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Further aggravation of the situation with monetary liquidity and high inflation expec tations have made a stronger effect over the government bonds denominated in rubles, than strengthening of RUR against USD. The government proposed a series of counter inflation measures to be taken in the economy to restrain the greater prices growth rates, than planned ones. Some downward trend in yield was ob served in May. The dominating factors were monetary liquidity, which has consid erably raised as compared with other periods; stronger RUR against USD, as well as lower inflation expectations due to slower rates of consumer prices growth (in May it made only 0.5 per cent against 1.4 per cent in May 2005). The situation in the primary market was also rather favorable and the auctions on government bonds placements were successful.

In June there were no expressed changes in prices of traded securities. While there was observed a negative trend in quotations in the market at the beginning of RUSSIAN ECONOMY IN trends and outlooks the month, prices have been adjusted by the end of June. The market was sup ported by the information on complete recovery of the RF debt to Paris Club of Creditors, what allowed to save about USD 7.7 of interest payments. Inflation was getting down; consumer prices went up by 0.3 per cent against 0.5 per cent in May.

One more stabilizing factor in the market of government bonds denominated in ru bles was liberalization of the RF foreign currency legislation, planned for July 1, 2006, which could be taken into regard by the investors in their considerations on the structure of investment portfolios.

Quotations were growing till the end of July, and at that background the aver age weighted yield of GKO OFZ has decreased below 6 per cent for the first time since January and made 5.8 per cent per annum. Herewith, as can be observed in Fig. 12, the yield decrease was accompanied by the growth of trades. The basic factors of favorable dynamics were stabilization of external debt market, high liquidity, RUR strengthening, liberalization of the RF foreign currency legislation.

Rather favorable situation was also observed in August September, despite the fact that the yield came back to the level of 6 per cent per annum. Meanwhile, the volume of secondary trades has reached its peak as compared with preceding months of 2006. Among other standard factors of yield growth, the RF raised rating played an important role as well.

Some yield growth of the most liquid bonds was observed in October, though there were no vast scale trades. Comments of some authorized officials on exces sive RUR strengthening negative impact on the RF economy made some effect over the demand offer balance. For instance, the RF Minister of Finance has men tioned, that further RUR strengthening will provide negative effect on the Russian economy and can result in RUR devaluation after 2009. Lower liquidity in the bank sector has added to the yield growth. Only noticeable RUR strengthening against USD contributed to the situation of the end of November, when the yield of the government bonds denominated in rubles has considerably grown, regardless some liquidity problems. That growth was continued till the end of the year, and has resulted in decrease of the most liquid ruble bonds. The basic supporting eco nomic factors were the expected in 2006 high rates of economic growth and lower inflation. However, rather high volume of primary offer in the market of corporate bonds, characterized by high yield, and some aggravation of the situation in the sector of the Russian government foreign currency debt, prevented the bonds from reaching the level of potential, formed by the end of the year.

In 2006 the RF Ministry of Finance has successfully held 34 auctions on placement of GKO OFZ for the total amount of about RUR 208.1 bln (against auctions for the amount of RUR 165.7 bln in 2005). The actual placement volume amounted to RUR 188.6 bln. The yield at the average weighted price varied from 6.08 per cent to 7.06 per cent per annum (in 2005 the range of average weighted price varied from 6.22 per cent to 8.85 per cent per annum). Therefore, an ex pressed growth of government debt was observed in domestic market, accompa nied by significant yield reduction, as compared with the preceding year. As of De cember 28, 2006, the volume of GKO/ OFZ bonds market amounted to RUR 875.Section Monetary and budgetary spheres bln billion at par value and RUR 879.3 bln at market value. Duration of the GKO/ OFZ market portfolio was 5.46 years.

