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The group of losers has been formed by 31 regions53, while the one of victors by16 ones54. The breach of the principle in question forms a substantial drawback of the new methodology, but one should bear in mind that observance with the principle poses a problem even in the frame of the existing budgetary system, while it becomes hardly doable in the event of the transition to a three year budgeting.

Overall, one should note the ambiguity of the 2007 novelties in the methodol ogy of allocation of the FFSR resources: on the one hand, most of them pursue the goal of creation of incentives to improve efficiency of the regional finance man agement, with a parallel compensation for whatever probable losses that may arise due to changes in the methodology, while, on the other hand, subsidies from the second part of the Fund break the principle of monotonousness in their allocation.

Plus, as already noted above, subsidies on equalization of the budget sufficiency level should first of all ensure the possibility for the provision of an equal level of budgetary services vis vis equal tax efforts by all the regions, providing there is no discouragement of regions attempt to boost the level of their budget sufficiency on their own. But an efficient stimulation of regions to boost their tax capacity is most likely to become possible under employment of other government regulation mechanisms.

There also are other novelties associated with FFSR in 2007. More specifi cally, there will be 68 regions that will receive subsidies from FFSR, or at 3 regions more than in 2006. Underlying this change are the following causes:

The IET computations on the basis of the data of the RF Ministry of Finance.

Volgograd oblast, Arkhangel oblast, Tula oblast, Krasnodar krai, Republic of Karelia, Orel oblast, Kursk oblast, Khabarovsk krai, Kaluga oblast, Tver oblast, Vladimir oblast, Voronezh oblast, Kos troma oblast, Amur oblast, Stavropol krai, Kirov oblast, Magadan oblast, Pskov oblast, Chita oblast, Republic of Chuvashia, Republic of Mordovia, Kurgan oblast, Altay krai, Bryansk oblast, Republic of Buryatia, Chukotka AO, Republic of Kalmykia, Kabardino Balkar Republic, Republic of Dagestan, Taymyr (Dolgano Nenetsky) AO, Republic of Tyva.

Novosibirsk oblast, Novgorod oblast, Saratov oblast, Primorsky krai, Ulyanovsk oblast, Republic of Yakutia, Tambov oblast, Penza oblast, Republic of Mary El, Ivanovo oblast, Koryaksky AO, Jewish AO, Republic of North Ossetia Alania, Karachaevo Cherkess Republic, Evenk AO, Republic of Altay.

Section Monetary and budgetary spheres 1. The Republic of Bashkortostan has begun receiving the subsidies, as its budget sufficiency level had plunged below the average nationwide one;

2. Ust Ordynsky and Koryaksky AOs once again became eligible for the subsidies separately from the respective oblasts.

In 2007, the volume of FFSR in real terms (with account of CPI) posted a 6.1% growth vs. the respective index of 2006. Meanwhile, this year 26 regions should re ceive lesser volumes of subsidies from FFSR in real terms than in 2006 (when this group comprised 16 regions)55. As well, there also exists some correlation between the change in the volume of subsidies from FFSR in real terms and the level of budget sufficiency of the RF Subjects (Table 24).

Table Correlation between Changes in the Volume of Subsidies from FFSR in Real Terms in 2007 vs. 2006 from the Level of Budget Sufficiency of the Region The number of regions that received subsidies from FFSR in real terms in Budget sufficiency level Lesser amount than in 2006 Greater amount than in Under 60% 10 6080% 12 Over 80% 4 The data of the Table 24 evidence that some 77% of regions with the level of budget sufficiency below 60% will receive greater amounts of subsidies (in real terms), while the respective rate for regions with the budget sufficiency rate be tween 60 and 80% is just 29%. Last year, the respective proportions were 86% and 55%, accordingly. The situation in the group of regions with the budget sufficiency rate over 80% has not undergone any drastic changes. It should be noted that the above data may witness some rise in progressiveness of allocation of subsidies from FFSR.

It should also be noted that the minimum budget sufficiency of an RF Subject (after equalization) still remains very low, and in 2007 it accounts just for 62% of the average nationwide one. The respective index tends to fall vs. the period between 2005 and 2006 (at the time, it was 64%). It can be argued that, according to Rawls56, the allocation of the FFSR subsidies is still unjust. The dynamic of the change in the regions minimum budget sufficiency rate after equalization is pre sented in Fig. 11.

