14Section 3. Financial markets and financial institutions
3.1. The Russian financial market1
3.1.1. The stock market in 2019 and Q1 2020
The year 2019 was one of the luckiest periods in the history of Russia's stock market. On a 10-year time horizon (2010-2019), the geometric mean return on investment in Russian ruble-denominated stocks amounted to 8.3% per annum, which was below the corresponding indices of only a few markets like the USA, the Scandinavian economies, Japan, India, the Philippines, and Argentina (Fig. 1). The average annual return on investment in Russian stocks denominated in US dollars stood at 0.7%, which was significantly below the ruble-denominated return on investment in those same stocks due to the ruble weakening in the post-crisis period.
Fig. 1. The geometric mean return of 36 world stock indexes on major stock exchanges
over the period 2010-2019, % per annum
Source: own calculations based on data released by The Wall Street Journal.
1 This section was written by Abramov A. E., Candidate of Economic Sciences, Director of the Center for Institutions Analysis and Financial Markets, IAES, RANEPA; Chernova M. I., researcher at the Center for Institutions Analysis and Financial Markets, IAES, RANEPA.
In 2019, the returns on Russian stocks were among the highest, compared with the other stock indexes around the world (Fig. 2), rising to 44.9% (RTS Index) and to 28.6% (MICEX Index). Among the 36 indexes of the world's largest stock exchange markets, the RTS Index was behind only ATHEX Composite (the Greek stock market indicator), which gained 49.5%. It was also unusual that the RTS Index, which is denominated in US dollars, significantly outperformed IMOEX, which has the same constituents, only they are denominated in rubles. This happened because the high returns on Russian stocks in 2019 were concurrent with the ruble strengthening against the US dollar, which created some additional incentives for foreign investors to invest in shares issued by Russian companies.
However, the events that followed in Q1 2020 and led to the collapse of stock markets in Russia and around the world, were yet another reminder of the fact that rapid growth in stock prices cannot continue over a long period of time, and the years of high dividend yields usually give way to periods of severe recession. As of March 20, 2020, Russian stocks became the world leaders in falling stock quotes: since the beginning of 2020, the RTS Index had lost 40.3%, and the MOEX Index, 23.5%. Out of the 36 stock indexes shown in Fig. 2, only those of Thailand, Argentina and Brazil plunged deeper than the RTS Index. This time, the more impressive downfall of the RTS Index compared to the MOEX Index was caused by the stock market adjustment on the back of the ruble weakening against the US dollar.
The main factor behind the stock and forex market crisis at the beginning of 2020 was the combination of two unexpected events: the onset of a pandemic of coronavirus infection (COVID-19) and the breakup of the oil price deal between OPEC and Russia on March 6, 2020, which unleashed a price war and the collapse of oil prices in the market.
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Fig. 2. The returns of 36 world stock indexes on major exchanges in 2019 and Q1 2020 (as of
March 20), % per annum
Source: own calculations based on data released by The Wall Street Journal.
As shown in Fig. 3, in 2019, Russia nearly topped the list of 27 countries in terms of national currency strengthening against the US dollar, as the ruble exchange rate climbed by 12.1% over that period. Among the other national currencies, the ruble fell behind only the Ukrainian hryvnia, which gained 17%. At that time, the ruble's exchange rate was being sustained by comfortably high oil prices, the fiscal rule effects on the budget, and the macroeconomic stabilization measures that contributed to the inflow of foreign investment into the government debt market.
However, in Q1 2020, the situation in the foreign exchange market changed dramatically. From the start of the year through March 20, 2020, the ruble exchange rate against the US dollar fell by 22.4%. The ruble depreciation rate was nearly the highest among the corresponding indices demonstrated by the 27 major world currencies. Only the Mexican and Argentinean pesos and the Norwegian krone experienced a steeper downfall, plungng by 22.5%, 25.5%, and 36.9%, respectively. As can be seen in Fig. 3, the impact of the March 2020 shock was felt most strongly by the national currencies of those countries that depended heavily on their oil export revenues (Norway, Mexico, Russia, Brazil, Kazakhstan, etc.), as well as those that largely depended on external financing to maintain their financial sustainability (Argentina and Ukraine).
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Fig. 3. Changes in the value of 27 national currencies in 2019 and Q1 2020
(as of March 20), %
Source: own calculations based on data released by The Wall Street Journal.
The behavior of financial markets in 2019 cannot be discussed separately from the shocks that occurred in investment asset markets in Q1 2020. Unlike many previous crises, the developments in the financial markets at the beginning of 2020 were caused by unexpected external shocks: a pandemic and the price war between oil-exporting countries. The current crisis was triggered not by the debt crises experienced by certain companies or countries, but by falling prices in the markets for certain assets, such as stocks, oil and other raw materials, and some national currencies. At the time of writing this review, the shock that originated in the markets for these assets has not yet penetrated the debt markets and become manifest in the form of a recession officially recognized by major economies.
An analysis of the development trends in Russia's financial market in Q1 2020 can be based on the generally accepted criteria for financial crises. The estimates presented in one of the most authoritative works on financial crises in the world written by US economists Carmen Reinhart and Kenneth Rogoff, released in 2009 and published in Russian in 2011, can be applied here as such criteria (Table 1).
Table 1
The quantitative criteria of financial crises, according to Carmen Reinhart
and Kenneth Rogoff
Type of crisis Crisis criteria
Inflationary crises Threshold inflation of 20% per annum
Currency crises Annual depreciation rate above 15%
Banking crises Presence of at least one of two events: 1) bank insolvency caused by massive withdrawal of deposits, resulting in closure, takeover or nationalization of one or more financial institutions; 2) closure, takeover, nationalization, or large-scale state support of important financial institution (or group of institutions).
External debt crisis Sovereign (state) default, as inability of government to make principal debt or interest payments as of specified date.
Debt crisis Same definition as that of external debt crisis also applies here. Additionally, it includes freeze on bank deposits and/or forced conversion of dollar deposits into national currency.
Corporate defaults Due to limited availability of historical statistics, there is no strict definition of signs of such crisis. However, corporate defaults and banking crises correlate in many of their aspects.
Stock market crash Criterion by Barro and Ursua was applied, whereby stock market crash is understood as cumulative decline in real stock prices by 25% or more.
Source: own compilation based on data from the monograph by Reinhart and Rogoff. 1
The main channel of influence on the ruble weakening and the plunging market for Russian stocks in early 2020 was the onset of a price war in the oil market between the OPEC countries and Russia against the backdrop of falling demand for oil produced by a slowdown of global economies in response to the coronavirus pandemic. Formally, this happened when Russia walked out of the agreement at a joint meeting on March 6, 2020. As shown in Fig. 4, over the period from December 2019 to March 20, 2020, the average monthly price of Brent oil decreased by 45.5%. Reinhart and Rogoff, in their monograph, do not consider crises in commodity markets, and therefore we do not define this event as an oil crisis. However, compared with the previous three oil price shocks in 1998, 2008 and 2014, the downward trajectory of oil prices during the first three months of 2020 was almost as steep as during the 1998 crisis.
1 Reinhart, C.M., Rogoff, K. S. (2009). This Time Is Different: Eight Centuries of Financial Folly. Princeton, NJ, Princeton University Press.
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Note. The average monthly price of Brent crude oil in March 2020 was calculated for the period from March 1 to March 20, 2020.
Fig. 4. The average monthly decline of the price of Brent crude oil relative to its peaks of December 1996, July 2008, June 2014, and December 2019,
as % (peak value = 100%)
Source: own calculations based on data released by Thomson Reuter and Finam (URL: https://www.finam.ru/ profile/moex-akcii/gazprom/export/).
Over the period from December 2019 to March 20, 2020, the ruble plunged by 29.5%, while Reinhart and Rogoff define a currency crisis as the national currency weakening by 15% against the US dollar over the course of one year. As shown in Fig. 5, compared with the crisis scenarios of 1998, 2008, and 2014, the ruble's weakening in early 2020 in response to the movement of oil prices followed a very steep trajectory, although, of course, it can hardly replicate that of its downfall in August 1998. Under the present circumstances, the ruble depreciation was contributed to by the fact that oil prices were plummeting against the background of an almost complete liberalization of the exchange rate regime, as a result of which the exchange rate mechanism had become much more transparent even in such a troublesome situation. At the same time, at the time of writing this review, it is not yet clear whether the ruble will remain at its current depreciated level in face of the inevitable recovery of oil prices in the future. Judging by the previous experiences, we know that because of the Russian economy's high dependency on the prices of its exports, even a relatively short-term weakening of the ruble can translate into its long-term depreciation, if the average price of oil, after it has
experienced price shocks in commodity markets, over the next few years stays at a lower level compared with the pre-crisis period.
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Fig. 5. The average monthly movement of the USD-to-ruble exchange rate relative to its peaks of May 1998, May 2008, July 2014, and December 2019, as %
(peak value = 100%)
Source: own calculations based on data released by the Bank of Russia.
As shown in Fig. 6, over the period from December 2019 to March 20, 2020, the RTS Index lost 40.3%, its plunge translating into the deepest market decline compared with the acute phases of the crises of 1998, 2008 and 2014. According to the classification of Reinhart and Rogoff, Barro and Ursua, if this decline pattern is confirmed by the year-end results of 2020, the current developments in the stock market will be defined as a fully fledged financial crisis. However, it is important to note that the sharp decline of stock quotes both in the Russian and global financial markets in response to the economic recession threats so far has not given rise to crises in the financial debt markets.1
1 For more details on the impending financial crisis and the financial market prospects, see Sukhova, S. (2020). 'We got a strange crisis'; economist A. Abramov on the economic turbulence against the background of the coronavirus pandemic. Ogonyok, No 12, March 30. URL: https://www.kommersant.ru/doc/4299705?from=vybor
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Note. The movement of the RTS Index in March 2020, as of March 20, 2020.
Fig. 6. The movement of the RTS Index relative to its peaks of July 1997, May 2008, February 2014, and December 2019, as % (peak value = 100%)
Source: own calculations based on data released by the Moscow Exchange.
However, even despite its fall in early 2020, the Russian stock market retained its investment attractiveness for a number of foreign investors, as evidenced by the publication in Barron's,1 a leading source of business news. It cites the opinion of Justin Leverenz, Senior Portfolio Manager for the OFI Emerging Markets Equity team at Invesco Ltd. (an American independent investment management company), who believes that 'Russia at a headline level is one of the most attractive places on the planet to invest now.' But 'there's just one problem: it may take a year or two to come to pass.' David Aserkoff, J.P. Morgan's chief of equity strategy for emerging Europe, notes that 'Russian companies have also been swept by a quiet governance revolution that has transformed them into some of the better dividend payers in emerging markets.' Aaron Hurd, senior currency portfolio manager at State Street Global Advisors, sees the ruble bouncing from its current level near 80 to the US dollar to 60 or 65 over the next two years, driving returns of up to 40% in local bond markets.
The onset of a new wave of falling stock indices in Russia occurred at a time when they had not yet completed their full recovery to the levels prior to the 2008 crisis (Fig. 7).2 According to the year-end results of 2019, the ruble-denominated MOEX Index surged to 158.5% of its value as of May 2008, while the RTS Index denominated in US dollars amounted to only 63.0% of its level as of the same date. The recovery of the same stock portfolio in ruble terms was faster than that of its value in US dollars, because over that period the ruble fell 160.8% against the US dollar.
1 Mellow C. (2020). Russia's Stocks Are a Buy Only for Very Patient Investors. Barron's, online. March 27.
2 The fact of the stock indexes recovering to their pre-crisis level is purely symbolic, but it is still important for investors as a sign that the stock market has overcome the issues that led to its decline during the crisis.
However, the partially successful recovery of stock prices in 2019 gave way to a recoil in Q1 of 2020. As of March 20, 2020, the RTS Index fell to 37.6% of its peak value of May 2008. The MOEX Index was still considered to have recovered, but it had declined to 121.1% of its peak value of May 2008, in spite of the ruble's highly noticeable weakening in Q1 2020.
The rate of stock market recovery after the 2008 crisis differed significantly from its movement pattern after the previous crisis of 1998, when the ruble-denominated MICEX Index recovered in just 8 months, while the RTS Index took almost 5 years (58 months) to do so.
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Fig. 7. The movement of the USD-to-ruble exchange rate, the RTS Index, and the MOEX Index from May 2008 through March 20, 2020 (May 2008 = 100%)
Source: own calculations based on data released by the Bank of Russia and the Moscow Exchange.
At present, similarly to the situation in the aftermath of the 1998 financial crisis, a key factor that influenced the recovery speed of Russian stock indices is the level of oil prices. As shown in Fig. 8, after the crisis period 1997-1998, when the price of oil plummeted to 31.1% of its pre-crisis peak in December 1996, the period of its full recovery lasted 3 years, or 36 months. As of March 20, 2020, over the 140 months that had elapsed since the price of Brent crude oil peaked at USD 133.9 per barrel in July 2008, its current price amounted to only 28.4% of its peak value. Moreover, the year 2020 saw a third wave of oil price decline to 56.5% of its December 2019 level.
-------Russia 1997-1998 -Russia 2008 — — — Russia 2020
Fig. 8. Brent crude oil price growth during the financial crises in Russia (pre-crisis peak price = 100%), as of March 2020
Source: own calculations based on data released by the International Monetary Fund and the International Energy Agency.
Fig. 9 and Table 2 show the recovery process of stock indices in the BRICS countries. For comparability of data, the country indices of the MSCI family, calculated in dollar terms, were used as indicators. Assessment of changes in the Russian market was carried out using the RTS currency index, including a similar index that takes into account the dividend yield of its share issues.
As of March 20, 2020, out of the five BRICS members, the stock indices after the 2008 crisis did not recover in Russia and Brazil, where the long-term stagnation of stock markets has been of the most chronic nature. Over the 142 months that had passed since May 2008, the RTS Index recovered to only 37.6% of its pre-crisis level, and the MSCI Brazil Index, to only 24.1%. In 2019, due to the high dividend yield on Russian stocks, the RTS index fully recovered, demonstrating a dividend yield of 102.5% relative to its May 2008 value; however, as a result of the plunging stock prices in early 2020, that index recoiled to the level of 61.3% of its value in May 2008.
The MSCI indexes for India, South Africa and China recovered to their pre-crisis levels over the periods of 22, 28, and 82 months after May 2008, respectively. However, by March 20, 2020, the stock indices of South Africa and India had slid to 53.0% and 84.0% of their pre-crisis peaks of May 2008. The economies of BRICS members differ significantly in their structure; thus, India and South Africa do not depend on oil prices, in contrast to Russia and Brazil. The simultaneous downfall of large emerging markets in early 2020 was caused by factors that they all share, namely the forced shutdown of companies under the quarantine
measures and foreign capital outflow from their markets in the direction of the developed markets with safer investment conditions.
