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Third, the investment oriented nature of the Fund of Regional Development does not correspond to the fact that financial resources for the state support of motor road net works in RF subjects are expended not only for capital construction and capital repairs of motor roads for general use, but also for maintenance and current repairs of motor roads.

All these circumstances result in a significant distortion of objectives of FRD transfers and may have a significant negative impact on other components of this Fund.

Besides, it should be noted that in 2005 there will significantly decrease the expendi tures (the amount of which in preceding years was rather large) associated with the federal targeted programs for development of the Republics of Tatarstan and Bashkortostan, which were adopted as a compensatory measure after the cessation of special tax and Section 2.

Monetary and budgetary spheres budgetary conditions of agreements about the division of powers between these regions and the federal center. Thus, while in the preceding years the expenditures associated with these programs made more than Rub. 20 billion, in 2005 the respective financing will make about Rub. 11 billion.

The law on the federal budget for year 2005 also contains certain decisions aimed at the alteration of the procedures governing the granting of discretional (i.e. not regulated and formalized) types of interbudgetary transfers. Thus, in accordance with the new ver sion of the RF Budget Code, which does not envisage such types of financial aid as budg etary loans, the law on the budget for year 2005 contains a tough requirement that budg etary credits to the budgets of RF subjects were extended within the budgetary year.

Credits to the budgets of RF subjects from the federal budget may be provided for the pur poses of liquidation of temporary cash gaps and financing of expenditures relating to the liquidation of consequences of natural calamities. At the same time, a clearly positive result of the switching to the use of budget credits is that credits from the federal budget are pro vided on paid basis: in 2005 the payment of the use of newly extended credits will make one fourth of the refinancing rate of the Central Bank; however, the credits extended in re lation to the liquidation of consequences of natural calamities should be free.

The law on the federal budget grants the RF Finance Ministry to prolong budgetary loans extended prior to the enactment of the law, i.e. prior to October 1, 2005. However, after this date free budgetary loans should be reregistered as paid budgetary credits. The law also envisages tough measures in the cases of non repayment of the funds of the fed eral budget like write downs from accounts, withholding of revenues generated by federal taxes, recovery of transfers.

On the face of it, the provisions of the law on the federal budget for year 2005 facili tate an enhancement of efficiency of interbudgetary relations and regional finances. No doubt that the introduction of payment for the use of the financial resources of the federal budget will facilitate a gradual cessation of the use of budgetary loans as an additional type of financial aid provided on approval of the RF Finance Ministry in the case of financial diffi culties.

However, the consequences of the decision to cease the use of budgetary loans will to a great extent depend on the practices of granting of budgetary credits in 2005. Taking into account the low interest rates of the credits, it may be surmised that in the case these credits are granted at a significant scale, are frequently restructured, and may be legisla tively prolonged, while no measures are taken to exact overdue indebtedness, this meas ure may result in a further softening of budgetary constraints on regional authorities and gradual waning of positive effects expected from the introduction of these stipulations of the law on the budget.

RUSSIAN ECONOMY in trends and outlooks 2.4. Russian Financial markets 2.4.1. The Market for Public Debt Since 2001 the government has demonstrated different trends in its policy on the market for external and domestic debt. More specifically, despite the existence of a stable surplus of the federal budget, the volume of the domestic debts has been growing over last 23 years, while the volume of borrowings overseas was declining gradually (Table 13).

Table The Dynamics of Russias External and Domestic Debt in 1993(as of End of the Year) 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Domestic debt (as 0.22 10.62 76.76 248.98 450.97 493.74 529.83 531.81 511.06 654.7 663.67 756.Rb.bln.) Foreign debt (as 112.7 119.9 120.4 125 130.8 150 157.5 143.4 130.1 123.5 119.7 112.USD bln.) Against the background of an extremely favorable state of affairs on mineral markets in 2004, the government raised the issue of the possibility of an early debt repayment to the Paris Club. Should the parties concerned arrive to an agreement on the issue, the vol ume of Russias foreign debt may decrease substantially. The state of affairs in the area of the nations domestic and external debt in 2004 found itself under the impact of various factors that will be addressed below.