External Debt As of 2006 results, there was an upward trend for some bonds denominated in foreign currency (Figs 2 and 3). Thus, as of the end of December, 2006, the yield of the fifth tranche of MinFin Bonds amounted to 5.47 per cent per annum (as op posed to 5.14 per cent early in the year), the seventh tranche of MinFin Bonds 5.48 per cent per annum (as opposed to 5.24 per cent) eight tranche of MinFin Bonds 5.57 per cent per annum (against 4.76 per cent at the beginning of trades as of May 2006). The yield of RUS 30 varied within the year from 5.42 per cent to 5.5 per cent and RUS 28 bonds stayed at the level of the beginning of the year, 5.96 per cent; the yield to maturity of RU 07 varied insignificantly and was estab lished at the level of 5.05 per cent versus 5,03 per cent early in the year, and RUS 18 bonds were traded at prices corresponding to the yield of 5.64 per cent per an num ( as opposed to 5.5 per cent early in the year ).

Several most significant factors regarding the movement in the Eurobonds market can be highlighted. The first one is extremely favorable conditions in the world oil and metal markets, as well as stable macroeconomic situation in the coun try. The second factor is the early repayment of a share of the RF sovereign debt to the Paris Club of Creditors. The third factor: it is essential that Standard & Poors upgraded the Russias credit rating in foreign currency from up to +, and rating in national currency from A to , as well as Fitch upgraded the RF sover eign credit from BBB to BBB+. The key adverse factor for the market throughout the year was the movement of the yield of the US Treasury Bonds, which was influ enced by periodical increases of the discount rate by the US Federal Reserve Sys tem, as well as the growth in inflationary processes in the US economy.

In the analysis of Russian bonds quotations dynamics several periods should be highlighted, when the market situation was variable. Thus, quotations were steadily growing up to mid July with occasional corrections. During the second pe riod, from mid July to early October quotations were decreasing, partially winning back the growth of the beginning of the year. Throughout the third period, in Octo ber December the yield was variable within a certain range. Let us consider the ba sic factors, which have influenced the dynamics of prices in the market of Russian Eurobonds. In January February favorable information on the US economy were published in the USA, what has reduced the expectations of the slow down in the economic growth rates, but supported inflation growth, especially in view of the forthcoming meeting of Committee on open markets of USA FRS. As a result, investors were selling US government bonds, what provoked trades in the Russian market as well, which nevertheless did not reach a vast scale, since the Russian bonds were substantially supported by high oil prices, demonstrated an expressed growth within January. In late January investors expectations came true, the basic rate in US was raised by 0.25 p.a. and reached 4.5 per cent per annum. The inves tors were also influenced by several developments, in particular, by the statement RUSSIAN ECONOMY IN trends and outlooks of B. Bernake, the new head of the US Federal Reserve System, though there was no new information in his words. He has mentioned, that the mechanism of the ba sic interest rate adjustment will be further applied as a balance instrument against inflation pressure. As a result of the month, quotations of the Russian bonds, de nominated in foreign currency, have been decreased.

7.0% Tranche 5 Tranche 8 Tranche 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% Source : Finmarket Asset Management Company.

Fig. 13. MinFin Bonds Yield to Maturity in Similar trends were prevailing in the market up to July. The interest rate in USA went up several times (up to 4.75 per cent per annum in March, to 5 per cent per annum in May). A greater portion of US economic statistics stated a steady eco nomic growth rate, whereas the upsurge of the world prices for energy sources created additional grounds for stronger inflation development and as a result, for further growth of interest rates. Comments of financial authorities in Europe also pointed to their intentions to raise the interest rates. In this situation one could most likely expect a downward trend in the sector of the Russian Eurobonds, what has actually happened in the market.

In July the upward trend of the Russian Eurobonds yield was replaced by an adverse tendency. The basic factor in the dynamics of the market situation was a reduced probability of further tightening of US Federal Reserve System monetary and credit policy, which effected both, the markets of the US government bonds and consequently, Eurobond markets of other countries. Moreover, statistical data, published in USA, reflected some slow down in economy and inflation stabilization.

In that situation investors were planning a decrease of interest rates in their fore casts, what also inspired price upswing. Their forecasts came true in October, when FRS made a pause in the series upgrades of interest rates. To the contrary, Monetary and budgetary spheres the Central bank of Europe has increased the interest rate by 0.25 p.p. up to 3.per cent per annum, but commented on low likelihood of further growth. In Novem ber and December there was no expressed dynamics in the market of Russian Eurobonds as well. Herewith, while in the US market the bonds were downgrading in December due to contradictory publications on macroeconomic data, provoked one more review of expectations in regard to the US Federal Reserve System pol icy, the Russian debt market demonstrated high resistance to that factor, though there was observed some yield upgrading in some bonds.

