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INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru Table Net Borrowings on the Market for Internal Subfederal and Municipal Securities, RUR thousand Consolidated Regional Budget Regional Budgets Municipal Budgets Year Net Borrowings 17 696 530 17 153 760 542 Attracted Funds 29 141 777 28 169 158 972 Repayment of the Principle 11 445 247 11 015 398 429 Amount Year Net Borrowings 6 601 447 6 667 592 -66 Attracted Funds 15 123 785 14 226 931 896 Repayment of the Principle 8 522 338 7 559 339 962 Amount Year Net Borrowings - 1 877 328 -2 286 175 408 Attracted Funds 13 042 220 10 090 208 2 952 Repayment of the Principle 14 919 548 12 376 383 2 543 Amount Source: RF Ministry of Finance In the course of the past four years only 25 constituent entities of the Russian Federation and 10 cities have used security market instruments to borrow funds. Moscow, St.Petersburg, the Republic of Chuvashia, Volgograd Oblast and city of Volgograd have been issuing bonds every year following the crisis, and the Tomsk Oblast, Republic of Komi and city of Ekaterinburg in the course of the past three years (See Table 26).

Table Issues of Subfederal and Municipal Securities in 1999 - Russian Federation Issuers: Con- Date of Registration stituent Entities of the 1999 2000 2001 Moscow * * * * St.-Petersburg * * * * Republic of Chuvashia * * * * Volgograd Oblast. * * * * Tomsk Oblast. * * * Republic of Komi * * * Republic of Bashkiria * * Leningrad Oblast. * * Irkutsk Oblast. * * Moscow Oblast. * Belgorod Oblast. * Tver Oblast. * Khanty-Mansi Autonomous Okrug * Khabarovsk Krai * Murmansk Oblast. * RUSSIAN ECONOMY in trends and outlooks Table 26 (contd) Russian Federation Issuers: Con- Date of Registration stituent Entities of the 1999 2000 2001 Kostroma Oblast. * Republic of Sakha (Yakutia) * Republic of Mordovia * Kursk Oblast * Sakhalin Oblast * Stavropol Krai * Primorye Krai * Kabardin-Balkar Republic * Republic of Mari-El * Novosibirsk Oblast. * Municipal Entities Volgograd * * * * * Ekaterinburg * * Ufa * Nizhny Novgorod * Yuzhno-Sakhalinsk Novocheboksarsk * * Kostroma * * Cheboksary * Arkhangelsk * Dzerzhinsky * Source: RF Ministry of Finance In December, 2002, Standard & Poor's upgraded the ratings of Moscow and St.Petersburg to BB, practically simultaneously with the rating of the Russian Federation; thus, these ratings have exceeded the pre-crisis level of BB- (1997) and, as before, correspond with the sovereign rating (See Table 22 above).

It should be noted that, in the period from February to December, 2002, both the sovereign rating and the rating of Moscow and St.-Petersburg jumped two levels at one stroke (starting from B+), and now there remain only two steps to the investment-level rating of BBB-, which makes it possible to attract funds from the largest foreign institutional investors.

Despite the relatively high rating of some federation entities, the problems of restructuring past-due debts on a number of previously issued subfederal securities still remain to be solved. E.g., according to Rosbank's depository, as at 1 November, 2002, 19 constituent entities of the Federation did not even begin their payments under the 3rd tranche of the 'agricultural' bonds20 due as long ago as 2000 - 2001 (See Table 27). Other regions have redeemed their agricultural bonds only partially.

It is noteworthy that the available funds in accounts of those regions that have past-due debts on the 'agricultural' bonds are sufficient to redeem the bonds. E.g., as at the end of the amount of all three tranches of the unredeemed agricultural securities issued by the Arkhangelsk Oblast was RUR 52.27 million, and the balances in the Oblast's budget accounts were RUR 168.0 million. The situation is similar in the Kostroma Oblast: the amount of three tranches of agricultural bonds that have not been redeemed at least partially is RUR 22.million, and the amount of budgetary balances is RUR 98.7 million.

