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Amount of Revenues of the RF Federal Budget in 2007-(in % of GDP in terms of cash basis execution) 2007 January 2007 January Taxes and other payments administered by the Federal 11,50% 10,85% 15,97% Tax Service Taxes and other payments administered by the Federal 9,98% 9,46% 11,76% Customs Service Receipts administered by the Federal Agency for Man0,25% 0,13% 0,46% agement of Federal Property Revenues of the federal budget administered by other 2,14% 0,86% 1,73% federal structures Total revenues 23,87% 21,30% 29,92% Source: RF Ministry of Finance, IET estimates The amount of taxes and fees, administered by the Federal Tax Service have exceded the indicators of January 2007 by 5.1 per cent of GDP, those ones administered by the Federal Customs Service have grown by 2.3 per cent of GDP; the volume federal budget revenues, administered by other federal agencies, has increased by 0.9 per cent of GDP. Revenues, administered by the Federal Agency for Federal Property Management, has grown by 0.3 per cent of GDP.

At the fifth Krasnoyarsk Economic Forum on February 15, 2008, the future President of Russia, Dmitry Medvedev, at that time the First Vice Prime Minister, suggested to adopt a law on the time lines for transition to a decreased flat rate of value-added tax (VAT) "as soon as possible". Currently the VAT rate accounts to 18 per cent. The tentative rate reduction is under discussion in the government for nearly two years. Back in 2006 Mikhail Fradkovs government proposed a significant decrease of that rate to the level of 13 per cent. However, at that time, the Ministers of economic sector, Alexei Kudrin, the Head of the Ministry of Finance and German Gref, the Head of the Ministry for Economic Development, did not agree with that proposal. In their view, such a move would lead to a significant decrease of budget revenues.

Currently, Alexei Kudrin, the Vice Prime Minister and the Minister of Finance, believes that the idea of reducing the tax burden on businesses, expressed by the first Vice Prime Minister Dmitry Medvedev, is absolutely correct, but requires a stepwise implementation. Reduction of taxes will enable to extend the social tax base. Nevertheless, A. Kudrin has highlighted, that tax reduction could provoke problems with the implementation of the strategic objectives of national infrastructure development and, at his request, the discussion on the Russian tax policy in for the 2009-2011 was postponed from February 14 to March of the current year.

Let us refer to Tables 5 and 6, where the estimates of tentative consequences of tax reduction for the budget system are presented for a variety of VAT rates (with regard to the cancellation and without cancession of beneficial 10 per cent rate) in prices of 2007. One can see, that in case of VAT is decreased to 10 per cent, the losses of the budget will account to 2.5 per cent of GDP per annum.

Table Option 1 VAT Rate Reduction with Beneficial Rate in Effect VAT rate option Budget losses, RUR bln, in prices of 2008 2009 10% 895,4 1015,4 1146,11% 783,5 888,5 1002,12% 671,6 761,5 859,13% 559,6 634,6 716,14% 447,7 507,7 573,15% 335,8 380,8 429,16% 223,9 253,8 286,17% 111,9 126,9 143,18% - - - : , 35 000 39 690 44 . .

Source: IET estimates Table Option 2 VAT Reduction upon Transfer to Flat VAT Rate VAT rate option Budget losses, RUR bln, in prices of 2008 2009 10% 895,4 1015,4 1146,11% 770,4 873,7 986,12% 645,5 732,0 826,13% 520,5 590,3 666,14% 395,6 448,6 506,15% 270,6 306,9 346,16% 145,6 165,2 186,17% 20,7 23,4 26,18% +104,3 +118,3 +133,Reference: GDP in nominal terms, RUR bln 35 000 39 690 44 Source: IET estimates 7.

The estimates are based on the assumption that VAT share in imports, taxable at the rate of 10 %, makes about 7.5 % of the total VAT proceeds from imports (this is the most unfavorable scenario, and in case the VAT share stays at the level of 2006, i.e., 9.5 %, the losses would be less by 2-5 %). The share of VAT on At present, the Ministry of Finance is making assessments of tentative impact of VAT rate reduction on the national fiscal system. According to Sergey Shatalov, the Deputy Minister of Finance, the is little probability for the planned VAT rate decrease, starting from 2009, as the budget for 2009 is already drafted. He also noted, that the volume of losses, expected from VAT rate reduction, will be significant and it is hardly possible to compensate them from other sources.

