the European Union acknowledged Russia as a country of market economy). In particular in the second part of July the yield of all of the OVVZ and the European bonds (independently of their pay-off terms) grew by approximately 1 per cent point.

In August 2002 the yield growth tendency at Russias external debts market stopped and gave place to a downtrend for the most types of securities. These changes in Russian securities ratings were basically caused by the fact that Standard & Poors increased the national rating of Russia from B+ to BB- (on July 26, 2002) and fluctuations at international markets were dampened among other things due to the agreement between Brazil and the IMF on a package of financial aid of 30 bln dollars. Besides, the negative expectations potential connected with elections in Brazil in all probability got exhausted in October November prior to the new presidents appointments.

As the most important event at the Russian securities market in November one can regard the restructuring of commercial debts of the former USSR by the Ministry of finance for a total sum of 1.1 bln dollars into European bonds to be paid off in 2010 and 2030.

2.4.2. The Market for Municipal and Subfederal Borrowings The State of the Market The market for subfederal and municipal loans consists of two large sectors: bank lending and debt securities (bonds). Furthermore, there are loans of non-market character granted by higher-level government agencies. The market for subfederal and municipal loans was founded in 1992, reached its peak in 1997 and contracted significantly following the 1998 crisis when dozens of territorial government agencies defaulted on their obligations. (See Table 1).

As at 1 November, 2002, the estimated volume of the internal market for municipal and subfederal securities was RUR 32.1 billion, or 15 percent of the total volume of the internal market for government securities and one third of the corporate bond market.

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