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Figure 4. Exchange Trading of Shares in 2006*, USD bln remove USD bln from the picture The volume of stock trading in Russia reached $597 bln in 2006 vs. $180 bln in 2005, i. e. demonstrated 3.3 times growth. Compared to other emerging mar kets, Russia has given way only to China with regards to this indicator (similar to capitalization). However, Russias breakaway from global markets with regards to liquidity has not become any more visible. Despite significant growth of quantitative indicators of Russian exchanges liquidity in 2006, globalization of various interna tional exchanges has become another serious challenge. NYSE and Euronext (leader of European term contracts and bonds market) integration is currently in its final phase, Tokyo Stock Exchange and Indian National Exchange are ready to join the alliance all this symbolizes the beginning of the process of starting new global markets for stock, derivatives and other financial instruments. Market exchanges of Nordic countries have united into OMX. China has developed coordinated market exchange strategy oriented towards global interests in cooperation with Hong Kong, Beijing and Shanghai stock exchanges. Unfortunately, Russian exchanges are currently limited by domestic market only and are not undertaking any notice able steps within the framework of world trading globalization. In a just a few years any national stock exchange, even a major one, is unlikely to be competitive enough compared to global exchanges from the point of view of traded instru Section Institutional Problems ments, accessibility to different investors resources, diversity of trading strategies and other parameters.

A visible increase of stock turnover rate has become a positive factor of Rus sian capital market in 2006. International practice of calculating this index is based on dividing average monthly stock exchange turnover by the total amount of market capitalization (see Figure 5).

Comment. * Russian data include indices of RTS and MICEX.

Source: WFE (World Federation of Exchanges) data; MICEX and RTS data.

Figure 5. Stock Turnover Rate in 2006, % remove second title Russian stock turnover rate in 2006 made c. 5.5% vs. 3.2% in 2005. Russia is holding a mid level position compared to other countries and visibly behind the leading markets, which is a clear evidence of a low level of Free Float for the shares of Russian issuers.

2006 provided for continuation of the 2005 trend for strengthening Russian capital market position with regards to stock and depositary receipts of Russian is suers, which is reflected in Figure 6.

RUSSIAN ECONOMY IN trends and outlooks Source: stock exchanges data (without NYSE).

Figure 6. Exchanges Share in Trading Russian Stock In 2006 LSE share decreased from 45.9% down to 30.3% in the overall trading of Russian stocks and depositary receipts; MICEX (Moscow Inter Bank Currency Exchange) share during the same period grew from 40.6% up to 62.0%; the aggre gate share of RTS exchanges fell from 10.0% down to 5.6%. In 2006 Gazprom shares liquidity center was moved from RTS to MICEX. This has seriously knocked the bottom out of RTS position at spot stock exchange.

The term market growth continued in 2006, which is reflected by the data in Figure 7.

In 2006 trading volumes at Russian stock exchange markets made: for futures $88.8 bln, for options $11.5 bln, which meant exceeding the level of 2005 by 4.1 and 4.6 times accordingly. London Stock Exchange and Germany Stock ex changes announced their plans for establishing Russian term depositary receipts market during the current year.

Section Institutional Problems Source: RTS data.

Figure 7. Trading Volumes and Number of Deals at RTS Term Market from September 1, 2001, to December 29, *GKO: State Treasury Bills **OFZ: Federal Loan Bonds ***GSO: State Savings Bonds Source: data provided by RF Ministry of Finance, CBonds and Stock Exchanges.

Figure 8. Bonds Secondary Market, Trading at MICEX RUSSIAN ECONOMY IN trends and outlooks Simultaneously with stock market growth 2006 displayed domestic bonds market growth. As shown in Figures 8 and 9, the secondary bonds market turnover and bonds trading volumes overtopped T bills (State Treasury Bills) market of 19961997 by a number of times.