In order to implement the federal law "On Amendments to the Budget Code of the Russian Federation" and in accordance with the Order of the Ministry of Finance of Russia "On the transfer of assets of the Stabilization Fund of the Russian Federation to the Reserve Fund and to the National Welfare Fund", on January 30, 2008 the Federal Treasury has effected the transfer of assets to the separate accounts of the Reserve Fund and the National Welfare Fund, denominated in USD, EURO and GBP accordingly.

The total volume of the Stabilization Fund as of January 30, 2008 amounted to RUR 3851.8 billion, i.e., 11.8 per cent of GDP. Funds to be transferred to the Reserve Fund and the National Welfare Fund, are distributed in foreign currency in accordance with the standard monetary structure: 45 per cent denominated in USD; 45 per cent in EURO and 10 per cent in GBP of the total volumes of the Reserve Fund and the National Welfare Fund. The Minister of Finance Alexei Kudrin noted, there is a plan to include the Japanese yen in the currency structure of the Reserve Fund and the National Welfare Fund, but its share is not defined yet. The expected amount is 2-3 per cent.

As of January 31, 2008, the gross total of the Reserve Fund amounted to RUR 3069 billion; the total volume of the National Welfare Fund made RUR 782.8 billion.

The selection of management companies, which could be authorized to invest the assets of the National Welfare Fund in securities and corporate bonds, can be completed by the end of 2008 or early in 2009, - said the Minister of Finance Alexei Kudrin. The fund assets are already being invested by the RF Central Bank, but so far they are allocated basically in the securities of countries with the highest reliability ratings. However, starting probably from 2009, somewhat more risky instruments, such as corporate bonds, will be involved. Herewith, it is anticipated to make financial, rather than direct investments, and the amount of investment in one company will be limited to 5 per cent of its shares.

Financial MarketsN. Burkova In February the Russian financial market dynamics was determined by the situation in the world financial markets, based on the relatively negative news background. Positive factors to the Russian stock market were oil prices increase in the global market and further USD decline. Those trends were explicitly observed in the Russian stock market, where the investors' activity has grown over the month by more than 30per cent. The Russian stock indices were demonstrating positive dynamics. However, by late February news on the losses of the USA largest insurance company have strengthened negative expectations of further financial problems of international companies, what, in turn, was reflected in the Russian financial market as well Government securities market In February the Russian Eurobonds have demonstrated volatility in the yield as a result of the positive situation in the top world markets. Herewith, there was noted an insignificant downgrading of an average daily turnover in the secondary market due to the scheduled tax payments period, which caused some tension with ruble liquidity. Moreover, a fairly high level of primary placements was observed in February.

As of February 22, 2008, the Russian Eurobonds RUS-30 yield to maturity made 5.65 per cent per annum (increased by 4.1 per cent as compared with the level of January 25, 2008), RUS-18 5.49 per cent per annum (+3.2 per cent), RUS-28 6.07 per cent per annum (+4.8 p.p.). However, the yield to maturity of the Russian Eurobonds RUS-10 has significantly declined by 36.6 per cent against preceding period and made 3.05 per annum. As of the same date, the yield to redemption of the Russian Eurobonds made: for the seventh tranche of external currency debt bonds 4.54 per cent (0.44 per cent growth as compared with the domestic operations is distributed by the level of 2004, at 95:5. VAT assessments for domestic sales were made without regard to tax revenues, obtaines in 2007 from UKOS In the course of the survey preparation, there were used analytical materials and surveys, published by the Zenith Bank, investment company ATON, MICEX, and the materials presented at web sites of Russian issuing companies.

level of January 25, 2008), for the fifth tranche 3.83 per cent (reverse dynamics, decline by 7.26 per cent versus preceding period) (see Figs. 1-2).

FIG. Minfin bonds' yields to maturity in December 2007 - February 5,75% Tranche 5 Tranche 5,50% 5,25% 5,00% 4,75% 4,50% 4,25% 4,00% 3,75% 3,50% FIG. Yields to maturity of the Russian eurobonds with maturity in 2010, 2018, and 2030 in December 2007 - February 6,5% RUS-2030 RUS-2010 RUS-2018 RUS-6,0% 5,5% 5,0% 4,5% 4,0% 3,5% 3,0% 2,5% In February a smooth decline in the yields was observed in the ruble debt market, started in January. At the same time, there were observed volatile yield trends in the Eurobond market dynamics. Activity in the debt market has also somewhat decreased (the turnover fell down by more than 15 per cent), reflecting the on-going negative situation in external markets, including the investors' expectations of further financial losses of a number of international financial companies. the period from January 22, 2007 to February 25, 2008, the total turnover of GKO- OFZ secondary market amounted to approximately RUR 70.8 billion with an average daily turnover of RUR 3.54 billion.