Out of all the BRICS stock markets, only the Chinese stock market turned out to be the most sustainable one. As of March 20, 2020, the MSCI China A Index stood at 102.2% of its May 2008 value. The stability of this index relative to the ongoing decline in the stock markets, although China was the first country to come to grips with the threat of coronavirus, for the most part was ensured by the secure position of the yuan against the US dollar due to the forex interventions undertaken by the People's Bank of China.
Table 2
The recovery of BRICS stock indices denominated in US dollars after the 2008 crisis, as of March 20, 2020
Index Index recovery period from May 2008, months End of recovery Current index value, % (May 2008 = 100%)
RTS 142 No 37.6
RTS Total Return 140 Yes 61.3
MSCI Brazil 142 No 24.1
MSCI South Africa 28 Yes 53.0
MSCI India 22 Yes 84.0
MSCI China 82 Yes 102.2
Source: own calculations based on data released by the Moscow Exchange and Bloomberg.
—•-MSCI MXCN (China) ............. MSCI MXIN (India) ----MSCI MXBR (Brazil)
RTS Index (Total Return) .......RTS Index -MSCI MXZA (RAS)
Fig. 9. The depth and duration of the impact of the 2008 financial crisis on BRICS stock indices denominated in US dollars, as of March 20, 2020
(peak in May 2008 = 100%)
Source: own calculations based on data released by the Moscow Exchange and Bloomberg.
The most protracted crises in the modern history of stock markets were the recession in the US stock market during the Great Depression of 1929-1933 and the downfall of the Japanese stock market after 1989. The recovery of Dow Jones Industrial Average (DJIA) in the USA after the Great Depression lasted 303 months, or 25.3 years (Fig. 10 and Table 3). In 2015, this record was broken by the Japanese NIKKEI-225 index, which as of March 20, 2020, had failed to recover in 363 months, i.e. more than 30 years. Its value in March 2019 amounted to only 42.5% of its peak achieved in 1989. The crises followed by such lengthy periods of stock price recovery are unique; they are caused not just by some deeply rooted structural problems of the economy, but by a combination of these problems with some serious economic and monetary policy mistakes.
The markets where financial crises were of medium-term duration and were brought about by structural imbalances in the economy, such as the recession in South Korea in 1989 and the dotcom bubble burst in the USA in 2000, typically demonstrated a W-shaped index recovery trajectory (Fig. 10). These two crises lasted 183 and 177 months, respectively.
Against the backdrop of these crises, the recovery of the Russian RTS Index and MSCI Brazil to the levels of 37.6% and 24.1%, respectively, which has lasted 142 months, has not yet formally exceeded the time horizon of a typical medium-term crisis. However, as can be seen in Fig. 10, the recovery pattern currently displayed by RTSI and MSCI Brazil has begun to follow the trajectory of a long-term crisis rather than a medium-term one, which is usually a characteristic feature of the stock markets of those countries where structural problems coincide with unresolved economic and monetary policy challenges.
USA - 1929 -Japan - 1989 -•— Korea 1989
— — Brazil (MSCI MXBR) - 2008 ---USA-NASRAQ-2000 .........China (MSCI MXCN) - 1997
-□-Russia (IRTS)-2008
Fig. 10. The depth and duration of the recoveries of stock indexes after the longest crises of the 20th and 21st centuries, as of March 20, 2020 (pre-crisis peak = 100%)
Source: own calculations based on data released by the Moscow Exchange and Bloomberg.
Table 3
The longest recovery periods of stock indexes after the major crises of the 20th and 21st centuries
Country (index - year of crisis onset) Period of index recovery from its peak value, moths End of recovery Current value of unrecovered index, % (peak = 100%)
Japan (Nikkei - 1989) 363 No 42.5
USA (DJIA - 1929) 303 Yes
South Korea (KOSPI - 1989) 183 Yes
USA (NASDAQ - 2000) 177 Yes
Russia (RTS (USD) - 2008) 142 No 37.6
Brazil (MSCI (USD) 2008) 142 No 24.1
China (MSCI-Shanghai (USD) - 1997) 122 Yes
Japan (Nikkei - 1989) 82 Yes
USA (DJIA - 1907) 64 Yes
Source: own calculations based on data released by the Moscow Exchange and Bloomberg.
The lengthy recovery period of the Russian stock index, even by the standards of the global stock market, has demonstrated that the causes of its stagnation have more to do with the internal situation in the Russian economy than with the volatility effects of the global financial system.
3.1.2. Equity risk premium
For domestic and foreign investors, the equity risk premium is one of the key characteristics of a country's stock market. It is the main component of the cost of capital to be considered when assessing investment projects, it also serves as a universal corporate governance performance indicator and as a benchmark of a stock's attractiveness for foreign investors. The essence of the problem is that there exist several different equity risk premium indicators of Russian stocks, and the relevant information concerning these indicators is provided by foreign agencies. Our review relies on our own estimates of these indicators.
We can point out several most popular approaches to assessing the market risk premium of Russian stocks (Fig. 11). Fernandez et al. estimate the average equity risk premium based on opinion polls of scientists and businessmen in different countries. Dimson, Marsh, and Stainton, in their book 'Triumph of the Optimists'1 and their investment return reports released by Credit Suisse,2 calculate the long-term equity risk premiums for different countries, including Russia,
1 Dimson E., Marsh P., Stainton M., Garthwaite A. Triumph of the Optimists: 101 Years of Global Investment Returns. Princeton University Press. - 2002.
2 Dimson E., Marsh P., Stainton M., Wilmot J. Credit Suisse Global Investment Returns Yearbook 2009 // Credit Suisse Research Institute, Switzerland. - 2009; Dimson E., Marsh P., Stainton M., Wilmot J. Credit Suisse Global Investment Returns Yearbook 2010 // Credit Suisse Research Institute, Switzerland. - 2010; Dimson E., Marsh P., Stainton M., Holland D., Matthews B. Credit Suisse Global Investment Returns Yearbook 2011 // Credit Suisse Research Institute, Switzerland. - 2011; Dimson E., Marsh P., Stainton M., Wilmot J., McGinnie P. Credit Suisse Global Investment Returns Yearbook 2012 // Credit Suisse Research Institute, Switzerland. - 2012; Dimson E., Marsh P., Stainton M., Garthwaite A. Credit Suisse Global Investment Returns Yearbook 2013 // Credit Suisse Research Institute, Switzerland. - 2013; Dimson E., Marsh P., Stainton M., Mauboussin M. Credit Suisse Global Investment Returns Yearbook 2014 // Credit Suisse Research Institute, Switzerland. - 2014; Dimson E., Marsh P., Stainton M., Holland D., Mattenws B., Rath P. Credit Suisse Global Investment Returns Yearbook 2015 // Credit Suisse Research Institute, Switzerland. - 2015; Dimson E., Marsh P., Stainton M., Wilmot J. Credit Suisse Global Investment Returns Yearbook 2016 // Credit Suisse Research Institute, Switzerland. - 2016; Dimson E., Marsh P., Stainton M. Credit Suisse Global Investment Returns Yearbook 2017 (Summary Edition) // Credit Suisse Research Institute, Switzerland. - 2017; Dimson E., Marsh P., Stainton M. Credit Suisse Global Investment Returns Yearbook 2018 (Summary Edition) // Credit Suisse Research Institute, Switzerland. - 2018; Dimson E., Marsh P.,
as the difference between the estimated real return on stocks and the estimated real return on safe (government) bonds. A more sophisticated approach is used by Damodaran, who estimates country risk premiums (CRP) by adding country premiums to a risk-free rate calculated using the indicators of return on government securities and the volatility of shares issued by local companies.
Fernandez, with a team of co-authors whose composition has been changing from year to year, conducts annual surveys of experts, asking them which premium values and risk-free rates they used in their reviews for the previous year.1 The experts are grouped into university professors and analysts employed by companies and financial organizations. The data summary published by Fernandez offers a sociological picture of how different specialists perceive the equity risk premiums in one or other country.
The information on Russia is included in the surveys for the period from 2012 through 2019, thus making it possible to obtain a certain historical perspective and follow the changes in the researchers' assessments. It is noteworthy that according to the surveys, in almost every country the premium varies very broadly. Thus, for example, in 2012, according to a survey of 70 experts, the average equity risk premium on Russian stocks was 7.6%, the estimates falling within a range of 2.7% to 25.0%. In 2019, according to 30 experts' answers, the average premium was 8.5%, and the range narrowed to 5% to 10.1%. This result indicates that, in spite of the current trend in the scientific/academic and business communities towards a more uniform assessment of the size of equity risk premiums, there is still no common understanding of their size and calculation methods.
Dimson, Marsh and Staunton, in their book 'Triumph of the Optimists'2 and subsequent investment return reports published by Credit Suisse3, calculate the historical stock premium for the majority of developed markets and selected developing countries. Their data have made it possible to compare the long-term returns on investment in stocks and government bonds. The interest rate spreads that they assess can be regarded as performance indicators of public companies in comparison with the returns on government securities.
Stainton M. Credit Suisse Global Investment Returns Yearbook 2019 (Summary Edition) // Credit Suisse Research Institute, Switzerland. - 2019.
1 Fernandez P., Aguirreamalloa J., CorresL. Market Risk Premium Used in 56 Countries in 2011: A Survey with 6,014 Answers. Downloadable in http://ssrn.com/abstract=1822182. - 2011; Fernandez P., Aguirreamalloa J., Corres, L. Market Risk Premium Used in 82 Countries in 2012: A Survey. Downloadable in http://ssrn.com/abstract=2084213. - 2012; Fernandez P., Aguirreamalloa J., Linares P. Market Risk Premium and Risk Free Rate Used for 51 Countries in 2013: A Survey with 6,237 Answers. Downloadable in http://ssrn.com/abstract=914160. - 2014; Fernandez P., Linares P., Fernandez A. I. Market Risk Premium Used in 88 Countries in 2014: A Survey with 8,228 Answers. Downloadable in http://ssrn.com/abstract=2450452. -2014; Fernandez P., Pershin V., Fernandez A. I. Discount Rate (Risk-Free Rate and Market Risk Premium) Used for 41 Countries in 2015: A Survey. Available at: https://ssrn.com/abstract=2598104. - 2015. Fernandez P., Ortiz A., Fernandez A. I. Market Risk Premium Used in 71 Countries in 2016: A Survey with 6,932 Answers. Available at: https://ssrn.com/abstract=2776636. - 2016; Fernandez P., Pershin V., Fernandez A. I. Discount Rate (Risk-Free Rate and Market Risk Premium) Used for 41 Countries in 2017: A Survey. Available at: https://ssrn.com/abstract=2954142. - 2017; Fernandez P., Pershin V., Fernandez A. I. Market Risk Premium and Risk-Free Rate used for 59 Countries in 2018: A Survey. Available at SSRN: https://ssrn.com/abstract=3155709. -2018; Fernandez P., Martinez M., Fernandez A. I. Market Risk Premium and Risk-Free Rate Used for 69 Countries in 2019: A Survey. Available at SSRN: https://ssrn.com/abstract=3358901. - 2019.
2 Dimson et al. 2002.
3 Dimsom et al. 2009-2019.
According to their methodology, the equity risk premium is calculated as a geometric1 mean of the return on stocks and the return on a risk-free asset. To calculate the latter, the authors apply two benchmarks: short-term government bonds and 10-year government bonds. In each year, the authors average the premiums on stocks over a long-term period starting from 1900, and on a medium-term horizon covering the last 40-50 years. Dimson et al. disclose the data for Russia only in the reports published by Credit Suisse from 2014 to 2018; for other years, no data is available. The equity risk premium for Russia is available for two periods: the longer one from 1995 to the year of publication of each of the reports, and the shorter one starting from 2000, which does not include the crisis period 1998-1999. The equity risk premium for Russian stocks vs. long-term government bonds, calculated from 2000 onwards, turns out to be negative: for the period 2000 to 2016, it amounts to -3.7%, and for the period 2000 to 2012, to just -6.7%. When compared with short-term government bonds, the premium is positive, amounting to 3.2% in 2000-2016, and to 5.1% in 2000-2012. Thus, we can conclude that long term government bond yields in Russia are significantly higher than short-term government bond yields.
In the analysis of investment projects, the most popular approach to estimating equity risk premiums is that suggested by Damodaran.2 The equity risk premiums calculated using his method are based on forecasts of future returns and estimated market expectations. These indicators are most often used by investors in calculating the cost of capital and predicting the cost-effectiveness of future investment projects. The resulting estimates, as a rule, are customized depending on the specific method applied in the calculations; moreover, the method itself is never fully disclosed.
The equity risk premium, according to Damodaran, is made up by a 'base premium for mature equity market' plus the cost of 'country risk' for the stocks issued in a given country. The base premium is calculated as the discount rate for cash payments to shareholders in the form of dividends and share buybacks that grow over the medium term of 3-5 years according to market expectations (based on the consensus forecasts data services, e.g., Bloomberg, Thomson Reuters, etc.), and thereafter, at a growth rate equal to the current risk-free rate on 10-year government bonds in the base country. The country risk premium in this approach is determined by using the spreads between 10-year government eurobonds issued in a given country and the bonds denominated in the same currency issued in the base country, or by using CDS spreads. Additionally, the methodology is further optimized by the inclusion of the coefficient of relative volatility of stocks compared with that of bonds traded in the domestic market of a given country, whereby the country risk premium can be adjusted by the relative risk of a given stock.
Fig. 11 presents summary data on all the equity risk premiums in the studies and reviews discussed here. Besides, the chart is augmented by data published by Bloomberg, where the premium is calculated as the difference between the return of a stocks index and the yield to maturity of 10-year ruble-denominated government bonds. Such a benchmark is extremely simple to build; it does not fully explain the premiums, but is often used in practice as a guide for investors.
The data of Dimson et al. represent the geometric mean of the return on stocks over the period 2012-2016 for the time horizon from 2000 to each reporting date: compared with the
1 (1+Premium)=(1+return on shares)/(1+bond Yield) in annual terms.
2 Damodaran A. (2019). Equity Risk Premiums (ERP): Determinants, Estimation and Implications - The 2019 Edition. Available at SSRN. URL: https://ssrn.com/abstract=3378246.
return on long-term bonds, it is negative, i.e. the average stock market return for that period is less than that on government bonds, and it is positive compared with that on short-term government securities. For the period after 2017, the data is no longer publicly available. The equity risk premiums based on the other four indicators (by Damodaran, Fernandez and Bloomberg), as a rule, differ little from one another. Thus, for example, in 2019, the equity risk premiums declined on 2018: Damodaran's indicators based on bond spreads - from 9.4% to 7.4%, and those based on premiums on credit default swaps (CDS) - from 8.1% to 6.2%; the geometric mean based on expert surveys by Fernandez declined from 8.7% to 8.5%; and those based on Bloomberg estimates - from 9.3% to 6.3%.