Agricultural bonds were issued in accordance with Resolution of the RF Government No. 224 of 26 February, 1997, "On Economic Conditions of the Functioning of the Agroindustrial Complex in1997".

INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru Thus, even if one considers the necessity for these regions to pay the interest income due in the amount of 10 percent p.a., the refusal by many regions to redeem their bonds at least partially testifies to the weakness of enforcement in respect of borrowings by subfederal level government agencies.

Table Constituent Entities of the Russian Federation that Have Not Started to Redeem the Nominal Value of the Third Tranche of their 'Agricultural' Bonds (as at 01 November, 2002) Komi-Permyak Autonomous Okrug, Taimyr Autonomous Okrug, Republic of Tyva, Republic North Ossetia - Alania, Ulyanovsk Oblast, Primorye Krai, Kurgan Oblast, Pskov Oblast, Republic of Adygeya, Kabardin-Balkar Republic, Republic of Altai, Novosibirsk Oblast, Evenki Autonomous Okrug, Belgorod Oblast, Arkhangelsk Oblast, Kursk Oblast, Kostroma Oblast Source: Rosbank Depositary The Issues of Improving Legislative Regulation of the Market for Subfederal and Municipal Loans Development of the market for subfederal and municipal securities is related to two issues; their solution will determine further directions and dynamics of the market's development.

Issue No. One relates to the remaining relatively high level of credit risk on the liabilities of cities and regions.

On the one hand, this is determined by objective reasons. These include unstable municipal entities' revenues from regulated taxes; the authorities of constituent entities of the Russian Federation have a right to redistribute these taxes between municipalities as often as they like and to a very large extent.

At the same time, the amount of expense liabilities of the federal constituent entities and municipal entities remains undefined. E.g., federal government agencies still apply the practice of establishing the so-called 'non-funded mandates'. As a result, a territorial government agency's wish to repay its debts on time may contradict the demand by federal authorities just as binding to increase social expenses (e.g., in respect of increasing salary to public sector workers).On the other hand, there is a risk that the borrower would act in irresponsible, 'opportunistic' manner. The history of the market for 'agricultural' bonds has demonstrated that, due to lack of the mechanism of compulsory collection (restructuring) of past-due debts of federal and municipal entities an investor may spend an indefinite time on unsuccessfully trying to realise its right to collect the debt through the court, even if the respective court ruling has been positive and the region has got the necessary funds.

However, even subject to full realisation of the reform of interbudgetary relationship aimed at balancing and strengthening the regional government agencies' power over the ex The reform of salaries in the public sector related to abolition of the single tariff scale implies grating greater rights to regions in respect of establishing the salary amount.

RUSSIAN ECONOMY in trends and outlooks penses and revenues22, and to formation of a working normative base for collecting past-due debts, the extremely important issue of efficient application of the attracted funds remains a priority both for creditors and taxpayers.

Due to low transparency and efficiency of the system of budget expenses, including budgetary investments, the risk of inefficient application of budget funds is too great. In this connection one understands the requirements of the Budget Code that has introduced strict constraints on borrowings by regions and municipalities, relating them to the amount of their revenues, and has almost banned any external borrowings.

At the same time, against a background of low real interest rates in the internal market, the need for investments in the territorial social and economic infrastructure (road building, modernisation of the housing and communal services infrastructure, etc.) makes it necessary to analyse the possibility of changing the market regulation priorities.

Budgetary planning, budget implementation and control remain the main means of fighting inefficient application of borrowed funds; this is true first of all for capital expenditure and government purchases, and, besides, for the modernisation the system of funding housing and communal services that is one of the largest (12.9 percent of the regions' consolidated budget) and least efficient items of expenditure in territorial budgets.

It is obviously unpractical to support debt increases by the territorial budgets that 'have a hole' on the expense side. It would be expedient to considerably reduce limitations on territorial borrowings only upon increasing the efficiency of budgetary policy related to expenses and implementing \structural reforms at the regional and municipal levels.