Belgorod oblast, Kursk oblast, Moscow oblast, Ryazan oblast, Smolensk oblast, Arkhangel oblast, Murmansk oblast, Novgorod oblast, Karachaevo Cherkess Republic, Volgograd oblast, Republic of Mary El, Saratov oblast, Ulyanovsk oblast, Republic of Khakassia, Irkutsk oblast, Kemerovo oblast, Novosibirsk oblast, Omsk oblast, Taymyr (Dolgano Nenetsky) AO, Evenk AO, Republic of Sakha (Ya kutia), Primorsky krai, Amur oblast, Kamchatka oblast, Sakhalin oblast, Jewish autonomous oblast.

See Rawls, John. A Theory of Justice. Harvard University Press. 1999 [originally published 1971].

RUSSIAN ECONOMY IN trends and outlooks 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2001 2002 2003 2004 2005 2006 Minimum budget sufficiency Fig. 11. Dynamic of Minimum Budget Sufficiency of the RF Subjects between 2001 and The analysis of the structure of FFSR allows the following observations: its newly established second part accounts for a meager 3.5% of its 2007 overall vol ume. The first part of FFSR is broken by stages as follows: 50% (of the total volume of FFSR) falls on the first stage, while 46.5 on the second one. In 2006, the situa tion was opposite (44.3% on the first stage and 55.7% on the second). The change in the proportions has resulted in the following situation: the resources of the first part of the Fund remained after the allocation of subsidies at the first stage allowed allocation in 2007 of just 18.2% of the volume of budgetary subsidies needed to get the level of budget sufficiency of the regions of the second group to the average nationwide one (in 2006, this index made up 24.2%). As a result, the RF Subjects with a greater level of budget sufficiency (over 60% of the average na tionwide one) ended up loosing, as they became eligible to a smaller fraction of FFSR.

In conclusion, it is worthwhile noting that the insufficient volume of FFSR and a low level of equalization of the budget sufficiency level indirectly entail the neces sity of employment of subsidies on support of measures on getting the RF Sub jects budgets balanced, soft budget constraints, and the whole complex of asso ciated with these phenomena effects on the subnational authorities fiscal behavior.

2.5. Russian Financial Markets 2.5.1. Internal Debt Market In 2006, the internal debt of the Russian Federation in securities grew in vol ume by nearly 20.8 per cent, from RUR 851.15 bln to 1,028.04 bln (in terms of GDP, the national debt has somewhat reduced from 3.94 per cent to 3.86 per cent of GDP).

Table The RF Internal Debt Structure (RUR, billion) Type of securities As of 01.01.2006 As of 01.01.G 0,02 0,OFZ PK 0,001 0,OFZ PD 123,64 205,OFZ FK 131,13 94,OFZ AD 596,33 675,GSP PPS 0,00 0,GSO FPS 0,00 52,Total 851,15 1028,Source : the RF Ministry of Finance Over the period of the first three quarters of 2006, the external debt of the Russian Federation (government authorities and monetary credit control bodies) reduced from USD 82.3 54.7 bln (according to the data of the Central Bank of Russia). Thus, the absolute value of external debt of the Russian Federation re duced by 33.5 per cent. At the same time, the private sector (banks and other insti tutions) increased its debt to non residents from USD 175.1 billion to USD 214.billion ( +22.2 per cent ) over the same period. Thus, the external debt of the Rus sian Federation grew from USD 257.4 to 268.6 billion in total within nine months of 2006.

Domestic Debt In 2006, there was no such a substantial reduction in average weighted yield of the traded issues, that was noted in the ruble government debt market year ago.

Thus, according to the data at closing on December 29, 2006, the average weighted yield has been reduced to 6.39 per cent per annum as opposed to 6.per cent p.a. at the beginning of 2006.(See Fig. 12). Herewith, up to July the situa tion in the market remained quite stable, but in the second half of the year volatility was growing to a certain extent. Before July average weighted yield was kept up within the range of 6.24 per cent to 6.79 per cent per annum, while it changed to 5.36 per cent6.57 per cent per annum in the second half of the year. A special emphasis should be placed on the fact that in 2006 the parameters of investment activity has somewhat decreased as compared with the data of preceding year of 2005. The total trading volume of GKO/ OFZ bonds in 2006 made RUR 333.04 bln against RUR 355.07 bln in 2005.