-5% .r>.............................°
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2012 2013 2014 2015 2016 2017 2018 2019
Dimson: equity risk premium (vs long-term bonds) from 2000 Dimson: equity risk premium (vs short-term bonds) from 2000 Fernandez et al.: geometric mean of equity risk premium based on expert surveys Damodaran: equity risk premium based on bond spreads Damodaran: equity risk premium based on CDS spreads Bloomberg: equity risk premium vs. 10-year bonds (yield to maturity)
Fig. 11. The equity risk premiums on Russian stocks, based on the most cited international sources, %, 2012-2019.
Source: own compilation based on data from the studies by Dimson et al., Fernandez et al., Damodaran and Bloomberg.
When the relationship between the equity risk premium indicators shown in Fig. 11 and the cash flows of private investors in foreign investment funds specializing in Russian stocks was tested throughout the period 2012-2019, no significant or interesting dependencies were found, except that the changes in the equity risk premium assessed on the basis of CDS spreads according to Damodaran turned out to be directly proportional to the changes in the relative size of cash flows of private investors in foreign equity funds (Fig. 12). The counter-cyclical strategy of these portfolio investors produces a situation where an increased equity risk premium, as a rule, boosts an inflow of investor funds, while a reduced equity risk premium prompts the withdrawal of investor funds.
Considering that foreign sources do not always promptly disclose their assessments of Russian stock risks and do not publish in full their calculation methodology, we decided to publish our own equity risk premium estimates, with due regard for Damodaran and Dimson's methods, but based on our own time data on the movement of financial instruments and their portfolios.
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Fig. 12. The equity risk premium based on CDS spreads according to Damodaran (%) and changes in the cash flows of private investors in foreign investment funds specializing in Russian stocks, relative to the asset value of those
funds at the start of a reporting year (%), in 2012-2019 Source: own calculations based on data published by Damodaran and Emerging Market Portfolio Research
The first group of consists of new indicators (projected risk premiums, or PRP) calculated as suggested by Damodaran.1 There are four indicators in the group: PRP1 is country risk premium, determined on the basis of yield spreads of RF and US sovereign bonds denominated in US dollars; PRP2 is country risk premium calculated on the basis of credit default swap (CDS) premiums on RF sovereign bonds denominated in US dollars; PRP3 is country risk premium estimated by adjusting PRP1 for the volatility of Russian stocks; PRP4 is country risk premium calculated by adjusting PRP2 for the volatility of Russian stocks. PRP3 and PRP4 are
1 According to Damodaran (2019), the forecast risk premium for Russian stocks is calculated as the sum of the current default spread and the implied risk premium for the base country. The implied premium for the base country (USA) is calculated as the rate of return in a two-stage growth model of dividend payouts to investors (dividends + share buybacks), where the first stage lasts 5 years with volatile growth rates adjusted by data in the current consensus forecasts and S & P500 Earnings, and the second stage lasts 'indefinitely' for a long time, with income growth rates equal to the current risk-free rate. Thus, predictive power becomes part of the calculation of the equity risk premium components. The default spread (or country risk premium) can be calculated as the spread between Russian and US 10-year government bonds, or Russia CDS.
The disadvantage of this method of assessing risk premiums and country risks is its reliance on the assumption that country risk premium can be reduced to the differences in government bonds yields, or CDS, relative to a mature equity market. In this connection, the specific stock market properties are not taken into account. Therefore, in our calculations, we introduced the factor of relative volatility of stock returns compared to bond returns. One example of this factor is the ratio between the standard deviations of stocks and bonds. However, the standard deviation of bond returns is not comparable with the standard ratio of annual stock returns. Therefore, a coefficient of variation can be calculated for bonds (normalized standard deviation). After that, relative stock volatility can be calculated as the ratio between the standard deviation of stocks and the coefficient of variation of government bonds. The country risk premium value, calculated on the basis of default spreads, is multiplied by their calculated coefficient of volatility, and then added to the equity risk premium in a mature equity market. Thus, the premium accounts for the additional risk associated not only with the risk of stocks compared with that of bonds in a 'base' developed country, or with country risk, but also with stock volatility in a given financial market.
(EMPR).
the indicators that most adequately determine the forecasted value of equity risk premium on Russian stocks.
As shown in Fig. 13, during the periods of relative stability in the stock market, the values of all the four indicators of forecasted equity risk premium on Russian stocks become close to each other. In 2019, the equity risk premium estimates shrank on 2018 as follows: PRP1 from 9.43% to 6.65%, PRP2 from 8.95% to 6.68%, PRP3 from 11.38% to 6.95%, and PRP4 from 10.48% to 6.99%. As can be seen from these data, the spreads of all four risk indicators fell within the range of 6.65% to 6.99%, i.e. they were negligible.
However, during crisis periods, the equity risk premium spreads, especially those based on indicators that take into account stock volatility, become quite significant. In December 2018, PRP1 and PRP2 amounted to 19.05% and 19.25%, respectively, while those indicators that were adjusted by stock volatility (PRP3 and PRP4) increased to 33.83% and 34.52%. During another crisis period with an increased ruble volatility (January 2015), while PRP1 and PRP2 stood at 12.39% and 13.11%, respectively, PRP3 and PRP4 rose to 15.34% and 16.46%, respectively.
' ' Country risk premium based on bond yield spreads (PRP1)
• ••••• Country risk premium based on CDS premium (PRP2)
----Country risk premium estimated as PRP1 adjusted by stock volatility (PRP3)
-Country risk premium estimated as PRP2 adjusted by stock volatility (PRP4)
Fig. 13. The current and historical equity risk premiums on Russian stocks, adjusted for their relative volatility in the domestic market, %, 2006 - January 2020
Source: own calculations based on data released by Bloomberg.
The second group of equity risk premium indicators consists of the historical risk premiums (HRP) on Russian stocks denominated in US dollars relative to short- and long-term portfolio yields of RF eurobonds. The methodology applied in calculating these spreads, without much detail, was described in the book 'Triumph of the Optimists', and later in the reviews released by Credit Suisse and authored by the same team. The problem with the data for Russia applied by Dimson et al. is that they are publicly available only for a limited number of years, and rely on a calculation methodology that is not entirely transparent. For these reasons, we decided to calculate HRP1 and HRP2 on our own; these are the historical risk
premiums that we calculated on a longer time horizon relative to the long- and short-term yields of RF eurobond portfolios, respectively, and reviewed on a monthly basis (Fig. 14)1
The calculation of historical equity risk premiums is of practical importance for forecasting the movement of premiums and stock returns, evaluating the cost of capital for companies, as well as using it as a benchmark for the required rate of return on investments. A positive long-term equity risk premium is indicative of the relative safety of long-term investments in stocks compared with a risk-free rate (in practice, the authors have come to the conclusion that stocks most stably outperform bonds over at least a 40-year horizon). A comparison of premiums across many countries makes it possible to draw reliable conclusions as to the feasibility of global or regional portfolio diversification.
Fig. 14 presents long-term premiums as the difference between the geometric means of the returns of the main asset classes. The resulting premium values are compared with the values from the Credit Suisse reports, where a similar technique was used. When calculating our indicators, we managed to obtain similar results. The stock return is compared with that of short-term eurobonds (the most 'correct' proxy for the risk-free rate) and long-term eurobonds (the most commonly used proxy for the risk-free rate). The premium on short-term bonds is positive and amounts to 5.6% over the 20-year period from 2000 through 2019. Over the shorter periods in 2016-2018, it hovered around 3.5-3.8%, and its surge to the 2019 level was caused by the sharp increase in the stock returns in that year. The premium on long-term bonds has
1 Essentially, the method developed by Dimson et al. aims at comparing long series of historical data on the returns on stocks and two types (short- and long-term) of government bonds, which are used to calculate their geometric mean for a certain period. The risk premium on stocks is calculated as the difference (cleared of inflation) between the return of a stock index and the return of bonds. This estimate is historical, and not predictive. It describes the aggregate behavior of markets and the success of long-term investment in stocks over a long period of time (30 years or more). Nevertheless, the authors of the book believe that the expert forecasts of future stock returns and risk premiums rely to a greater degree on exactly such historical estimates, and that the calculations based on empirical data have confirmed the existence of some connections between the historical and future equity risk premiums.
The stock returns on long historical horizons are calculated taking into account the exchange rate and dividend yield of a given country's stock market index denominated in the base currency, and thus it becomes possible to compare the indices of different countries, for example, in US dollar terms. Next, the cumulative return of that stock index is calculated from the start of its monitoring period until the present. One example of such an index is MSCI Russia, which has been followed since December 1994. Accordingly, to calculate the equity risk premium of that index for 2019, its cumulative return for the period 1995-2019 was used, and the premium for 2013 was based on data for 1995-2013.
As a proxy for the risk-free rate, Dimson et al. used both short-term and long-term government bonds. Both approaches have their advantages and disadvantages. Short-term bonds, according to the authors, are more consistent with the concept of a risk-free asset, and their volatility is lower. However, during the periods of a sudden surge in inflation or other extreme conditions, their cost varies significantly. On the other hand, long-term bonds are often used as a benchmark for calculating equity risk premiums (Dimson et al., 2001, p. 74). Thus, the authors insist that it is important to calculate equity risk premiums relative to both instruments, because they represent two key alternatives for investors. The benchmark in this case should be the yield of the national eurobond price index denominated in US dollars. After compiling or selecting such an index, the calculation algorithm is similar to that applied to stocks: their effective yield for the longest period is calculated. In Russia, there is no eurobond index denominated in US dollars with a sufficient historical depth. All the available indexes, as a rule, are compiled either by Cbonds or by foreign agencies (for example, Bloomberg), and have been followed from the mid-2000s. Probably, for Russia, Dimson used the eurobond index that he had compiled himself, and he does not disclose its composition. In our calculations, we relied on a similar approach and compiled our own short-term and long-term indexes for RF eurobonds, and thus also calculated our own values of historical risk premium for Russian stocks (HRP1 and HRP2).
been negative since 2008 and reflects the fact that after the 2008-2009 crisis, the Russian stock market has never fully recovered. Since 2017, Credit Suisse has removed Russia from its reviews, and so for that period, we replaced the classical calculations by Dimson et al. by our own data. For the period 2000-2019, the premium relative to long-term bonds amounted to -1.2%, which points to a higher investment attractiveness of RF government bonds compared with Russian stocks.
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' ' Stock premium (vs long-term bonds) - own calculations Stock premium (vs short-term bonds) - own calculations
^ ^ Stock premium (vs long-term bonds) - Dimson Stock premium (vs short-term bonds) - Dimson
Fig. 14. The long-term historical equity risk premiums vs short-and long-term eurobonds (in US dollars), 2000-2019 Source: own calculations based on data released by Bloomberg.
As can be gleaned from Credit Suisse's reports over several years, most of the major stock markets are characterized, on a long-term horizon, by positive equity risk premiums on stocks relative not only to short-term government bonds, but also to long-term ones, and so the negative premium on stocks in our study, calculated relative to long-term debt instruments on the domestic stock market, points to the existence of some stock market problems that prevent investors from receiving their expected amount of equity risk premium on their investments in more risky assets.
3.1.3. The fundamental characteristics of the stock market
Fig. 15 shows data on the parameters of returns and risks of 31 stock indexes from 27 countries; for the sake of data comparability, the stock indices are recalculated in US dollars. The return and risk assessments of each country's index portfolios were done for 2019, the 5-year period from 2015 through 2019, and the 12-year period from 2007 through 2019.
In 2019, the dividend yield on the RTS Index was 44.9%, second only to the Greece stock market index, and several times higher than the average return of 16.5% for a sample of country indexes (Fig. 15a). The risk index (standard deviation) of the RTS Index amounted to 17.6%, which was below the sample's average of 22.0%. However, the risk score of approximately 2/3 of all the indexes included in the sample was still lower than that of the RTS Index.
On a 5-year time horizon (2015-2019), the RTS Index also demonstrated some decent results by its return-risk ratio (Fig. 15b). Its dividend yield of 14.4% per annum was the highest among all the stock indexes included in the sample; the average return for that group of countries barely reached 2.2% per annum. The risk of the RTS Index for the period under study amounted to 22.5%, which was lower than the sample's average standard deviation of 25.6%. However, 3/4 of all country indexes had a lower risk indicator than the Russian stock index.
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Source: own calculations based on data released by the Moscow Exchange and Bloomberg.
1 The values of Venezuela's stock index are not shown on the chart due to the scaling limitations of the X and Y axes.
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On the 12-year horizon from 2008 through 2019, which encompasses the global financial crisis of 2008, the return-risk indicators of the RTS Index were among the worst in the group of stock indexes included in the sample (Fig. 15c). While the sample's average return was 0.4% per annum, that of the RTS Index amounted to -3.2%; the risk ratio of Russian stock portfolio was 32.8%, while the sample's average stood at 30.2%.
Thus, by comparison with the other competing countries, Russian stocks and their index offer the investors higher returns at a moderate risk. However, during global crises, Russian companies 'spoil' their track record for many years by creating, in the eyes of investors, the image of their stocks as a highly speculative asset, suitable only for relatively short-term investment.
All other conditions being equal, Russian stocks are priced lower than their foreign counterparts, and this underestimation has become a persistent phenomenon. The low price-earnings multiples on Russian equities are not an upshot of some temporary market factors; their causes are rooted deeper and have to do with their inadequate investment attractiveness. As shown in Fig. 16, out of the 26 national stock indexes,1 the price-to-book (P/BV) ratio2 of the constituent companies of the RTS Index was among the lowest in the world. Although, in 2019, this indicator of Russian companies increased to 1.0, over the 5-year period from 2015 through 2019 its average value was 0.8. According to the period-end results, only companies from Greece demonstrated a lower P/BV ratio.
□ 2019 IHMean, 2015-2019
Fig. 16. The financial indicator 'price-to-book per share ratio' as of December 31, 2019 and its mean value for the period 2015-2019 based on 26 national stock indexes
Source: own calculations based on data released by Bloomberg.
1 In comparison with the sample of 31 stock indexes in the calculations to Fig. 15, the stock indexes of Venezuela, Indonesia, Italy, Colombia, Portugal and the Russell 2000 index of American companies are excluded here and further due to abnormal values of their financial coefficients.
2 The P/BV ratio also describes the relative capitalization level of companies. It is the per share ratio between a company's market capitalization and the book value of its net worth, including charter capital, reserves and retained earnings.
The stock prices of Russian PJSCs are underestimated compared to their competitors in other countries, even though their return on equity (ROE) ratio is significantly above that of the companies trading in other markets.1 As shown in Fig. 17, in 2019, among the 26 national stock indexes, the ROE of 15.3% for the RTS Index was among the highest in the world, second only to the Argentina Stock Market index and the Dow Jones Composite Average. The average ROE of Russian companies in a 5-year time horizon (2015-2019) stood at 11.5%, which was above the mean value of 9.5% in the sample of 26 stock indexes and below that of only 6 stock indexes.
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Source: own calculations based on data released by Bloomberg.