Against this background one could propose a plan implying that the regions and municipalities, which have adopted and realised a programme of budgetary finance restructuring, would be granted a right to borrow in excess (to a certain extent) of the current limitations and to issue external loans23.

2.4.3. The Stock Market In 2002, despite persisting negative trends, the Russian stock market again demonstrated steady growth. Insignificant economic growth rates in the USA, Japan and the European Union, financial and political crises in a number of developing countries (e.g., Argentina and Venezuela) could not make investors any more optimistic, either. Among the factors that have supported the Russian stock market one should note high prices in the oil market, the continuing growth of the Russian economy, on-time external debt payments, recognition of Russia as a market economy and its exclusion from the FATF blacklist. Further steps aimed at reforming the Russian legislation in accordance with the requirements of the market economy have without doubt attracted investors to the Russian market. However, one cannot help noting a number of negative factors. Lack of considerable structural changes in the economy (such as reforms of natural monopolies and the housing and communal services, public service, banking and stock markets), frequent cases of opacity of corporate and financial management systems, significant influence of the so-called 'political factors' in solving economic disputes has impeded the normal functioning of the market of corporate securities.

The Programme of Budget Federalism Development in the RF for the Period up to 2005. Approved by Resolution of the RF Government No. 584 of 15 August, 2001.

The formalised criteria used in selecting the regions applying for funds from the Fund for the Reform of Regional Finances may be used as a basis for developing the methodology for determining the region complying with the conditions for abating limitations on the size of borrowings.

INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru In 2002 the Russian stock market demonstrated excellent results compared with other markets. Consequently, the Morgan Stanley index calculated for the Russian market (MSCLRU) grew 16.2 percent during the year, while the similar index for emerging markets (MSCLEMGLF) dropped 7.97 percent and the world index dropped 16.94 percent. In Quarter One of the current year the RTS index retained its second position in the list of the fastest growing stock indices of the world published by Merrill Lynch, with only Merval (Argentina) in front of it. During the year the Russian stock indicator became more than one third heavier (38.07 percent); compare with the indices of other emerging markets: Bovespa (-24.22 percent); IPSA (-25.11 percent); IPC (-10.03 percent); KOSPI (- 0.12 percent); Strait Times (12.45 percent); and the indices of developed countries: DJIA (-13.14 percent); NASDAQ (26.09 percent); NIKKEI (-16.79 percent); DAX (-35.64 percent).

Volume of Trade (US$) RTS Index US $ Mi llioin Fig. 30. Dynamics of the Russian Stock Market During the year the RTS index grew 101.1 points (38,88 percent), and the trade volume was cca. US$ 3.8 billion. It should be noted that, compared to last year, it has remained practically unchanged. In describing the RTS index dynamics several periods could be pointed out. In January the stock index grew 10.57 percent and the trade volume grew 51.48 percent.

In February the stock indicator remained practically unchanged (1.12 percent) and the trade volume fell 41.12 percent. Then a growth followed until mid-May. On 20 May the market reached a new historic high: 425.4324 points with the trade volume of cca. US$ 450 million during that month. It should be noted that on 30 May, 2002, the turnover was US$ 43.5 million, the highest value of the day in that year. In mid-May a recession began that lasted until 26 June, when the index dropped 89.54 points down to the value of 335.89 points. Then a new "increase-decrease" cycle followed: by 10 July the RTS index grew up to 391.17, and by August the index fell to the levels observed in March: 313.99 points. In August market participants were traditionally inert: the trade volume was the least, US$ 239 million, and on The maximum value since 6 November, 1997. ECONOMY in trends and outlooks August the turnover hit the year's lowest value of US$ 3.49 million. A slow growing trend was observed in the market until late November, and by 29 November the index grew up to 361.15 points. A greater index growth was prevented by the fact that the consideration of the key legislation on reforms in the Russian power industry was postponed until next year and by alarming rumours pertaining to Gazprom's capability to service its enormous debt. By the end of the year the index somewhat decreased; on 31 December it was 359.07 points.

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