6.8% RUS-2030 RUS-2007 RUS-6.5% 6.3% 6.0% 5.8% 5.5% 5.3% 5.0% Source : Finmarket Asset Management Company.

Fig. 14. Russian Eurobonds Yield to Maturity due 2030, 2018 and 2007, in 2.5.2. The market for Municipal and Subfederal Borrowings The dynamic of market development By the results of the year 2006, the consolidated regional budget was drawn with a surplus of 139.8 bn roubles (0.53 % of GDP). The budgets of subjects of the Federation were drawn with a surplus of nearly 133.8 bn roubles, the budgets of city okrugs and the intracity municipal formations of the cities of Moscow and St.

Petersburg with a surplus of 0.3 bn roubles, the budgets of municipal raions with a surplus of 9.8 bn roubles, the budgets of urban and rural settlements with a surplus of 2.2 bn roubles57.

For five subjects of the Russian Federation (Moscow Oblast, the Republic of Ingushetia, the Chechen Republic, Koriak AO, and Chulotka AO), the budget statistics on municipal formations is cited without ECONOMY IN trends and outlooks In 2005, the consolidated regional budget was drawn with a surplus of 57.1 bn roubles, or 0.26% of GDP. The budgets of subjects of the Federation were drawn with a surplus of nearly 53.8 bn roubles, the budgets of municipal formations with a deficit of 9.4 bn roubles (Tables 26 and 27).

Thus, in one year the surplus of the consolidated regional budget against GDP increased more than twofold by 0.27 p.p. of GDP.

Table Ratio of the surplus (or deficit) of territorial budgets to budget expenditure (in %) Consolidated regional Regional budgets Municipal budgets budget 2002 2.7 3.0 2.2003 2.6 2.3 3.2004 1.1 1.6 0.2005 1.6 2.3 0.2006 3.7 4.Source: the IETs estimates, based on the data of the Federal Treasury.

Table Ratio of the surplus (or deficit) of territorial budgets to budget expenditure in 2006 (in %) The budgets of city okrugs Local budgets of five subjects of Budgets of urban and intracity municipal Budgets of munici Russian Federation (Moscow Oblast, and rural settle formations of Moscow and pal raions Republic of Ingushetia, Chechen ments St. Petersburg Republic, Koriak AO, Chukotka AO) 0.04 1.63 2.52 2.As of 1 January 2007, the consolidated budget was drawn with a surplus in subjects of the Federation (as compared to 33 in 2005). The aggregate volume of budget surplus in those regions amounted to 190.6 bn roubles, or 6.9% of the total revenue of their budgets (in 2005 5.4%). The average budget surplus amounted to 2.5% of budget revenue budget.

The highest surplus to revenue ratio in the consolidated budget was achieved in Agin Buriat AO 22.9%, in St. Petersburg and Nenets AO 14.7% each, in Che chen Republic 13.4%, Koriak AO 12.0%, in Cheliabinsk Oblast 11.7%, in the republic of Bashkortostan 10.3%, in Krasnoyarsk Krai 10.2%, in Pskov Oblast 9.3%, in the city of Moscow 8.8%, in Tumen Oblast 8.5%. Nearly 2/3 (or 64.2%) of the aggregate surplus of the consolidated regional budget was achieved by four subjects of the Federation: the city of Moscow 35.0%, or 66.6 bn roubles, the city of St. Petersburg 16.8%, or 32.0 bn roubles, Tumen Oblast 7.1%, or 13,5 bn roubles, and Krasnoyarsk Krai 5.4%, or 10.2 bn roubles.

The substantial budget surplus in two autonomous okrugs was produces by additional budget funding in connection with the approaching merging of Agin Buriat AO and Chita Oblast, as well as Koriak AO and Kamchatka Oblast. The high surplus in breaking it into the categories of city okrugs, municipal raions, and urban and rural settlements.

The budgets of the municipal formations in these regions were drawn with the deficit of 2.2 bn roubles.

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