Under the conditions of economic sanctions that restrict a capital inflow from external sources and the relatively high domestic key rate compared with the other economies, the characteristic feature of Russia's biggest public companies is their low debt burden, which has been shrinking over the past 5 years. As shown in Fig. 18, in 2019, among the 26 national stock indexes, Russia's RTS index constituent companies had the lowest D/EBITDA ratio of 0.3, compared with the sample's mean value of 3.4. On average over the period 2015-2019, that constituent of the RTS index was also the lowest in the sample, amounting to 0.7 vs the sample's mean of 3.4.
1 ROE is calculated as the ratio between the company's net profit and the book value of its net worth, which should not be confused with the company's capitalization, because the latter depends on the number of ordinary shares outstanding and their market prices.
Thus, the persistently underpriced Russian stocks over the past 5 years alongside their higher returns on equity compared with those observed in many other stock markets, and their lower debt load according to the D/EBITDA ratio, have led us to the assumption that the main factors responsible for the lower prices of shares in Russian PJSC are exogenous and have to do with the general investment climate and some other risks typical of the Russian economy.
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Source: own calculations based on data released by Bloomberg.
A positive trend in the domestic stock market observed after the 2008 crisis has been a significant growth of dividend yield on Russian stocks. The dividend yield on the RTS Index increased from 1.5% in Q1 2010 to 6.5% in Q4 2019, or 4.3 times (Fig. 19a). In 2019, as well as on average over the 5-year period from 2015 through 2019, the dividend yields on the RTS Index of 6.5% and 5.2%, respectively, turned out to be the highest among all the 26 stock indexes included in the sample (Fig. 19b). Over the same periods, the mean dividend yields on those indices were 3.0 and 2.8%, respectively.
According to some studies (see Abramov et al.1), the main factors that were pushing up the dividend yields during these years were the desire of issuers to keep up the investment attractiveness of their securities in the eyes of investors; the pressure put by the RF Ministry of Finance on the biggest state-owned companies (SOE) to make them pay at least 50% of their
1 Abramov, A.E., Radygin, A.D., Chernova, M.I., Entov, R.M. The 'dividend puzzle' and the Russian stock market. Part 2 // Voprosy Ekonomiki. 2020. No 1. P. 66-92; Part 2. // Voprosy Ekonomiki. 2020. No 2. P. 89-85.
net profit in the form of dividends; and in part, the desire of major stakeholders to receive additional payments from companies in the form of money that they had not invested.
In theory, the dividend yield is considered as the quotient of the dividend payout ratio (as a percentage of net profit) divided by the price-to-earnings (P/E) ratio.1 This means, for example, that the growth of dividend yield can result not only from an increasing dividend payout ratio (which is a positive factor for shareholders), but also from a declining P/E ratio in response to a company's falling stock prices relative to its net profit, which points to negative consequences for investors.
As shown in Fig. 19c, during the 12-year period from 2008 through 2019, the increasing dividend yield on the RTS Index noted in Fig. 19a resulted from the combined effects of two trends: growth of the amount of net profit paid out as dividends from 11.6% in Q1 2008 to 34.7% in Q4 2019, and shrinkage of the P/E ratio over the same period from 9.6 to 6.8. Meanwhile, the behavior of these two indicators in 2008-2019 was highly volatile. Thus, the accelerated growth in the dividend yield on the RTS Index on the said 12-year horizon was caused not only by a factor that was positive for investors - an increase in the share of companies' net profit earmarked for dividends, but also by a downward trend in the intrinsic value of their stocks, which was a negative factor.
Although over the period 2015-2019, the average annual dividend yield on stocks issued by Russian PJSCs was the highest among the 26 stock indexes around the world (Fig. 19a), this was achieved, as shown in Fig. 19d, primarily due to the extremely low value of the P/E ratio constituent of the RTS Index relative to the other stock indexes. Over the 5-year period under consideration, the average annual P/E ratio of the RTS Index was the sample's lowest, at 6.6 vs the mean P/E ratio of 20.9 of the other 26 stock indices. At the same time, the RTS average annual dividend payout ratio amounted to 34.7%, which was below 19 out of the other 26 stock indexes, while the sample's mean stood at 50.9%.
a) Dividend yield of RTS Index in 2008-2019, % per annum 8,00 --------------------------------------------
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1 This financial ratio describes the relative amount of companies' capitalization, i.e., for how many years the amount of net profit per share pays off its market price.
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as of December 31, 2019
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Over the period 2008-2019, the cumulative equity risk premium on Russian stocks1 amounted to only 9.5% for the MOEX Total Return Index2, and to 51.5% for our calculated broad market portfolio index (RMRF) (Fig. 20). As a risk-free return, we applied the monthly rate of return on individual bank deposits of 181 days to 1 year.
The issues of tradable Russian stocks are definitely non-homogeneous, because they differ by certain criteria that are typical of their issuers. In our classification of stocks, we applied the following criteria: capitalization index; liquidity on the secondary market; P/BV ratio; dividend yield; the size of state-owned stakes; and stock returns over the previous period. A separate stock portfolio was compiled for each of these criteria, to be reviewed once a year. This approach makes it possible to evaluate, on a monthly basis, the returns on stocks issues by different groups of companies, each group sharing one or other specific feature.3 Besides, it becomes possible to evaluate their corporate strategies on the basis of these financial indicators, as well as to plot factor investing strategies, which are widely used by institutional investors all over the world.4
1 The difference between the yield on a market stock portfolio and on a risk-free asset. As market portfolios, we used in our calculations the MOEX Russia Total Return Index (MCFTR) and a broad market portfolio (RMRF) that we compiled using all the stocks traded on the market, where each stock was weighted by the market capitalization index of its issuer (with weight cap of 15%). Unlike the MOEX Index, a broad market portfolio is adjusted by survivorship bias, i.e. the yields on stocks no longer traded on the stock exchange.
2 Hereinafter, the total returns on the MOEX and RMRF Indexes are understood as the sum of a proportional rise in the market value of stocks included in the index portfolio and their dividend yield.
3 We publish the regularly updated historical series of returns for each of these stock market factors at the official website of the Center for Institutions Analysis and Financial Markets (RANEPA IAES) at https://ipei.ranepa.ru/en/capm-ru. Similar calculations for US stocks are available on the resource supported by US economist Kenneth French, at: https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
4 For more details on the use of factor pricing models in the Russian stock market, see Abramov, A.E., Radygin, A.D., Chernova, M.I.. Pricing models of shares in Russian companies and their practical application // Voprosy Ekonomiki. 2019. No 3. P. 48-76.
i I Moscow Exchanges Index -RMRF SMB
............1-MOM — LIQ
-*-DY -□-SOE
Fig. 20. The cumulative returns on the MOEX Index, the broad market portfolio index (RMRF), and the investment factors that were influencing them from December 2007
through January 20201
Source: own calculations based on data released by CAPM-RU (RANEPA, IAES). URL: https://ipei. ranepa.ru/capm-ru
1 The MOEX Index: the market equity risk premium on stocks, calculated as the difference between the return on the MOEX Index, including dividend yields (starting from January 2009) and the return of a risk-free asset; the RMRF index: the market equity risk premium on stocks, calculated as the difference between the return on a broad market portfolio, including dividend yields, and the return on a risk-free asset. SMB is a size and value factor, calculated as the difference between the weighted average return on small-cap stock portfolios and that on large-cap stocks (including dividend yields). The companies were grouped into 'small-cap' and 'large-cap' ones once a year, with the market cap set at the median. HML is a cost factor calculated as the difference between the weighted average return on portfolios of value stocks and that on portfolios of growth stocks (including dividend yields). The stocks were regrouped into the categories of growth and value stocks once a year according to their book-to-market ratio. MOM is a momentum (inertia) factor calculated as the difference between the returns on portfolios with high and low total returns in the previous 11 months (including dividend yields). The stocks were redistributed between portfolios with high and low total returns once a year, with the quantile caps set at 30% and 70%. LIQ is a liquidity factor calculated as the difference between the weighted average return on low-liquidity stock portfolios and that on high-liquidity stock portfolios, including dividend yields. DY is a dividend yield factor calculated as the difference between the weighted average return on high-dividend stock portfolios and that on low-dividend stock portfolios. The dividend yield is understood as the ratio of the sum of all dividends payable for a calendar year to the stock price at year beginning. SOE is a state ownership factor calculated as the difference between the weighted average return on stocks issued by private companies and that on stocks issued by state-owned companies (SOE). A company was treated as a SOE if in its quarterly reports for the previous year the stake held directly or indirectly by the State amounted to more than 10% of its charter capital.
For further details concerning the methodology applied in calculating each return factor, see the CAPM-RU project on the official website of the RANEPA. URL: https://ipei.ranepa.ru/ru/capm-ru/metodika-rascheta-faktorov
The data in the graph (Fig. 20) show that the use of three out of seven criteria for selecting stock issues - the company capitalization index, the presence of the State as a shareholder, and the dividend yield for the previous period - makes it possible for investors to increase the returns on their stock portfolios. Over the period from December 2007 through January 2020, as a result of their orientation to stocks issued by smaller companies and by joint-stock companies with smaller state stakes in their charter capital, as well as to stocks with higher dividend yields, investors received 12-year accrued premiums of 204.8%, 101.1%, and 42.2%, respectively, compared with the premiums on stocks issued by big companies, companies with large stakes held by the State, and stocks with low dividend yields.
At the same time, in 2019, when investing in less liquid stocks and stocks with higher returns, the investors were not compensated with premiums in an amount that they usually expected to receive on low-liquidity financial instruments and when they relied on an 'inertial' investment strategy. No obvious benefits could be derived from investment in value stocks or growth stocks, either.
Thus, the fundamental internal factors that influence the return on investment in stocks placed by specific groups of issuers are beginning to play an increasingly important role in the domestic stock market, which may be a sigh of a transition of this market segment to a higher level of development, more typical of mature capital markets.
3.1.4. The stock market organization
In response to rising stock prices, the capitalization index of Russian companies increased from USD 576 billion in 2018 to USD 792 billion in 2019, or by 37.5%1 (Fig. 21). By this indicator, the Russian market had rebounded to its level of 2013, when it was operating prior to the introduction of economic sanctions. However, the volume of market transactions, on the basis of which the market value of stocks is calculated, is still growing at a slow pace. In 2019, it reached the level of USD 180 billion, which represents an increase of 7.8% on the previous year, but only 74.4% of its 2013 level. This means that a moderate capitalization growth occurred against the backdrop of liquidity stagnation in the stock exchange market in response to an insufficient activity there of non-residents and institutional investors, alongside a freeze of the domestic pension savings system.
For more than 7 years already, starting from 2013, there has been a trend towards reducing the number of listed issuers on the Moscow Exchange (Fig. 22). Their number shrunk from 225 in 2018 to 217 in 2019, or by 3.6%. The problem is not that one or other issuer is struck off the exchange lists, which may happen as a result of a natural process of company reorganization or tightened requirements to listed companies, but that the exchange market is not being entered by new medium-sized and small businesses, and the process of emergence of new national business champions in is not properly realized.2
1 The quantitative parameters of the Russian stock market were evaluated in dollars in order to make it comparable with similar statistics of other countries.
2 In Q1 2020, in the framework of business support measures, the government compiled a list of 646 system-forming enterprises, which it would be ready to help in the first place. The support of such companies is a timely and important step; however, interestingly, 66% of those companies were not listed on the Moscow Exchange, which points to difficulties in assessing their performance and transparency. Probably, in the future, the condition for placing big companies on a government support list could be their listing on the stock exchange, because then it would be easier to monitor in a transparent and efficient manner the government support measures provided to them.
2013 2014 2015 2016 2017 2018 2019
Stock market capitalization r i Stock market trading volume — — — Linear capitalization trend ...........Linear trading volume trend
Fig. 21. The capitalization and volume of market stock transactions1 on the Moscow Exchange in 2013-2019, billions of USD
Source: own calculations based on data released by the Moscow Exchange and the Bank of Russia.
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Fig. 22. The number of companies listed on the Moscow Exchange in 2006-20192
Source: own calculations based on data for 2006-2008 taken from NAUFOR's (Russian National Association of Securities Market Participants) factbook 'Russian stock market: 2015. Events and facts'; and data for 2009-2019 released by the World Federation of Exchanges (WFE).
1 Market transactions are understood as the transactions concluded during an anonymous auction on the Moscow Exchange.
2 The figures for the period 2006-2011 are based on the listing data released by the MICEX; for the period 20122019, on the listing data released by the Moscow Exchange PJSC.
In 2019, the statistics on public stock offers and M&A transactions participated by Russian companies, i.e., the indicators of the domestic stock market performance in terms of attracting investment and redistributing the ownership of stakes in companies, somewhat improved (Fig. 23). While in 2018 no IPO-SPO stock market transactions1 with the participation of Russian companies took place on the Moscow Exchange or foreign exchanges, in 2019 several such deals were closed, mainly in the form of SPOs on foreign exchanges, to the total value of USD 2.3 billion. The only classic IPO in 2019 was the initial public offering, on the Nasdaq stock market in the USA, of shares in HeadHunter, a Cyprus company registered in Cyprus, which carried out the bulk of its activities in the Russian Federation, to the value USD 220 million. The total volume of IPO-SPO transactions in 2019 was 3.9 times lower than the corresponding index for 2013, which stood at USD 9.0 billion.
The value of completed M&A transactions increased from USD 34.9 billion in 2018 to USD 41.9 billion in 2019, or by 20.0%. However, in spite of this growth, the current volume of mergers and acquisitions is still significantly below its 2013 level, when it amounted to USD 156.1 billion, or 3.7 times more than in 2019.
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------31,4
____34,9
1,7 0,6 2,1 4,7 0 2,3 0
2013 2014 2015 2016 2017 2018 2019 2020 Q1
I IPO-SPO by Russian companies on Moscow Exchange and foreign exchanges DM&A transactions in Russia
5,2
* Russian legal entities and public companies registered in foreign jurisdictions and operating in the Russian Federation.
Fig. 23. The value of IPOs and SPOs by Russian companies on the Moscow Exchange and on foreign exchanges, and the value of mergers and acquisitions participated by Russian companies from 2013 through Q1 2020, billion USD
Source: own calculations based on data released by the World Federation of Exchanges (WFE); Merger.ru (http://mergers.ru/) and Preqveca (http://preqveca.ru/placements/) (sources owned by Cbonds Group).
1 An IPO (initial public offering) is an initial public placement of stocks on the market. In the WFE statistics, an IPO deal is understood as the initial sale on the stock exchange of newly issued stocks or bundles thereof owned by their issuer. A SPO (secondary public offering) is a deal of sale of stocks issued by listed public companies on a stock exchange. This type of transaction may also involve newly issued stocks or bundles thereof, which during a SPO already belonged to their previous owners.