Volumes of bonds trading at the exchanges in 2006 exceeded the maximum State Treasury Bills market liquidity (set in 1997) 6 times. During this year the vol umes of trading corporate bonds at the secondary market (through exchanges) in creased 2.9 times, regional and federal bonds trading 1.7 and 1.1 times respec tively. And the fact of most bonds issues having negative effective yield was not at all a barrier for their liquidity growth for their floating. This fact may be explained by banks and non residents being major participants of this market those who have enough capacity for using various speculative strategies to cover their potential losses from passive ownership of such securities116. Incremental liquidity flow into the Ruble bonds market will allow the issuers to successfully float new issues of bonds (Figure 9).

*State Treasury Bills **Federal Loan Bonds ***State Savings Bonds Source: data provided by RF Ministry of Finance, CBonds and Stock Exchanges.

Figure 9. Volume of Bonds Float The volume of bonds float in 2006 grew less than the respective secondary market turnover. Corporate bonds became the driving force for issues at debt mar One of the most popular strategy globally (including Russia) is carry trade the one that stipu lates, borrowing at low interest rates, possibly in currency the value of which is going down, with the purpose of further investing those funds into financial assets with higher yield (e. g., bonds nominated in Rubles).

Section Institutional Problems ket, their float volumes grew from RUR 260.6 bln in 2005 up to RUR 465.3 bln in 2006, i. e. 1.8 times. The amount of regional bonds issue in 2006 decreased down to RUR 51.7 bln compared to RUR 56.8 bln in 2005, i. e., by 9.9%. The overall amount of issues of Federal Loan Bonds and State Savings Bonds in 2006 made RUR 237.6 bln vs. RUR 167.2 bln in the preceding year, i. e., grew by 42.1%. Avail ability of sustainable revenue base for both federal and regional budgets makes government less interested in borrowing. However, contrary to the situation with the regional bonds, Federal Loan Bonds and State Savings Bonds are the key asset for investing the reserves of the RF Pension Fund (the part that is targeted at fund ing the financial defined contributions being managed by Vnesheconombank. Be cause of that the RF Ministry of Finance is forced to build up issues of government bonds even when federal budget has a surplus.

The overall amount of Rubles valuated bonds, including federal securities, corporate and regional bonds, grew from RUR 1.5 trillion in 2005 up to RUR 2.2 tril lion in 2006, i. e., 1.4 times.

Thus, despite serious problems in institutional sphere and with investment climate, Russian capital market is still of interest for foreign investors because of its yield and explosive growth of its quantitative parameters (liquidity, capitaliza tion, capacity). However, this growth of quantitative parameters will not directly impact the score of Russia calculated based on CalPERS Methodology in 2007, because this score with regards to quantitative parameters is already the highest possible (3).

As it was shown in 2005 overview by the Institute of Economy in Transition, Russia still lacks transparency of information about financial market growth factors.

Contrary to many countries, for some unknown reasons there arent any financial accounts statistics in Russia (which would allow for accurate registration of the level of various investors categories participation in Russian issued securities). In such environment only indirect data may serve the basis for analyzing the level of impact various factors might have on capital market development.

Role of foreign investment at Russian capital market 2006 growth of stock market was based on heavy commercial activity by non residents, Russian public and domestic institutional investors. The non residents dominated, just like in 2005. For them Russian capital market was attractive not only because of extremely high returns for investment into securities, but also be cause of such factors as stable macro economic situation in the country in general due to high prices for exported raw materials, liberalization of Gazprom shares market, strengthening of Ruble versus US Dollar, cancellation of limitations stipu lated in currency regulations and control framework, excessive liquidity of the global markets due to low interest rates. The impact of external factor on Russian capital market is represented in Figure 10.

RUSSIAN ECONOMY IN trends and outlooks Source: Balance of Payments of the Russian Federation.

Figure. 10. Net Import (+) / Export ( ) of Capital into/from Russia, USD mln 2006 demonstrated unprecedented inflow of foreign capital into Russia. The demand for Russian companies stocks on behalf of non residents during the first 9 months of 2006 increased: net direct foreign investment by $11.1 bln; portfolio investment by $11.5 bln. Major investment flow from hedging funds and direct investment funds falls under the category of direct foreign investment, so this group of investment in Russia does not differ much from portfolio investment.

Increased influence of non residents at MICEX stock exchange (constituting more than 95% of Russian exchanges turnover) is shown in Figure 11.