Domestic Debt By 2004 results, the volume of Russias public domestic debts in T bills grew roughly by 14.0% from Rb. 663.7 to 756.8 bln. (while it fell in shares of GDP equivalent from 5.0 to 4.5% of GDP). The federal bonds account for 99.99% of the public debt (Table 14).

Table The Structure of Russias Public Domestic Debt (as Rb. Bln.) Types of securities As of 1 January 2004 As of 1 January GKO 2.72 0.OFZ PK 24.1 0.OFZ PD 50.48 43.OFZ FK 199.31 171.OFZ AD 375.42 542.OGNZ 11.5 1992 ORVVZ. 0.04 0.OGSZ 0.1 0.Total 663.67 756.In 2004, the dynamics of quotations of the Rbdenominated T bills was not gradual.

By the 2004 results the average weighted yields of the traded issues fell by just 0.43% from 7.1 down to 7.08% annualized (Fig.17). However the market has been quite volatile through the year, with the average weighted yields fluctuating between 4 to 9% annual ized, while investors activity grew notably vs. the respective 2003 indicators. Thus the ag As of October 1,2004.

Section 2.

Monetary and budgetary spheres gregate turnover if trades in the market for GKO OFZ in 2004 roughly accounted for Rb.

350.8 bln. vs. 243.8 bln. in 2003 (44%). The peak weekly volume of trades in 2004 was a.

Rb. 35.87 bln. (20.43 bln. in 2003), while the minimum volume was Rb. 350 mln. (in 750 mln.).

Volume of trades on GKO/OFZ (mln. of rubles) Weighted-avarage return (annual rate) 40 000 10.0% 36 000 9.0% 32 000 8.0% 28 000 7.0% 24 000 6.0% 20 000 5.0% 16 000 4.0% 12 000 3.0% 8 000 2.0% 4 000 1.0% 0 0.0% Source: Finmarket investment agency, the IET computations Fig. 17. The Dynamics of the GKO OFZ Market in The dynamics of the market for Rb. denominated government bonds have under gone a series of changes over 2004. Thus, between January through February the yelds tended to decline, with the market being affected by two main factors: that is, an excessive liquidity in the banking sector and a notable appreciation of Rb. against USD. The market was also affected by the RF Minfins declaration regarding the 2004 domestic borrowing program that provided for a more than 5 fold rise in the offer of the papers vs. the indicators. In February, the market for public debt demonstrated the rise in the primary of fer with a premium vs. the secondary one. That contributed to a successful completion of the actions, notwithstanding a moderate demand. Given a favorable situation with liquidity, the demand at the auctions was at an acceptable level, which, however, has led to some fall in investors activity on the secondary market and contributed to just a moderate price rise of Rb denominated bonds. Notably, it was February 2004 when the average weighted yields of GKO OFZ sank to the 2004 minimum value of 3.85 % annualized.

The average weighted yields rate grew by early March, while the markets absorbed up to a half of the volume of papers offered by the MinFin. The price rise resumed after V.

Putins re election, with non residents apt to buy Rb. denominated assets, which increased limits on Rb. denominated instruments. The average weighted yields slid by mid April to the level of 5.9% annualized, followed by the start of adjustment in the market that was in place until late May. The change of the trend was triggered by a drastic deterioration of the situa tion with liquidity in the banking sector, coupled with Rb. appreciating against USD.

2-8.02.1-7.03.2-8.08.5-11.01.7-13.06.5-11.07.8-14.11.6-12.12.19-25.01.16-22.02.15-21.03.12-18.04.10-16.05.24-30.05.21-27.06.19-25.07.16-22.08.13-19.09.11-17.10.25-31.10.22-28.11.20- ECONOMY in trends and outlooks Between June through July the quotations of T bills were experiencing sporadic fluctuations, with no clear trend in place. The situation was affected by the commotion around sodbisnessbank and Kredittrust; plus, the market proved to be sensitive to a cer tain negative impact of the takeover of Guta bank by Vshehtorgbank. And if it was not enough, YUKOS darkening prospects generated investors flow from the corporate se curities market to the one for T bills, which can potentially be viewed as a factor that supported the latter.