Over the past three years, the bulk of IPO-SPOs by companies operating in the territory of the Russian Federation took place on foreign exchanges. According to the World Federation of Exchanges, only IPOs to the total value of about USD 2 million and SPOs (less the sale of two blocks of shares in Gazprom to an unknown buyer) to the value of USD 282 million went directly to the Moscow Exchange in 2019 (Fig. 24). In 2018, there were no such stock market transactions at all. Thus, for a variety reasons, which primarily had to do with the unstable investment climate and the lack of market financing sources on the stock exchange, for three straight years from 2017 to 2019, the domestic stock market was not performing one of its key functions - the attraction of additional investment by company through public offering of their stocks.
1000 900 800 700 600 500 400 300 200 100
490
0
930
508
230
117
7
298
282*
2013
2014
2015
2016 DIPO QSPO
2017
2018
2019
2
* In our calculations, the WSE's data on the total value of SPO deals on the Moscow Exchange in 2019 (USD 5,329.7 million) were reduced by the amount equal to the value of big stakes in Gazprom PJSC (USD 5,048 million) sold on March 25, 2019 and November 21, 2019, because of the insufficient transparency of those transactions.
Fig. 24. The value of IPO and SPO transactions on the Moscow Exchange in 2013-2019,
million USD
Source: own calculations based on data released by the WSE and Preqveca (URL: http://preqveca.ru/placements/) (Cbonds Group).
A comparative analysis of the Russian stock market's competitiveness has revealed that its scale and performance, expressed as the sum of foreign investment attracted through stock issuance and the value of mergers and acquisitions with the participation of national companies, do not match the size of the Russian economy and the complexity of its goals. Executive Order of the President of the Russian Federation No. 2014 dated May 7, 2018 'On National Goals and Strategic Objectives of the Russian Federation through to 2024', outlined, as one of the national development goals, that of taking Russia into the top five largest economies. In order to achieve this goal in a situation of economic sanctions restricting the attraction of external financing, it will be necessary to mobilize massive sources of domestic savings, including market-based mechanisms for transforming savings into investment resources.
However, the data presented in Fig. 25 demonstrate that the domestic stock market is unlikely to help significantly in providing solutions to these problems, because it is rather small
compared with the stock markets of many other countries. While Russia seeks to become fifth largest economy in the world, the Moscow Exchange, an average over the period 2013-2019, was behind 36 foreign stock exchanges by the number of listed companies; 23 foreign stock exchanges by the capitalization index of listed companies; 25 foreign stock exchanges by its stock market liquidity; and 35 and 40 foreign stock exchanges by the number of IPOs and SPOs, respectively. On average over the same period, Russia's share in the total global number of listed companies was 0.5%; in the global capitalization index, 0.8%; in the global stock exchange trading volume, 0.2%; in the global value volume of IPOs and SPOs, 0.001% and 0.04%, respectively; and in the global value volume of mergers and acquisitions, 1.25%. In
2019, there were some minor improvements in terms of listing, capitalization, stock market liquidity, and the volume of SPO and M&A transactions. However, these improvements are purely cosmetic, and they do not change the general trends of the domestic stock market's low competitiveness on a global scale and the inadequacy of its potential to Russia's economic goals.
Some serious measures are needed to reform the domestic stock market and to reverse its development and competitiveness trends that prevailed over the period from 2013 through Q1
2020. These measures should be consistent with Russia's strategic economic and social goals outlined in the national projects and other strategic planning documents.
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38 39 38
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6 10 7 10 0,4 8 10
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Number of exchanges with more listed issuers than those listed on Moscow Exchange (left-hand side axis)
-Moscow Exchange's global market share (right-hand side axis)
» 30
<u
S 25
I 20
O
X 15
<u A-1
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.o
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29 b) capitalization
""T -126 - -22- -21---2-1- -2-1---21 -
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23 1,2
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Number of exchanges with higher index than that of Moscow Exchange (left-hand side axis)
-Moscow Exchange's global capitalization share (right-hand side axis)
J3
X
I
30 26 25 20 15 10 5 0
c) trading volume %
29
26 m 25 26 25 25 0°'425 0,40
0,30 0,20 0,10 0,00
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of exchanges with higher index than that of Exchange (left-hand side axis)
Exchange's global market share (right-hand side
60
d) initial public offering (IPO) -----------0,6950
a 50-----41
J 40----
a 30 0,3
<U
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i
£
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0
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ijiji - —
003 0
ky
35
29
/
■o Ph
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0,80 0,60
i,2°5'40 0,20
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3
Number of exchanges with higher index than that of Moscow Exchange (left-hand side axis)
Moscow Exchange's share of global IPO market (right-hand side axis)
50 40 30 20 10 0
s
3
£
e) secondary public offering (SPO) 50
----42 43 44 40 360,06 40 0,08
34 "
04
0,06 0,04 0,02 0,00
□ Number of exchanges with higher index than that
of Moscow Exchange (left-hand side axis) — Moscow Exchange's global market share (right-hand side axis)
f) mergers and acquisitions (M&A)
5000 4000 3000 ° 2000 o 1000
S 0
6,19
2 523
4 765
3 953
48
19
3 640 3 716
4 127
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1,25
2013 2014 2015 2016 2017 2018 2019
7,0 6,0 5,0 4,0 3,0 2,0 1,0 0,0
2020 Q1
□ Global M&A index (left-hand side axis) — Russia's share of global M&A market (right-hand side axis)
Fig. 25. The competitiveness indicators of the Russian stock market in 2006-2019
Source: own calculations based on data released by the WSE, Merger.ru (URL:http://mergers.ru/) (Cbonds Group), and the Institute of Mergers, Acquisitions and Alliances (IMAA). URL: https://imaa-institute.org/mergers-and-acquisitions-statistics/
The domestic stock market liquidity is mainly sustained by shares in a limited number of companies, and the market cap concentration index, which is already quite high, is still on the rise. The stocks of the top 5 issuers (Gazprom, Sberbank, Rosneft, LUKoil and Novatek) in 2019 accounted for 50.6% of the total combined market cap, compared with 48.7% in 2018; the combined market cap share of the top 10 PJSCs increased from 66.8% in 2018 to 70.1% in 2019; and that of the top 20 issuers - from 80.6 to 82.9%, respectively (Fig. 26, Table 4). Unlike other countries where companies belonging to the new economy often become leaders in capitalization, in Russia it is the companies operating in the fuel and energy complex, extractive industries, and Sberbank that continue to be the top ten largest issuers.
85 ----------------------------------------------------------------------82,9
80,6
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80 " 77,7 - - ^---------------------V-- - -----------------J*—
75
70
65
69,3
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70,1
60,6 59,8
60
60,4 60,3
55 -
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
—•—Top 10 JSCs —O— Top 20 JSCs
Fig. 26. The domestic stock market cap share of biggest PJSCs, % Source: own calculations based on data released by the Moscow Exchange.
Table 4
The market cap indices of Russia's top 10 public joint-stock companies
(PJSCs) in 2017-2019
2017 2018 2019
S n, e, n, e,
Issuer Capitalizatù billions of rubles Market shai % Issuer Capitalizatù billions of rubles Market sha % Issuer Capitalizatù billions of rubles. Market sha %
1 2 3 4 5 6 7 8 9 10 11 12
1 Sberbank PJSC 4,859 13.5 1 Sberbank PJSC 4,535 11.4 1 Gazprom PJSC 6,077 12.5
2 Gazprom PJSC 3,074 8.6 2 LUKoil PJSC 4,017 10.1 2 Sberbank PJSC 5,482 11.3
3 Rosneft PJSC 3,072 8.6 3 Gazprom PJSC 3,739 9.4 3 Rosneft PJSC 4,776 9.8
4 LUKoil PJSC 2,823 7.9 4 Rosneft PJSC 3,629 9.1 4 LUKoil PJSC " 4,405 9.1
5 NOVATEK PJSC 2,048 5.7 5 NOVATEK PJSC 3,431 8.6 5 NOVATEK PJSC 3,834 7.9
6 Norilsk Nickel PJSC 1,701 4.7 6 Norilsk Nickel PJSC 2,059 5.2 6 Norilsk Nickel PJSC 3,050 6.3
7 Gazprom Nefft PJSC 1,162 3.2 7 Gazprom Nefft PJSC 1,639 4.1 7 Gazprom Nefft PJSC 1,995 4.1
8 Tatneft PJSC 1,035 2.9 8 Tatneft PJSC 1,588 4 8 Surgutneftegas OJSC 1,814 3.7
9 Surgutneftegas OJSC 991 2.8 9 Surgutneftegas OJSC " 959 2.4 9 Tatneft PJSC 1,668 3.4
10 NLMK PJSC 885 2.5 10 NLMK PJSC 944 2.4 1 0 Polyus PJSC 945 1.9
Combined cap Combined cap Combined cap
of all Issuers on 35,896 100 of all issuers on 39,716 100 of all issuers on 48,579 100
Moscow Moscow Moscow
Exchange Exchange Exchange
Combined cap of Top 5 Issuers 15,876 44.2 Combined cap of Top 5 issuers 19,351 48.7 Combined cap of Top 5 issuers 24,574 50.6
Combined cap Combined cap Combined cap
of Top 10 21,650 60.3 of Top 10 26,541 66.8 of Top 10 34,047 70.1
issuers issuers issuers
Source: own calculations based on data released by the Moscow Exchange.
Another notable trend of the period 2014-2019 was a steady increase in the market cap index of state-owned companies (SOE)1, from 45.7% in 2014 to 53.2% in 2019 (Fig. 25). This trend was associated with an accelerated market cap growth demonstrated by energy companies, where SOEs prevail, as oil prices rebounded in 2017-2018 after their collapse in 2015-2016, as well as with the favorable situation in the European natural gas market. Besides, there were the factors of increasing attractiveness of shares in Sberbank of Russia for foreign investors and the effect of the acquisition, by the private company TNK-BP, of the state-owned oil company Rosneft (in 2013), as well as the transition of the formerly private companies Bashneft PJSC (in 2014) and Magnit PJSC (in 2018) into the category of SOE. 2 The dwindling share of private companies in the combined market cap may be an indirect sign of a worsening investment climate and a limited access to financing in the banking system, as well as to other sources.
As shown in Fig. 28, in the structure of all stock exchange transactions in stocks in 2019, market transactions accounted for only 19.9%, repos - for 79.3%, and the remaining share of 0.8% was taken up by negotiated deals. The economic scheme behind repo transactions in
1 A company with state participation (SOE) is an organization controlled by the state, acting as the sole owner, owner of a majority or significant minority stake (share in the authorized capital) in the amount of at least 10%.
2 For further details concerning the role of SOEs in stock market capitalization, see Radygin M.I. et al. Privatization 30 years later: the scale and performance of the public sector / A.D. Radygin, R.M. Entov, A.E. Abramov, M.I. Chernova, G.N. Malginov. - M.: Delo Publishing House, RANEPA, 2019.
stocks is that brokers use the assets of some of their clients for short-term lending to their other clients, the loans being secured by stocks or money, i.e. short sales1 or margin transactions.2 With the help of this market segment, individuals (brokers' clients) can also receive additional short-term loans from the broker and other legal entities. Repo transactions can boost stock liquidity by attracting additional money loans, while at the same time shifting the increased credit risks onto the multitude of private clients-intermediaries, who are not prepared to shoulder these risks. For brokers, the virtually free use of their clients' assets through repo transactions and the possibility to lend these assets to other clients is one of their key sources of income, which accounts for 27% of their revenue base, while their brokerage and other commissions bring only about 16 % of their income.3
56,0
120,0
54,6
53,2 110,0 100,0 90,0
80,0 a a
70,0 ^
60,0
50,0
40,0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 ■ 1 Share of SOEs (left-hand side axis) —O— Price of Brent crude oil (right-hand side axis)
* The data for 2019 on the market cap share of SOEs are preliminary.
Fig. 27. The relative share of state-owned companies (SOE) in the domestic stock market cap and the per barrel price of Brent crude oil in 2005-2019
Source: own calculations. URL: https://ipei.ranepa.ru/kgu
After the crisis of 2008, the brokerage business model in the domestic stock market, which implied that a traditional intermediary carried on market asset transactions for a commission on behalf of a client, underwent some profound changes, giving way to a new business model that closely resembles the activities of banks in the money market, when an intermediary, on its own behalf and on an ongoing basis, uses the assets of some its clients for lending cash and securities to other clients, its income generated by the spread between the interest paid to the former for the use of their assets and the interest on loans paid by the latter. However, unlike the banking
1 The sale of unsecured stocks in the hope of making a profit as a result of their reduced market price.
2 The purchase of securities using borrowed funds in the expectation of an increase in their market price.
3 Bank of Russia. Brokerage industry. Analytical review, 2017 and Q1 2018 (in Russian). Available at URL: http://www.cbr.ru/finmarkets/files/supervision/broker_18-01.pdf. In its report for Q4 2019, the Bank of Russia, unfortunately, does not disclose the year-end data for 2018 and 2019.
18,5
25,6
50,5
48,7
sector, the new brokerage business model and its specific systemic risks have effectively remained outside of the existing special regulation and supervision system. Although the number of individual clients of brokers is approaching 5 million, this system so far has not become subject to state guarantees as a mechanism of protecting client assets, and the discussion of existing proposals on this topic is being held up by the regulator and lawmakers.
100,0 90,0 80,0 70,0 60,0 50,0 40,0 30,0 20,0 10,0 0,0
69
69
46,0
62,8
34,9
49,
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41,7
65,1
32
78,0
20,3
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81,6
17
82,5
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11,4
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19,4
79,3
19,9
72,8
25,
Hh à
□Auction (market) mode
□Negotiated trades mode
□Repo mode
2
2
Fig. 28. The structure of trades in shares on the Moscow Exchange's Main Market
from 2005 through February 2020, %
Source: own calculations based on data released by the Moscow Exchange.
As shown in Table 5, non-residents (foreign investment funds and banks) and resident individuals were the main liquidity drivers in the trades in shares segment on the Moscow Exchange over the period from 2017 through February 2020. The relative share of non-residents in the trades volume increased from 47.5% in 2017 to 48.6% in February 2020; the share of individuals also increased, from 35.3 to 38.0%, respectively. The year 2019 saw a massive inflow of individual traders into the stock market. According to data released by the Bank of Russia, the number of broker's clients increased from 2.2 million in 2018 to 4.3 million in 2019, i.e. almost 2 times.
However, as shown earlier in the comments to Fig. 25, the Moscow Exchange by its volume of trades in shares falls behind 25 other stock exchanges in different countries of the world. This can largely be explained by the lower level of development of domestic institutional investors in Russia (private pension funds, administrators of private retirement plans and other savings programs, mutual funds, and other structures) compared with other developed and developing economies. According to data presented in Table 5, these institutions currently
account for only 2.0% of the total volume of trades in shares; their tiny market share shrank further, from 3.2% in 2017 to 2.0% in February 2020.