(against RUR 84.97 billion with an average daily turnover of RUR 4.47 billion in January).

A number of auctions on additional OFZ placements were arranged in the period from January 26 to February 22, 2008. Thus, an auction on additional placement of OFZ series 26200 was held on January 30 for the amount of RUR 5.08 billion, with an average weighted yield of RUR 6.22 per cent per annum. Two more auctions on placements of OFZ series 46021 and 25062 were held on February 6 for the amount of RUR billion each, actual placement made RUR 7.64 billion and RUR 9.89 5.85 billion with an average weighted yield of RUR 6.40 and 6.25 per cent per annum accordingly. Two auctions on additional placement of OFZ series 46021 and 46022 were held on February 13 for the amounts of RUR 3 billion and 3.15 billion with an average weighted yield of 6.46 per cent and 6.60 per cent per annum accordingly. On February 20 two more auctions on additional placement of OFZ series 46020 and 26200 for the amount of RUR 15 billion and RUR 10 billion, actual placement made RUR 3.61 billion and RUR 2.26 billion with an average weighted yield of 7.10per cent and 6. 50 per cent per annum accordingly.

As of February 28, 2008, the GKO-OFZ market amounted to RUR 1099.8 bln at face value and to RUR 1091.9 bln at market value. The duration of the GKO-OFZ market portfolio was 2076.86 days, having reduced by 23.99 days as compared with preceding month, when that duration was 2100,85 days (as of January 28, 2008).

Equity Market Stock market situation The neutral news background in the stock market has affected the results of the bids and led to some growth in market indices, in particular, the MICEX index, starting from the second week of the month. The volume of trades also increased slightly as compared with January. In late February the utmost effect on the market was provided by the information on expected further great losses of the US financial companies.

Thus, at the end of the month the largest US insurance company announced write-off of assets in the amount of USD 11.1 billion, including those related to mortgage lending. Moreover, further USD decline was observed.

Throughout February a strong positive dynamics in the Russian stock market was noted. As a result, the MICEX index started to grow steadily from February 11, having reached the level of 1 726.03 points on February 26, what corresponds to indicator of that index decline by 8.6 per cent form early 2008. Such MICEX index upgrading in February has reflected a general growth trend in the quotations of the Russian companies equities (Fig. 3).

FIG. Dynamics of MICEX Index and trading volume 150 2 000,The total volume of trading (roubles, 140 1 900,billion) MICEX Index 130 1 800,120 1 700,110 1 600,100 1 500,90 1 400,80 1 300,70 1 200,60 1 100,50 1 000,40 900,30 800,20 700,10 600,0 500,In general, within the period from January 29 to February 28, 2008, the MICEX index has grown by 0.per cent, i.e., by 11.08 points in absolute terms. Over the same period the turnover of trades in shares, included in the MICEX index, made about RUR 1536.1 bln at an average daily turnover of RUR 69.8 bln (as points roubles, billion with about RUR 1165 bln at an average daily turnover of RUR 61.3 bln in earlier period from December 25, 2007 through January 28, 2008). Therefore, the investors activity in the stock market in February has increased as compared with the preceding month over 30 per cent. The indicators of maximum and minimum turnover in the market trades in February made RUR 104.8 bln (as of February 6) and RUR 45.bln (as of February 26), accordingly.

As of monthly results (from January 29, through February 28, 2008), practically all blue chips have shown positive dynamics in their market values. The leaders in terms of growth rates were shares of GMK Nornickel (by 18.10 per cent) and Tatneft (by 17.80 per sent). Some lower growth rates were noted in the shares of RAO UES of Russia (by 7.54 per cent), Rosneft (by 6.97 per cent), as well as LUKOIL (by 1.58 per cent) and Mosenergo (o.23 per cent). Herewith, shares of Sberbank of Russia and Surgutneftegas have demonstrated downgrading trend in quotations by 11.95 and 7,98 per cent, accordingly. The next in terms of decline were Rostelecom (decline by 4.31 per cent), Gazprom Neft (by 1.6 per cent) and Gazprom (by 0.73 per cent (Fig. 4).

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