August 2004 saw a relatively stable market, whereat, on the one hand, an insignifi cant change in quotations could be explained by seasonality, while on the other hand, their low volatility could evidence a great stability of already emerged price levels. In September, the yields rates of the trade bonds were lowering against an extremely high level of liquidity in the banking system (with the respective indicators being the highest ones over the past half year). October November 2004 saw the investors overflow from the secondary to primary market, and the demand was chiefly steered by a favorable situation with the banking liquidity and the USD depreciation. Given this particular background, the Novem ber volume of trades on the secondary market sank to the 2004 minimum level, while that on the primary market proved to be record breaking. The demand for placed papers to a significant extent was inspired by Fitch, which had increased Russias credit rating from BB+ up to the investment level BBB , with the forecasted stability of the rating.

In December, the rise in quotations of T bills was fueled mostly by the improving situation in terms of the banking liquidity and the ongoing depreciation of USD against Rb.

The leap of yields at the very end of the year could be explained by growing inflationary ex pectations, which could not yet been compensated by a Rb. appreciation.

In 2004, the MinFin successfully held 27 auctions on placement of GKO OFZ. The volume of face value offer accounted for some Rb. 172.3 bln., while the actual volume of place papers made up roughly as much as 87.9 bln. As of December 31, 2004, the volume of the GKO OFZ market was Rb. 557.56 bln. at face value and 544.82 bln. in market prices. The duration of the GKO OFZ market portfolio made up 1756.63 days.

Given the dynamics of the 2004 market for Rb. denominated bonds, it can be as sumed that in 2005 the quotations will find themselves affected by two main factors: that is, the USD/Rb. exchange rate and a high liquidity in the banking sector. Plus, as on Janu ary 31, 2005, S&Ps increased Russias rating up to the investment level may also support a favorable state of affairs on the market for Rb. denominated T bills. However, given the remaining trends to growth in the volume of borrowings on the domestic market, a consid erable downfall in yields rates is unlikely. Yet another factor that can constrain the rise in quotations is inflation. As it has become clear in late 2004 that by results of the year the price rise rates would overshoot the 2004 original budget indicators, while the price rise over the first two months 2005 accounted for slightly under the half of the 2005inflation targets, the emergence of inflationary expectations can also exert a negative influence on prices of Rb. denominated bonds in 2005.

External Debt As of October 1, 2004, the volume of Russias external debt shrank from USD 105.bln. to 99.8 bln. (according to CBR), which means a 5.58% reduction in the absolute amount of foreign debt accumulated by the RF Government. In 2004 Russia paid on a sole Eurobond issuance, which took place in March. By contrast, over the period in question the private sector (banks and companies) boosted their debt to non residents from USD Section 2.

Monetary and budgetary spheres 80.0 bln. up to 92.3 bln. (+15.4%). So, by results of the first 9 months 2004 Russias ag gregate foreign debt grew from USD 185.7 bln. up to 192.1 bln.

As concerns the market of forex denominated bonds, quotations of a number of trade papers were surging over the period in question, while some other were declining.

More specifically, in late December 2004 the yields rates of the papers of the 5th OVVZ tranche accounted for 4.99% annualized (5.66% as of the beginning of the year), while those of the 6th OVVZ tranche 4.2% annualized (4.34%). By contrast, the yields rates of RUS 30 dropped from 7.35% to 6.64%, while yields to maturity of RUS 07 was a. 6.35% annualized (4.42 as of early 2004), and RUS 18 were traded at prices equivalent to 7.02% annualized (6.59% as of early 2004).

The dynamics of the 2004 Eurobond market found themselves under such critical positive factors as an extremely favorable price situation in the world markets for oil and metals and a fairly stable macroeconomic situation in the country. The noted increase of Russias investment rating by Fitch has also formed a positive factor, so long as the price dynamics for Eurobonds are concerned. Speaking of critical negative factors, one should primarily note the unfolding conflict between the authorities and YUKOS. In addition, the increase of interest rates in the US (in response to the peril of a rise of inflationary proc esses in the US economy) has fueled the rise in the yields rates of the US T bills, which was also mirrored by the dynamics of the Russian segment of the world market for Eurobonds.

9.0% Tranche 5 Tranche 6 Tranche 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% Source: Investment Agency Finmarket Fig. 18. Yields to Maturity of OVVZ in The dynamics of quotations of Eurobonds allows to single out several periods (Fig.19).

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