Table 5
The structure of investors participating in trades in shares on the Moscow Exchange's Main Market from 2017 through February 2020
2017 2018 2019 Feb 2020
Non-residents 47.5 51.2 47.5 48.6
Individuals 35.3 34.7 36.7 38.0
Dealers 8.9 8.2 8.1 6.6
Legal entities 5.1 3.8 4.7 4.8
Trust Managers 3.2 2.1 3.0 2.0
Source: own compilation based on data released by the Moscow Exchange. 1
3.1.5. The general characteristics of the domestic bond market
In contrast to stocks, bonds played a more significant role as a means of saving,2 as well as in financing the needs of business and the State. In 2019, the cost of bond loans in Russia was still on the rise, reaching the level of RUB 25.6 trillion, which represents an increase of 16.9% on 2018 (Fig. 29). The Bank of Russia bonds (OBRs), issued for the purpose of managing the liquidity level in the banking system, began to play an important role, their outstanding volume in 2019 amounting to RUB 1.9 trillion. Over the year, the value of corporate bonds, including non-market issues, increased from RUB 11.9 trillion to RUB 13.6 trillion, or 14.2%; that of federal bonds (OFZ, GSO, etc.), from RUB 7.7 trillion to RUB 9.3 trillion, or 20.8%. The volume of outstanding regional bonds in 2019 remained practically unchanged relative to the previous year, remaining at the level of RUB 0.7 trillion.
In 2019, the volume of bond placements once again increased after its decline in the previous year (Fig. 30). The volume of corporate bond placements sharply increased from RUB 1.6 trillion in 2018 to RUB 2.7 trillion in 2010, or by 68.7%. According to experts, the three key factors behind the growth of new corporate bond issues in 2019 and in January 2020, when companies placed their bonds to the total value of RUB 140 billion, were the reduced Bank of Russia's key rate, lower inflation, and a stronger ruble.3 Throughout the year 2019, the Bank of Russia reduced the key rate 5 times in a row; as a result, it dropped from 7.75% to 6.25% per annum. In February 2020, the key rate was reduced further, to 6.00%. In December 2019 -January 2020, for the first time in 23 months, there was a shrinkage in the total portfolio of bank loans to the corporate sector, by RUB 180 billion, which some experts explained by the banks' switchover to corporate bonds as their principal mechanism of providing companies with borrowed funds, instead of bank loans.4 Besides, as bank deposits were becoming less attractive as a result of declining interest rates, biggest banks were trying to keep their hold on their clients' assets by channeling part of their savings kept with banks as deposits into ordinary and structural bonds. The bonds issued by banks and non-banking financial institutions accounted
1 URL: https://www.moex.com/s2184?fbclid=IwAR1Xl1wazyliXc5_77Q7usAilbS4BwecrqBWQ8XtdlHJ78fvoc 0bej FDTLA
2 According to NAUFOR, the share of assets in brokerage accounts other than individual investment accounts (IIAs) invested in stocks was 28%, and that invested in bonds was 59%; out of the total assets kept in IIAs, the investments in stocks and bonds amounted to 34% each. NAUFOR (2020). Annual study of individual investor activity in the stock market. February.
3 Brzezinski D. (2020). Repayment beautifies debt. RBC+ (thematic supplement to the RBC weekly business newspaper). February 26, No. 17 (3184).
4 BuilovM. (2020). Debt goes public: companies replace loans with bonds. The Kommersant. March 2.
for more than half of all corporate bonds placed in 2019.1 In one of its market reviews for 2019, the Bank of Russia referred to bank bonds as a driver of the development of brokerage services.2
Fig. 29. The outstanding volume of ruble bonds, billion of rubles Source: own calculations based on data released by the RF Ministry of Finance and Cbonds.
The volume of federal loan bond (OFZ) issues increased from RUB 1.1 trillion in 2018 to RUB 2.1 trillion in 2019, or by 90.9%. The increasing attractiveness of OFZ to global investors had to do in the main with the reduced country risk premium3 and the rising yields of ruble bonds on the back of the ruble strengthening against the US dollar.4 In the situation of a stable reduction in the key rate, the interest of foreign investors was whipped up by OFZ issues with maturities of more than 7 years, because their yield grows faster than that of short-term bonds when the Bank of Russia key rate is reduced. Over the same period, the volume of regional bond issues increased from RUB 84.6 billion to RUB 111.8 billion, or 32.0%. The volume of short-term OBRs issued over the same period increased from RUB 7.0 trillion to RUB 7.9 billion, or 12.9%.
As shown in Fig. 31, in 2019, the ruble bond issues were bought in the main by nonresidents, who accounted for 28% of their total value. Next came credit institutions (25%), followed by non-governmental pension funds (NPFs) (15%); individuals (11%); insurance companies (7%); non-financial organizations (3%); professional securities market participants and the Pension Fund of the Russian Federation (PFR) (1% each).
1 Brzezinski D. (2020). Repayment beautifies debt. RBC+ (thematic supplement to the RBC weekly business newspaper). February 26, No. 17 (3184).
2 Bank of Russia (2020). Review of Key Indicators of Professional Securities Market Participants. 2019. P.7.
3 As stated in the comment to Figure 13, in 2019, the amount of the equity risk premium decreased compared to 2018, from 9.43 to 6.65% in terms of PRP1, and from 8.95 to 6.68% in terms of PRP2.
4 Lomskaya, T. (2019). Foreigners once again take their share. The RBC newspaper. November 8, No. 177 (3132).
14 000 13 000 12 000 11 000 10 000 9 000 8 000 7 000 6 000 5 000 4 000 3 000 2 000 1 000
222
□ GKO-OFZ- GSO
] Regional bonds
□ Corporate bonds
lOBR
Fig. 30. The value volume of ruble bond issues placed in 1993-2019, billions of rubles Source: own calculations based on data released by the RF Ministry of Finance and the Moscow Exchange.
■ Non-residents ■■i NPFs
□ Insurance companies * Professional securities market participants
Credit institutions - Individuals
□ Non-financial organizations 11 RF Pension Fund
Fig. 31. The structure of buyers of ruble debt securities issued in the domestic market
in 2019, %
Source: own compilation based on data released by the Bank of Russia (2020).1
1 Bank of Russia (2020). Financial Market Risks Review. February. P.15.
9
In 2019, growth in the ruble debt market was taking place against the backdrop of aggravating liquidity problems, created in the main by the inadequately developed domestic institutional investors and major market makers trading in this particular market segment, including the subsidiaries of large foreign financial organizations. The secondary government and corporate bond market in Russia functions primarily as a money market for repurchase transactions, and not as a stock market where long-term investors can rely on various portfolio strategies. In 2019, repos accounted for 94.8% of the value volume of trades in bonds on the exchange, and that index has remained practically unchanged over the past 6 years (Fig. 32). In 2019, trades in bonds accounted for only 2.1% of the total trading volume. For reference: in 2005, the relative share of repos was 28.0%, and that of market transactions - 12.8%; the rest (59.2%) was taken up by negotiated trades. The low liquidity of trades in bonds on the exchange makes it difficult to determine their fair market value, without which the risks reflected in the records of bond owners are distorted, and investors are prevented from promptly withdrawing their investments from these assets when they need to adjust their portfolios. All other conditions being equal, the low liquidity of financial instruments makes them less attractive in the eyes of investors and pushes up the equity risk premium.
100,0 90,0 28,0 53,3 73,1 78,4 77,3 84,0 87,4 92,7 92,9 94,2 94,1 96,1 96,0 95,6 94,8 93,7
80,0 70,0 59,2
60,0
50,0 39,2
40,0
30,0 20,0 10,0 0,0 jjj ■ 21,2 5,7 16,6 5,0 15,8 6,8 11,0 5,0 8,6 4,0 5,6 5,5 4.4 1.5 4,2 1,7 23 2.5 1.6 2,5 2,0 3,1 m 4,1 ■g
•Î <f >> O J- w
■ Auction (market) mode DNegotiated trades mode DRepo mode (incl. SOEs)
Fig. 32. The structure of trades in bonds on the Moscow Exchange from 2005
through February 2020, %
Source: own calculations based on data released by the Moscow Exchange.
As shown in Fig. 33, the year 2019 saw a continuation of the downward trend in the bond market's value volume that had emerged in the previous year and was not followed by an increase in the market transactions segment's liquidity. The shrinkage of the bond segment in the repo market from RUB 219.9 trillion in 2018 to RUB 192.6 trillion in 2019, or by 12.4%, was not offset by a 15% increase in the volume of trades in clearing participation certificates (CPC) from RUB 46.9 trillion to RUB 54.1 trillion, or by a 14.2% increase in over-the-counter repo transactions with the participation of the RF Treasury and the Bank of Russia through the
National Settlement Depository (NSD) from RUB 17.6 trillion to RUB 20.1 trillion. A likely reason for the shrinkage of the bond segment of the money market in 2019 was the reduction of the programs of bank refinancing through repurchase agreements launched by the Bank of Russia and the RF Ministry of Finance.
350,0 300,0 250,0 200,0 150,0 100,0 50,0 0,0
"318,7
29,5
39,4
0,6
2005 2006
2,7 —•—
8,8 —T*T~
2007
11,0
>rrn
284,3
». 266,7 î-â
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
■ ■ Repos with RF Treasury and Bank of Russia through NSD
■ 1 Repos in CPCs via Central Counterparty
C
□ Repos in bonds — Repos, total (less shares)
Fig. 33. The value of repos in bonds and clearing participation certificates (CPCs) on the Moscow Exchange in 2005-2019, trillions of rubles
Source: own calculations based on data released by the Moscow Exchange.
3.1.6. The fundamental characteristics of corporate bonds
At the end of 2019, the euphoria of success reigned supreme in the domestic corporate bond market. At the beginning of 2020, the journal 'Expert' described it as follows: 'At the annual Russian Bond Congress, which is traditionally held by Cbonds in December, the managers of the industry's major operators did not bother to hide their high-spirited mood and hinted at the sizable year-end bonuses they were going to receive as a result of fruitful work in 2019.'1 However, as early as the end of March 2020, Moody's warned that the oil price collapse and a weakening ruble could have a negative effect on the capital of those Russian banks that display high numbers of debt securities on their balance sheets.2 This situation is a good illustration of the high volatility of corporate bonds and the associated risks for investors.
In Fig. 34, the return and risk (standard deviation) parameters of the corporate bond indexes of 12 countries, including the Russian IFX Index,3 were compared on the time horizons of 1, 5, and 12 years over the period 2008-2019. For the sake of data comparability, the historical series
1 Remizov, M. (2020). One wants to get a higher interest. Expert, February 24 - March 1, No 9.
2 Kazarnovskiy, P., Koshkina, Yu. (2020). Securities add to insecurity. The RBC newspaper. March 20. No 33 (3200).
3 The relatively limited sample size can be explained by the fact that Bloomberg publishes the historical data series of corporate bond indexes only for a rather limited number of countries.
of returns and, consequently, also the risks are adjusted by the movement of the US dollar exchange rate.
On all the time horizons considered in this study, the IFX Index was demonstrating, as a rule, the highest risk level, and the return indicator varied depending on a time horizon, declining as they lengthened. In 2019, the return of the IFX Index was 28.9% per annum, while the sample geometric mean stood at 11.0%; the standard deviation on the Russian bond portfolio was 8.9% vs the sample mean of 6.2%. On the 5-year horizon from 2015 through 2019, the mean return of 10.8% per annum on the IFX Index was also above the sample mean of 4.6%, but the risk index of the Russian bond portfolio was 16.2%, or more than twice the sample mean of 7.1%. On the 12-year horizon from 2008 to 2019, the return of the IFX Index was 1.9% per annum, i.e., significantly lower than the sample mean of 4.3%, and the risk indicator was once again almost 2 times higher than the sample mean - 15.9% vs 7.5%.
20,0%
15,0%
5,0%
0,0%
a) 2019: mean return 11.00%, risk 6.19%
Q Russia (IFX Index)
Thailand (SPBTHCPT Index)
Indonesia (IBPRXCTR Index)
-ÇT
USA (LUACTRUU Index)
UK (MSBIKRTR Index)
"O
Canada (I03385US Index)
- India (CCILBRTR Index)
- Malaysia (SPBMYCPT Index)
Europe (LP06TREU Index)
China (SPBCNCPT Index)
Q Japan (SPBJPCPT Index)
4,0% 6,0°0 8,0% 10,0% 12,0% 14,0% 16,0% 18,0% 20,0%
South Korea (KBICTR Index)
Risk (standard deviation), % per annum
30,0%
25,0%
10,0%
2,0%
b) 2015-2019 (5 years): mean return 4.65%, risk 7.19%
12,0%
10,0%
,0%
ä 6,0%
4,0%
2,0%
India (CCILBRTR Index)
Russia (IFX Index)
o
Thailand
(SPBTHCPT Index)
Indonesia (IBPRXCTR ^^ Index)
[H^pr
UK (MSBIKRTR Index) -------Q-
Q USA (LUACTRUU Index)
Europe (LP06TREU Index)
r-x Canada (I03385US Index)
........^--o.....o-^o
China (SPBCNCPT Index) v J
Japan (SPBJPCPT Index)
Malaysia (SPBMYCPT Index)
South Korea (KBICTR Index)
0,0%
2,0%
4,0%
6,0%
,0%
10,0%
12,0%
14,0%
16,0%
18,0%
Risk (standard deviation), % per annum
0,0%
c) 2008-2019 (12 years): mean return 4.32%, risk 7.48%
12,0%
10,0%
S 8,0%
» 6,0%
« 4,0%
2,0%
India (CCILBRTR Index)
O-
UK (MSBIKRTR Index)
Thailand
(SPBTHCPT Index)
China (SPBCNCPT Index) Q W USA (LUACTRUU Index) Q Europe (LP06TREU Index)
Indonesia(IBPRXCTR Index)
Malaysia (SPBMYCPT Index)
Canada (I03385US Index) South Korea (KBICTR Index)
Q Japan (SPBJPCPT Index)
Russia (IFX Index)
-o—-
0,0% 2,0% 4,0% 6,0% 8,0% 10,0% 12,0%
Risk (standard deviation), % per annum
14,0%
16,0%
18,0%
Fig. 34. The geometric mean returns and risks of 12 corporate bonds indexes of different countries1 from January 2008 to December 2019, on time horizons of 1, 5, and 12 years, % per annum
Source: own calculations based on data released by Bloomberg and Cbonds.
These observations indicate that, in terms of their risk-return tradeoff denominated in foreign currency, long-term investments in Russian ruble bonds are significantly less attractive than their competitors from other countries, both developed and developing ones. The main problem of investing in ruble bonds is the lack of stability in the ruble exchange rate movement, because its frequent downturns reduce the attractiveness of these investments for investors. This also explains why global investors prefer to make short-term investments in ruble bonds, in expectation of snatching an additional yield through the use of a speculative carry trade strategy during the periods of a climbing ruble.
As shown in Fig. 35, after the 2008 crisis, the return on the IFX-Cbonds index of ruble corporate bonds was periodically on the rise on the back of oil price downturns and investor fears amid geopolitical risks and international economic sanctions.
