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#14 - JRL 7225
June 16, 2003
Russian companies use the securities market for long-term investments and acquisitions. This means the Russian capital market depends less and less on Western
commodity and stock exchanges.
By Yury Danilov

Senior Adviser in Macroeconomics at the Center for the Stock Market Development Foundation, Candidate of Economics

Many believe that the stock market in Russia doesnt perform its function. They think it is not a source of investments and therefore of interest only to stags. This is a delusion and has been a myth for a long time already. However, many domestic economists not only continue to believe it but also try to give advice to authorities and to "enlighten" the public with their outdated notion of the "unnecessary and inefficient" stock market.

The political elite is discussing the question seriously: "Do we really need the stock market? Is it worth making the effort to develop it if money will go abroad anyway?" All this reduces the possibilities of Russian enterprises attracting investments on the securities market.

In order to make out what is actually happening to the Russian stock market, lets look at the facts and figures. Well try to demonstrate that experts knowledge of the stock market is often far from the reality.

A source of investment

Contrary to the established ideas about insignificance and speculative nature of the Russian stock market, it has already begun to perform the macroeconomic function of transforming savings into investments. Russian enterprises are actively using the securities market as one of their largest sources of long-term investment. The total volume of investment attracted by Russian enterprises in the diverse sectors of the securities market (both on the domestic and foreign market) in 2002 totaled $5.6 billion, and over the first five months of 2003, $4.5 billion. Two thirds came from foreign eurobonds and ADRs, but a lions share of these papers were by Russian investors through their offshore companies.

For a business, market selection depends on investments objectives. In the overwhelming majority of cases, with the globalization of the world market, supranational markets are preferable for seeking investment. European and Japanese companies as well as companies from other countries with mature or developing markets do in the exact same.

Russian enterprises attract investments mainly via debt finance instruments. This is natural for a developing market; companies almost always begin to attract investments on bond markets, and only after a time turn to the stock market. Debt instruments will likely still prevail in the future, which is typical not only for emerging markets but also for developed ones.

In 2002, Russian company funds from the securities market amounted to over 10% of the total investments in fixed capital, or 20% of all sources of fixed capital financing. Of course, not all resources attracted by enterprises in the securities market end up financing fixed capital investments. A considerable finances acquisition deals. While asset concentration and share accumulation are in progress, majority holders have no objective incentives to attract investment via stock offerings. And Under these circumstances, it is quite reasonable for enterprises to enter the stock market by turning to possibilities of debt finance.

Who are you calling volatile?

The next assumptions to be disproved are that the Russian stock market is dependent on world markets and therefore highly volatile. Lets check them by using correlation coefficients (the measure of dependence See Table 1) and variation coefficients (the measure of spread See Table 2).

In 1996 and 1998-1999, we see strong dependence on world oil prices. Today, it is already difficult to speak about the Russian stock markets strong dependence on world oil prices. Dependence of the Russian stock market on the US stock market was very strong in 1997 and in 1999. But after 1999, steady reduction of the correlation coefficient between the RTS and the Dow Jones can be seen. Moreover, in the first quarter of 2003, global investors already regarded the Russian market as a "defensive instrument" with respect to the US market. Without a doubt, the Russian market is not completely independent from world trends, but it is absolutely evident that this dependence has decreased considerably compared with the end of 1990s.

Analysis shows that volatility of the Russian market has decreased steadily from 1998-2002. In the first quarter of 2003, volatility of the Russian market was even lower than that of the US "blue chips." In other words, the market in Russia turned out to be more stable in that period than the market in the US.

What high volatility are some stock market researchers talking about? Do they want market fluctuations stop altogether? Who would come to a market like that?

Here come the private investors

The increase in market stability and its increased independence has resulted from the emergence of a domestic financial base. The idea that the Russian market has no domestic investors has become hopelessly obsolete.

According to underwriters estimates, between $50 and $250 million of some issues of Russian corporate eurobonds are bought by Russian investors. In total, Russian investors purchased 25-30% of all corporate eurobonds in 2002.

Small private investors are also prevailing on the domestic stock market. In 2002, about 40% of the total turnover on the Russian stock exchanges came from individuals money. In addition, a significant share of the market comes from diverse investment funds, which also use individual peoples money for shares and corporate bond transactions.

Re-distribution of stock exchange turnover in favor of Russian stock exchanges is another consequence of the arrival of the domestic investor. The percentage of foreign, offshore transactions has drastically dropped from 84% in 1998 to one of the lowest levels among emerging markets in 2001-2003, it stabilized around 50%, meaning purchases have moved to Russia.

The average daily trading in the MICEX stock section can serve as indirect proof of this. In 2000, it amounted to $ 74 million, in 2001 $108 million, and in 2002 $163 million. In the first quarter of 2003, they amounted to $185 million. Hence, the shift of business activity from foreign exchanges to Russia has occurred not as a result of reduction in exchange trade but, on the contrary, against the background of their rapid growth.

The notion that the stock market lags behind the overall economy is also not worthy of criticism. The indicators of Russian market capacity have been rising since 2000 at a greater pace than all macroeconomic indicators, and equity market capitalization has increased from 17% of the GDP in 2000 up to 33.3% in 2002.

The capitalization-to-GDP ratio reflects the role the stock market plays in the national economy. If we accept this assumption, the role of the stock market in Russia is greater than in China (27% in 2002) and Brazil (28%), not to mention Mexico (18%), the Czech Republic (about 14%), Poland (16%), Hungary (23%), and Argentina (about 8%).

One more arguable thesis is that some industries and regions dominate the market. Indeed, oil and gas producers share in industrial capitalization was 70.2% as of April 30, 2003. That is a rather high share by international comparison, but quite adequately reflects the industrial structure of the Russian economy.

At the same time, analysis of the primary corporate bond market demonstrates that this market is becoming increasingly accessible to companies from various industries and regions. The percentage of Moscow-based companies among corporate bonds issuers is declining, whereas that of regional enterprises is increasing. The variety of industries is increasing, too. The domestic bonds market in Russia has low entrance barriers today. Today, any Russian company can take advantage of the opportunity to attract investments on the Russian corporate bonds market, irrespective of company size, industry or region.


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