Herewith, at the background of some decrease in the total trading volume in 2006, the average weekly parameters were also getting down and made RUR 6.bln as apposed to RUR 6.9 bln in 2005. The maximum weekly trading volume in RUSSIAN ECONOMY IN trends and outlooks 2006 reached nearly RUR 32.36 billion in 2005 ( as opposed to nearly RUR 24.2 bln in 2005),while the minimum was nearly RUR 993.8 bln (about RUR 993.8 bln in 2005). Thus, in the year of 2006, the maximum trading volume parameter has somewhat decreased as compared with the minimal weekly trading volume pa rameter in the market of government bonds denominated in rubles, despite the growth of maximum trading volume.

Volume of trades on GKO/OFZ (mln. rubles) Weighted-average return (annual rate) - right axis 35 000 8.0% 30 000 7.0% 25 000 6.0% 20 000 5.0% 15 000 4.0% 10 000 3.0% 5 000 2.0% - 1.0% Source : Finmarket Asset Management Company, estimates made by the authors.

Fig. 12. Market Dynamics for GKO/ OFZ bonds in In analyzing the annual market dynamics, it should be noted that market quo tations periodically moved up and down throughout the year. Thus, upon a short period of decrease to 6 per cent per annum at the beginning of the year, the aver age weighted yield of GKO OFZ was gradually growing up to July and then got sta bilized at the level of 6.5 7 per cent per annum. The process was continued till mid July, when a moderately negative trend in the dynamics of shot term up and down fluctuations was formed at the market. Let us consider in detail the monthly dynamics in liquidity in the market of government bonds, denominated in rubles.

Thus, within the first month of 2006, there were observed periods, when quo tations would go up or down, which resulted in insignificant average weighted monthly indicators. Liquidity situation was quite favorable, and only one auction was held at the primary market. Also in January the government has approved the Program of National Debt for the year of 2006, according to which the total OFZ volume was planned in the amount of RUR 186 bln, whereas in 2005 the total amount of domestic debt was planned within RUR 258.9 bln, and actually bonds were placed for RUR 182.3 bln. A session of market participants, arranged by the RF Ministry if Finance, MICEX and National Fund Association, involved in the above situation, where the Ministry of Finance has confirmed the sustainability of the pol 3-9.04.1-7.05.2-8.10.9-15.01.6-12.02.6-12.03.7-13.08.4-10.09.23-29.01.20-26.02.20-26.03.17-23.04.15-21.05.12-18.06.10-16.07.24-30.07.21-27.08.18-24.09.16-22.10.13-19.11.11-17.12.25- Monetary and budgetary spheres icy domestic debt with OFZ issues 3, 5, 10 and 15. It was also declared that Ministry of Finance is prepared to stop the extra liquidity on placed securities, which might become even lower than planed in the federal budget. The need of the Ministry of Finance in internal debt is decreased, and there is no necessity in extra yield of placed securities.

A month later the major part of investors activities was moved to the primary market, where the demand was several times higher than securities offer. Inconsis tency of the demand and offer in terms of price was noted in a number of issues, and hence, placement of some securities was incomplete. At the same time, insig nificant volatility of quotations was observed in the secondary market, prices varied within a narrow range. In general, the market was supported by the stable RUR rate with some trend to its strengthening against USD, as well as sufficient liquidity level in the bank sector. As opposed to that, prices were affected by inflation expecta tions, since within the first two months consumer prices have grown by 4.1 per cent, much higher than the level of official estimates. Economic situation in general has been aggravated, what was confirmed by lower indicators of GDP, industrial production, investment and trading activities within the first month of preceding year as compared with December 2005..

In March inflation estimates made a stronger negative impact on the market, as the inflation within the first three months of the year reached about 5 per cent, whereas according to the estimates, that level should have been in the limits of 8.5 per cent by the end of the year. In this context, the Ministry of Economy and Trade has to make adjustments to the target estimates up to 8 9 per cent, wile the Ministry of Finance admits that consumer prices can be increased by 10 per cent as of 2006 results. Apparently, all the above was taken into regard in the bonds yield estimates and resulted in the market quotations. Liquidity problems in the bank sector made an additional pressure on prices. Alongside with that, one of counter inflation measures, taken by the RF Central Bank, is effective strengthen ing of RUR in nominal terms. However, that factor provides an adverse effect, sup porting RUR liquidity, and the gross yield of securities has somewhat grown as compared with February indicators.

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