Meanwhile, from 2014 onwards, growth in the corporate bond market was sustained mostly by non-marketable bond issues that do not have stock quotes. Against this background, the situation in 2019 appeared to be favorable for growth in this market segment. The average yield to maturity of the IFX-Cbonds index plunged from 8.90% in 2018 to its post-crisis record low of 6.42% in January 2020. Over the same year, marketable bond issues were increasing at a fast rate, and their share in the total market capitalization of corporate bonds rose from 47.0% in 2018 to 50.8% in January 2020.
With the onset of a new wave of financial crisis, the average bond yield increased from 6.42 to 7.49% in March 2020. However, the first few weeks of the crisis have not yet led to any defaults in the corporate debt market.
0,0%
1 For the sake of data comparability, the historical data series of returns of each country index were recalculated in US dollars.
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
■ Marketable CBs - left-hand side axis Non-marketable CBs - left-hand side axis
Yield to maturity of CBs*, - right-hand side axis
* Yield to maturity of IFX-Cbonds portfolio.
Fig. 35. The value of ruble corporate bonds outstanding and the yield to maturity of IFX-Cbonds portfolio from December 2003 to March 2020 Source: own calculations based on data released by Cbonds.
As shown in Fig. 36, the yield to maturity of corporate bonds is closely linked to their duration, calculated with due regard for the terms of their offers. As a rule, declining rates of return translate into a faster growth of prices on the bond market, and thus into the shrinking yields to maturity of bonds with longer durations, which serves as an incentive for issuers to more actively offer bonds with long duration. This trend is clearly visible in Fig. 36 over the period 2015-2018, when declining bond yields were accompanied by a sharp increase in their average market duration. However, this trend demonstrated some significant changes in 2019, when a decrease in the average yield to maturity of the IFX-Cbonds portfolio unexpectedly gave rise to a shrinkage in its duration index from 3.22 years to 2.86 years. Probably, this was a manifestation of another corporate debt market trend that coexisted with the latter: the massive market entry of issuers of bonds with high return and risk levels and no credit history, issued, as a rule, for a short period of time; this resulted in a shrinkage in the average bond duration index, which ran contrary to the market expectations against the backdrop of sliding interest rates. At the same time, an increase in the IFX-Cbonds duration index to 3.15 years in March 2020 was a manifestation of a declining inflow into the market of more risky bonds.
One of the important trends observed in the corporate bond markets in Russia and elsewhere has been an accelerated growth of the so-called high-yield or junk bonds (JB), which are understood as bonds rated below the investment-grade level of BBB, or without any rating at all. According to data released by SIFMA, in 2019 the total value volume of junk bonds issued in the USA amounted to USD 278.3 billion, which represented a 64.3% rise on 2018. The
relative corporate bond market share of junk bonds increased from 12.7% in 2018 to 19.7% in 2019. Throughout the year 2019 and in early 2020, prior to the price volatility surge in the stock and oil markets in March, the US corporate bond market had been demonstrating noticeable downward trends in the yields of junk bonds and BBB-rated bonds towards their record lows of the entire period after the 2008 crisis, as well as an almost zero yield spread of these bond groups (FRB, 2020).1 All these developments point to an underestimation by market participants of the credit risks of corporate bonds, their current volume of the USA amounting to nearly USD 10 trillion.
25 23 21 19 17 15 13 11 9 7 5
3,14 3,00
Liberalization of CB market .
II
H 2
I I 0,74 New sanctions
- Yield to maturity of IFX-Cbonds portfolio - left-hand side axis •Duration of IFX-Cbonds portfolio - right-hand side axis
Fig. 36. The yield to maturity and duration indices of IFX-Cbonds portfolio over the period from July 1, 2003 to April 3, 2020
Source: own calculations based on data released by Cbonds.
The factor responsible for this state of affairs is believed to be the oppositely directed movement of the duration induces of junk and BBB-rated bond issues; more particularly, in 2019, the average duration index of investment grade corporate bonds increased by 13.0%, to 8.02 years, while that of junk bonds, on the contrary, plunged by 24.0%, to 2.98 years.2 This means that a higher duration of investment grade long-term bonds translated into an increase in their average yield, and a shorter duration of junk bonds pushed down their average yield, thus for the most part distorting the overall picture of yield spreads of corporate bonds with different credit risk levels. Another factor that boosted the demand for junk bonds was the activity of
1 Monetary Policy Report. February 7, 2020. Board of Governors of the Federal Reserve System. PP. 22, 24.
2 Goldfarb S. (2020). The Hidden Factor Making Junk Bonds Less Risky. The Wall Street Journal - online. Jan. 26.
pension funds, mutual funds and other institutional investors, who strove to achieve higher returns on their total investment portfolios by increasing the investments in these types of bonds in face of the key rate being reduced by the US Federal Reserve from 2.25-2.50 % to 1.51.75% in 2019, and then to 0-0.25% as of March 16, 2020, as well as the reduction of long-term government bond yields to levels below 1%.1
In March 2020, the junk bond market in the USA became one of the most dangerous segments that was generating credit risks for the entire financial market. The ICE BofA US High Yield Index Option-Adjusted Spread,2 which reflects the yield spread between issues of junk bonds and treasury bonds of a similar duration, increased from 3.57% as of February 19, 2020 to 7.42% as of March 12, 2020; this level was significantly below its peak of 19.88% observed in late November 2008, but nevertheless, the index doubled over the course of just one month. Over the period from February 19 to March 12, 2020, the yield spreads of BBB-rated corporate bond issues (lowest investment grade), as demonstrated by the ICE BofA BBB US Corporate Index Option-Adjusted Spread, also jumped from 1.31% to 2.77%, despite the fact that at the peak of the crisis, in December 2008, they stood on average at 7.84%.
A sharp increase in the yield of junk and lowest investment grade bonds heralds the start of withdrawal of investor funds from these bonds, which in an unfavorable situation may give rise to massive sales of bonds, an even steeper yield growth and, as a result, financial problems for their issuers, because the latter will be unable to refinance their corporate debts. An additional risk associated with BBB-rated bonds may be their downgrading by the rating agencies to the level of junk bonds, which will inevitably lead to sales of such bonds by conservative institutional investors, because the law does not allow them to keep in their portfolios the bonds with a credit rating below investment grade. As of mid-March 2020, although the rating agencies have so far been refraining from a large-scale revision of the investment ratings of corporate bonds, the data released by Credit Benchmark indicated that a number of major financial institutions that conduct own internal ratings of bonds in their portfolios had already begun to downgrade some bond issuers to a junk level.3
In the domestic Russian stock market, the junk bond segment is becoming one of the fastest-growing market segments, because it is considered to be an important source of financing by small and medium-sized businesses. However, in spite of the aggressive promotion of these financial instruments among domestic private investors, no reliable statistics on the issuance of junk bonds have been available so far. According to the estimates released by Forbes, the volume of the ruble junk bond market soared from RUB 8 billion in 2018 to RUB 20 billion in 2019; at the beginning of 2020, about 60 issuers of junk bonds had a second- and third-level listing on the Moscow Exchange. The average coupon yield of junk bonds was 14% per annum, which roughly corresponded to the average interest rates on bank loans issued to small and medium-sized businesses.4
It is rather difficult to analyze the risks in this segment of the financial market for lack of comparable historical data on the credit ratings of all corporate bonds issues, adjusted for their
1 WirzM., DaniesP., Goldfarb S. (2020). The Market Meltdown Has a Surprising Survivor: Junk Bonds. The Wall Street Journal - online. March 4.
2 Federal Reserve Bank of St. Louise https://fred.stlouisfed.org/series/BAMLH0A0HYM2
3 Wirz M. (2020). Investment-Grade Bonds Could Turn to Junk Amid Global Rout. The Wall Street Journal -online. March 13.
4 Samiev, P. (2020). No need to escalate. How to avoid a bubble in the high yield bond market. Forbes. January 28. URL: https://www.forbes.ru/finansy-i-investicii/391875-ne-nado-nagnetat-kak-izbezhat-puzyrya-na-rynke-vysokodohodnyh-obligaciy.
specific duration indices. Our calculations based on the maximum available statistical data concerning liquid marketable corporate bond issues released by Cbonds for the period from 2010 through February 2020 have revealed certain specific movement patterns of the various segments of the ruble corporate bond market, which point to their general similarity to the current situation in the US corporate debt market.1
The data on the value of corporate bonds outstanding over the period from 2010 to February 2020, presented in Fig. 37, indicate that in the corporate debt structure, high-risk investmentgrade bonds and junk bonds clearly predominated; however, in 2019, there was an increase in the relative share of minimum-risk investment grade bonds and junk bonds. In 2018, in our sample with the total bond value of RUB 3.5 trillion, high-risk investment grade bonds accounted for RUB 1.9 trillion rubles, junk bonds - for RUB 0.7 trillion. By the end of 2019, out of a total bond value of RUB 4.3 trillion, high-risk investment grade bonds and junk bonds had already taken up RUB 1.7 trillion and RUB 0.5 trillion, that is, 39.5% and 11.6%, respectively. The value volume of minimum risk investment grade bond issues in 2019 reached RUB 2.1 trillion. At the same time, there was a notable upward trend in the reliability of corporate debt issuers: the relative share of minimum risk investment grade bonds in the total value of bonds in the sample increased from 19.1% in 2017, to 31.4% in 2018, and to 48.6% in 2019, while the share of high risk investment grade bonds shrank from 70.4% in 2017 to 39.0% in 2019. The relative share of junk bonds did not change, in 2017 it was 10.2%, in 2018 -15.4%, and in 2019 - 12.3%. At the beginning of2020, there existed a trend towards an increase in the relative share of high risk investment grade bonds and a shrinkage in that of minimum-risk investment grade bonds, but the data available so far are preliminary.
From December 2015 through January 2017, there was a sharp surge in the issuance of speculative grade bonds. This happened because a rather large number of issuers (22 issuers of 114 bonds outstanding at that time) in late November - early December 2015 switched over to the speculative grade. Among these, we may point out Russian Railways, VTB, Russian Agricultural Bank, Russian Post, Aeroflot, the Auction House of the Russian Federation, and some other joint-stock companies.
After 2015, as the volatility indices of the forex market and financial market were on the decline, alongside the shrinking yields of ruble corporate bonds, there also emerged a general trend of the effective yields of junk and investment grade bonds to move nearer to one and the same level (Fig. 38). From January 2015 onwards, the yields of junk and investment grade bonds displayed a continuously downward movement, from 26.7 and 17.8%, respectively, to 8.9 and 7.1% at year-end 2019. The data for the first 2 months of 2020 demonstrate that this
1 In absence of comprehensive historical rating time series for a wide range of corporate bond issuers, we relied on an alternative credit risk assessment model for calculating the probability of a bond default over the next year or another period. The ranking of companies by their default probability can replace credit ratings and generate daily updated estimates. This model is used by Bloomberg in its credit risk assessments, where a sample of companies is subdivided into 21 groups: 10 investment grade groups (IG1 - IG10), 6 speculative grade groups (HY1 - HY6), and 5 defaulted investment grade groups (DS1- DS5). The IG1 group consists of companies with probability of default over the next year in the range of 0 to 0.002%, the HY1 group in the range of 0.52% to 0.88%, and the DS1 group in the range of 10% to 15%. The higher the group number, the greater the probability of default. Groups IG1 - IG5 roughly correspond to credit rating grades of AAA+ to A (however, the comparison just arbitrary, there is no direct correspondence between the two scales). Groups IG5 - IG10 roughly correspond to credit rating grades of A- to BBB-, and groups HY1 - HY6 - to credit rating grades of BB + to B-. For the period 2010-2018, bond issues were subdivided into three groups according to their credit risk level: investment grade level with minimal risk (groups IG1 - IG5), investment grade level with increased risk (groups IG6 - IG10), and speculative grade level (HY1 - HY6). Defaulted investment grade groups not included in the study.
downward trend in bond yields did not disappear, but do not reflect an increasing market uncertainty. Since 2016, the yield spread between the two classes of bonds has been steadily narrowing, never increasing beyond 2 percentage points, and sometimes it moved into negative zone.
4 500
4 000 3 500 3 000 2 500 2 000 1 500 1 000 500 0
□ Junk (HY1-HY6) QHigh risk investment grade (IG6-IG10) □Minimum-risk investment grade (IG1-IG5)
Fig. 37. The value of corporate bonds outstanding, by grade group, billions of rubles,
from 2010 through February 2020
Source: own calculations based on data released by Cbonds and Bloomberg.
30 25 20 15 10 5 0
r »
■Junk (HY1-HY6)
• Investment grade (IG1-IG10)
Fig. 38. The mean effective yield of junk bond and investment grade corporate bonds outstanding,1 %, from 2010 through February 2020
Source: own calculations based on data released by Cbonds and Bloomberg.
1 The yield is calculated as the arithmetic mean of all bond classes with equal weights, with no consideration for issue volumes or the relative share of each issuer in the total volume.
The very narrow yield spread of corporate bonds with very different risk levels observed over the period 2016-2019 in the domestic financial market closely resembled what was happening over the same period in the US debt market. This phenomenon in both countries was caused by approximately the same factors, namely the increasingly reckless attitude of investors to the credit risks associated with corporate bonds in their pursuit of higher returns in a situation of declining interest rates on bank deposits and the yields of government securities, as well as the somewhat biased estimates of spreads between junk and investment grade bonds, which were influenced by the multi-vectored duration trends in these debt classes.
As shown in Fig. 39, from H2 2016 onwards, the duration of investment grade corporate bonds in the domestic financial market was notably on the rise, while that of junk bonds remained at approximately the same level as in 2017, in spite of the increasingly volatile behavior of this particular market indicator in general. In 2018, the average duration of investment grade bonds increased to 2 years, while that of junk bonds - to 1.7 years. By the end of 2019, the duration index began to demonstrate a sharp decline, to 1.8 years for investment grade bonds and to 1.4 years for junk bonds, with a tendency for a further decline alongside an increasing duration spread in 2020. Because a higher duration of investment grade bond issues usually translates into their higher returns, this effect, in face of the unchanging average duration of junk bonds, also contributed to a narrowing average yield spread of the two classes of debt instruments.
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—O—Junk (HY1-HY6) -Investment grade (IG1-IG10)
Fig. 39. The average duration1 of junk and investment grade corporate bonds outstanding, %, from 2010 through February 2020
Source: own calculations based on data released by Cbonds and Bloomberg.
Duration is a measure of interest rate risks of debt financial instruments: bonds with longer terms to maturity are more sensitive than short-term bonds to the changing key rates in the financial market. All other things being equal, a reduced central bank key rate usually triggers a faster price growth, and consequently, a decline in the yield of long-term bonds relative to that of short-term bonds.2 If the majority of debt market participants display a surge of
1 If the corporate bond terms define that the bonds can be redeemed before the maturity date, their duration is calculated based on their redemption date, and not the maturity date.