In 2006 the non residents share in the total value of sales and purchase transactions at MICEX stock exchange reached 25.4% exceeding the share of indi vidual private investors (22.9%). The most noticeable increase of non residents participation at MICEX falls on the period starting from the date of canceling the limitations on transactions with the stocks of non residents(previously established within the currency control and regulation framework).

It is necessary to state here that practically the role of non residents in the transactions with Russian companies stocks in the territory of Russia is even big ger. The thing is, many major brokers and banks purchase stocks at MICEX in their own names for further re selling them to non residents through off shoe compa nies117. Such re selling is normally qualified as deals beyond the stock exchanges, and their share in the market makes up to 2030% of the stock exchange turnover As it has been stated above, because of imperfectness of Russian tax regulations and some other factors, non residents prefer to own stocks of Russian companies indirectly, i. e. through off shore zones.

Section Institutional Problems of shares. Non residents themselves sell stocks also outside the stock exchanges.

Taking this into account, we estimate the share of non residents participation in Russian stock exchange as almost 50%.

Source: calculated based on MICEX stock exchange data.

Figure 11. Individuals and Non Residents Share in Stocks Transactions at MICEX, % The problem of Russian stock exchange market from the point of view of for eign portfolio investors participation is that it so far has not yet become the key in vestment site for major global investment and pension funds focused at foreign re tail investment. The funds specializing in Russia are usually low capitalized ones, and most of them have a status of either hedging funds or funds focused on dealing with qualified investors (e.g., Hermitage Fund or funds managed by JPMorgan Fleming). According to the RF Statistics Agency, off shore zones (Luxembourg, Cyprus, Virgin Islands and Cayman Islands) in 2006 accounted for 40% of accumu lated foreign investment into Russia.

According to EmerginPortfolio.com, the value of portfolio funds investment into Russia made c. $10 bln as of the beginning of 2006. Table. 17 represents the profile of foreign funds investing into Russian companies securities.

Global investment funds specializing in emerging markets in Europe, as well as global funds of emerging markets are key investors for Russian JSCs. Invest ment funds registered in Luxembourg are dominating as for investment into Russia (they account for 47% of foreign portfolio investment into Russian companies stocks), the funds registered in the USA account for 23%, Ireland 8%, Austria 7%, and Cayman Islands 2% 8. Almost 60% of assets are funds set up in off shore zones (Luxembourg, Ireland, Cayman Islands and Guernsey).

RUSSIAN ECONOMY IN trends and outlooks Table Foreign Portfolio Investment Profile with regards to Russian Companies Stocks as of the beginning of 2006, % Areas of specialization of global investment funds Country of registra Global funds European Europe, Far tion of global invest International of emerging emerging East and Af Total ment fund markets markets markets rica Austria 10.8 6.Belgium 0.1 0.4 0.Bermudas 0.0 0.Canada 0.2 0.Denmark 1.1 0.France 1.9 1.9 1.Guernsey 2.7 0.0 0.Ireland 3.5 11.2 0.3 8.Jersey 0.4 0.0 0.Luxembourg 31.8 56.9 100.0 46.Switzerland 1.0 1.5 1.UK 9.2 4.8 0.4 6.USA 49.3 4.7 99.6 23.Cayman Islands 3.0 1.Finland 1.3 0.The Netherlands 0.7 0.Sweden 1.7 1.Total 100.0 100.0 100.0 100.0 100.Source: www. EmerginPortfolio.com.

These funds make package based investments into emerging markets seek ing to diversify their portfolios between different countries irrespective of macro economic situations they are in. The fact that emerging markets are very attractive in general for investment dominates over characteristic features of any specific market, country based approach usually dominates over the industry based one118.

This domination of country based portfolio strategy among foreign investors coming to Russia has a negative impact on the quality profile of the market for Rus sian companies stocks, because it creates a phenomenon of simultaneous devia tions of their prices irrespective of financial accounts of the companies themselves.

This is reflected in the fact that Beta coefficients are close to 1 for most of the blue chips, which characterizes the level of returns on investment into various securi ties dependent on stock exchange profitability indices. Table. 18 presents Beta co efficients for 15 issues with the biggest liquidity from MICEX list.

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