2 In the USA, when centralized interest rates lose 1 percentage point, the price of 25-year government bonds gains 25 percentage points, and that of 6-year bonds gains 6 percentage points. Pellejero, S. (2020). Long-Duration Bond Funds Thrive Amid Market Carnage. The Wall Street Journal - online. March 16.
uncertainty as to the future economic growth prospects, then, even if the central bank begins to gradually reduce its centralized rates, the yield spreads between long-term and short-term bonds can narrow, and in the end the yields of the former may even exceed those of the latter. This means that the bond yield curve becomes inverted, when the yields of short-term bond issues of a certain issuer rise above those of bonds with longer terms.
A negative yield spread between long-term and short-term bonds is often considered to be a harbinger of recession. However, this is truer of government bonds rather than corporate bonds.1
In order to better understand the relevant changes in the average duration of junk and investment grade corporate bonds issued from 2017 onwards, we relied on an aggregate data analysis of bonds grouped depending on their duration. Duration in this case is understood to be modified duration, i.e., period to maturity or coupon period, as applicable. In most cases, it is significantly shorter than the period to maturity of the majority of coupon bonds. As shown in Fig. 40, in spite of the positive growth dynamics in the groups of bonds with longer duration (1 to 3 years and more than 3 years), the bond issues with relatively short duration maturing not later than 2018 made up the bulk of corporate bonds outstanding. In 2019, there was an increase in the relative share of bonds with duration of 1 to 3 years, to 52.6% at yearend 2019 vs 43.7% in 2018. The bonds with duration of less than 1 year accounted for 26.6% of the total value of bonds outstanding, and those with duration of more than 3 years - for 20.2%. Corporate bonds, being a relatively short-term debt instrument, cannot function as a fully fledged source of financing for companies that invest in their real capital, because this type of investment required a longer period to generate an adequate return.
5000
O^fNon^in^sDt^OO^O
ooooooooooo
<n<n<n<n<n<n<n<n<n<n<n
ooooooooooo 01 01 01 01 01 01 01 01 01 01 01
■ 0-1Y □ 1-3Y 0D3Y+
Fig. 40. The total volume of bonds (fixed at the time of offer), by grade group, billions of rubles, from 2010 through February 2020
Source: own calculations based on data released by Cbonds and Bloomberg.
1 For example, as one of the 'signals' built into the Financial Condition Index, NBER experts use the yield spread between 10-year US government bonds and the Federal Fund Rate. See Hatzius J., Hooper P., Mishkin F., Schoenholtz K., Watson M. (2010). Financial Condition Index: A Fresh Look after the Financial Crisis. NBER Working Paper Series No 16150. July. URL: http://www.nber.org/papers/w16150
For 2010 and early 2020, the calculated mean effective yields in the groups of corporate bonds with durations of 1 year or less, 1 to 3 years, and 3 to 5 years turned out to be rather unexpected (Fig. 41). Contrary to the classical notion that there exists a bond risk premium on bonds with longer duration, the average yield of bonds with duration of 1 year or less was found to be the highest over the entire period under review, and the bond issues with the longest duration of 3 years or more demonstrated the lowest effective yield. At the same time, the yield spreads of bonds with different duration narrowed almost to zero in 2019 and early 2020, which means that at that time, investors no longer made any distinction between bonds with different duration from the point of view of bond risk premium.
In our opinion, this can in part be explained by the data presented in Fig. 39, from which it follows that corporate bonds with a higher credit risk had a higher average duration. This also explains why the yield of bonds with longer duration turned out to be lower than that of bonds with lower duration and a high credit risk. However, this does not rule out the possibility that the persistently higher yields of short-term corporate bonds compared with long-term debt instruments, coupled with the limited number of bond issues with really long durations of 5 or more years,1 may be an indication of a certain lack of investor confidence in the long-term prospects of the Russian financial market and their desire to receive an additional compensation for sustaining the liquidity of Russian bonds.
Fig. 41. The mean effective yield of corporate bonds outstanding with different duration, %, from 2010 through February 2020
Source: own calculations based on data released by Cbonds and Bloomberg.
3.1.7. The corporate bond market organization
As of April 1, 2020, 360 corporate bond issues of 141 issuers were listed on the Moscow Exchange; a year earlier, there were 412 issues of 181 issuers. This means that over the year, the number of listed issues shrank by 12.6%, and that of issuers, by 22.1%.
As shown in Fig. 42 and Table 6, the primary corporate borrowing market, similarly to the domestic stock market, is highly concentrated, although in 2019 its concentration level markedly decreased. The market share of the top 10 corporate bond issuers shrank from 58.5%
1 According to our calculations, in 2019, bond issues with duration of more than 5 years accounted for only 3.6% of the total corporate bond issue volume.
in 2018 to 53.5%, and that of the top 20 issuers over the same period from 78.8 to 68.3%, respectively. The corporate bond market boom observed in 2019 created more opportunities for bond offer by various types of issuers.
20 10
0 -
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
—.—Top 10 ^^Top 20
Fig. 42. The relative market shares of the top 10 and top 20 issuers of ruble corporate bonds in 2000-2019, % Source: own calculations based on data released by Cbonds.
Table 6
The top ten corporate bond (CB) issuers and their share in the total value volume of CB issues
Bond issuers 2017 Bond issuers 2018 Bond issuers 2019
billions of rubles % billions of rubles % billions of rubles %
1 Rosneft PJSC 1,051 36.8 1 Sberbank PJSC 301 17.9 1 Sberbank PJSC 465 16.1
2 VEB.RF (State Development Corporation) 126 4.4 2 DOM.RF LLC 137 8.2 2 DOM.RF JSC 253 8.7
3 AKB Peresvet (JSC) 125 4.4 3 Russian Railways 85 5.1 3 VTB Bank (PJSC) 172 5.9
4 MBS Factory 109 3.8 4 Russian Agricultural Bank 78 4.7 4 VEB.RF (State Development Corporation) 170 5.9
5 Transneft PJSC 107 3.8 5 Residential urban settlement LLC 76 4.6 5 Russian Railways 106 3.7
6 O1 Group Finance LLC 88 3.1 6 Rosneft PJSC 70 4.2 6 Gazprombank (JSC) 95 3.3
7 Russian Railways 85 3.0 7 Gazprombank (JSC) 67 4.0 7 Rosneft PJSC 80 2.8
8 Gazprom Neft PJSC 70 2.5 8 VTB Bank (PJSC) 59 3.5 8 MTS 78 2.7
9 Gazprombank (JSC) 65 2.3 9 DOM.RF JSC 55 3.3 9 Avtodor State Company 69 2.4
10 Otkritie Holding JSC 65 2.3 10 Avtodor State Company 52 3.1 10 RUSAL Bratsk OJSC 60 2.1
Total corporate bond market cap 2,852 100 Total corporate bond market cap 1,674 100 Total corporate bond market cap 2,893 100
Market cap of top 10 corporate bond issuers 1,890 66.3 Market cap of top 10 corporate bond issuers 979 58.5 Market cap of top 10 corporate bond issuers 1,547 53.5
Source: own calculations based on data released by Cbonds.
Our calculations based on data for a large sample of corporate bonds provided by Cbonds show a steady increase in the share of state-owned companies in the total value of corporate bonds outstanding (Fig. 43). While in January 2003, during the early phase of the corporate bond market's development, SOEs accounted only for 22.2% of the total market cap, by December 2019 it had increased to 71.8%, which clearly points to the specific evolution of the domestic stock market into a mechanism for the support of primarily state-owned companies, ill-suited for performing one of its avowed primary functions - the provision of financing for accelerated development of private companies and the business community as a whole. Over the past year, the corporate bond market cap share of SOEs increased from 70.0% in 2018 to 71.8% in 2019.
A steady growth of the corporate bond market cap share of SOEs testifies to the fact that it is easier for state-owned companies to build trust in their relationships with investors, domestic banks and private pension funds, among which state-controlled entities prevail.
In 2019, Russian companies were not very actively involved in the eurobond market, and the total value of their borrowing there in the amount of USD 103 billion remained approximately at the same level as in 2018 (Fig. 44). Meanwhile, the domestic ruble corporate bond market, the effects of the ruble's plunge against the US dollar notwithstanding, demonstrated growth from USD 191 billion in 2018 to USD 210 billion in 2019, or by 9.9%. At present, the domestic ruble corporate borrowing market is about twice as big as the corporate eurobond market.
80 70 60 50 40 30 20 10
7 0,04 71,81
22,2
Fig. 43. The relative share of SOEs in the total value of ruble corporate
bonds outstanding, %
Source: own calculations based on data released by Cbonds.
In 2019, new instruments appeared on the corporate bond market, and private investors were aggressively encouraged to buy them.
For example, this was true of junk bonds, i.e. debt instruments that were rated below an investment grade level, but offered higher returns. The market placements of junk bonds were organized by relatively small investment companies like Ivolga Capital, Unicervice Capital LLC, and BCS Global Markets. Surprisingly, despite the high risks and the low transparency of issuers, 60-70% of these junk bonds were bought by individuals who did not always
0
understand the risks associated with such investments.1 The market promotion of junk bonds was facilitated by the support mechanisms launched by government agencies like the Russian Bank for Small and Medium Enterprises Support (SME Bank), which provided guarantees in the amount of up to RUB 500 million. Another mechanism was represented by subsidies of the RF Ministry of Economic Development earmarked for covering the coupon rate of the bonds with the support of the SME Corporation, as well as subsidies to cover the cost of listing preparation, which involved reimbursement of the bond issuers for up to 2% of the bond issue value, but in an amount not more than RUB 1.5 million.2 Strangely, these programs did not require that in order to qualify for government support, the bond issuers should have a rating grade and demonstrate the transparency of their financial statements, and that no reasonable restrictions were imposed on the offer of such instruments mostly to inexperienced private investors.
Fig. 44. The volume of Russian corporate bonds outstanding in 1998-2019, billions of US dollars
Source: own calculations based on data released by Cbonds and the Moscow Exchange.
From October 16, 2018, amendments to the Russian legislation on securities came into force, whereby companies were allowed to issue so-called structural bonds, the payments on which are tied to the events or conditions previously agreed upon at the time of their issue. The income on such bonds is usually tied to changes in the value of stocks, stock indexes, commodities and other investment assets. According to The Kommersant, in 2019, about 158 structural bond issues were placed to the total value of RUB 145.5 billion.3 The leaders in bond issuance were major banks like Sberbank of Russia, VTB, Alfa Bank, and Gazprombank. The main buyers of structural bonds were solvent private investors, who were accredited under financial regulation laws. The investment strategies realized through the placement of structural bonds are not transparent, which in itself is fraught with significant risks for investors. According to The Kommersant s data on the already redeemed bond issues of several major banks, their yields
1 Remizov, M. (2020). A desire to earn higher interest. The Expert, February 24 - March 1, No 9.
2 Ibid.
3 Smorodskaya, P. (2020) Risk is structural business. The Kommersant. February 7. No 22.
turned out to be at the same level as the yields on similar issues of classic bonds, and frequently even lower.1
3.1.8. The government bond market
In 2019, the RF Ministry of Finance raised net borrowing in the amount of RUB 1,394 billion in the OFZ market, which was a record high of several previous years. It turned out to be significantly above the net borrowing indicators for 2016, 2017, and 2018, which were RUB 547 billion, RUB 1,270 billion, and RUB 670 billion, respectively. Only as late as March 2020, the previously successful OFZ mechanism began to run out of steam: over January - February, net borrowing amounted to RUB 251 billion, but in March, the RF Ministry of Finance was no longer able to offer OFZs on the market on the same terms. On March 4, 2020, a few days before the massive downfall of stock prices, the RF Ministry of Finance had to cancel the auction for placement of OFZs, and one week before this event, the yields of OFZ issues jumped 0.5-0.7 percentage points.2
In 2019, the policy of reducing the Bank of Russia discount rate contributed to growth in the domestic government securities market; the ruble strengthening, which stimulated an inflow of foreign portfolio investment; and a decline in government bond yields, which forced the RF Ministry of Finance to resort to record-high borrowing. As shown in Fig. 45, the total volume of federal loan bonds in Q1 2020 reached the level of RUB 9.2 trillion, which represents an increase of 22.7% relative to RUB 7.5 trillion in 2018.
The structure of OFZ issues on this time horizon, in many of its aspects, reflected the group composition of the key investors in this financial market segment during each phase of its development.3 Federal loan bonds with debt amortization (OFZ-AD), which accounted for 3.4% of the total OFZ value in 2019, are a convenient tool for investing pension savings in a volatile market, but they create difficulties for the RF Ministry of Finance in its public debt management. Over the period 2002-2014, NPFs acted as the growth driver in this segment of the government bond market, primarily due to investment of pension savings. However, from 2014 onwards, their popularity began to wane after the 'pension saving freeze'. Besides, in 2016, the RF Ministry of Finance exchanged OFZ-AD with face value of RUB 63.7 billion, on favorable terms, for OFZ-PD with face value of RUB 56.4 billion.
The largest segment of the OFZ market is taken up by OFZ-PDs with constant coupon income, which in 2019 accounted for 72.4% of the total OFZ market value; meanwhile, over the period from 2014 through March 2020, this segment was steadily on the rise. The coupon payments of these bonds are fixed in advance for the entire period until their maturity date, and so they are convenient and predictable instruments for different categories of investors. From 2009 to mid-2011, by way of financing the budget deficit, the RF Ministry of Finance placed OFZ-PD issues with the banks with excess liquidity, offering an additional premium above the market rate in the amount of 5-10 basis points.4 From early 2012 onwards, non-residents became the main source of liquidity in the OFZ market, and they found OFZ-PDs to be a more
1 Smorodskaya, P. (2020) Risk is structural business. The Kommersant. February 7. No 22.
2 Tretyak, A., Mikheeva, A. (2020). Government debt on a sick leave. Vedomosti. March 4.
3 For an analysis of the OFZ market's evolution, see Lu Y., Yakovlev D. Exploring the Role of Foreign Investors in Russia's Local Currency Government Bond (OFZ) Market. IMF Working Paper, No WP/17/28, February 2017.
4 Lu Y., Yakovlev D. Exploring the Role of Foreign Investors in Russia's Local Currency Government Bond (OFZ) Market. IMF Working Paper, No WP/17/28, February 2017, p.10.
convenient instrument.1 In later years, changes in the market share of these OFZ issues were mainly brought about by the activity of non-resident investors.
10 000 9 000 8 000 7 000 6 000 5 000 4 000 3 000 2 000 1 000 0
□ GKO OBQFZ □ OFZ-PK HOFZ-PD H OFZ-PK □ OFZ-AD IDlOFZ-IN
OFZ-N
Note. Hereinafter, the following abbreviations are used: BOFZ - zero-coupon federal loan bonds; GKO - short-term zero-coupon government bonds; OFZ - federal loan bonds; OFZ-AD - debt amortization federal loan bonds; OFZ-IN - federal loan bonds with a face value tied to the Russian Federation's official inflation rate; OFZ-PD -constant coupon income federal loan bonds; OFZ-PK - federal loan bonds with a floating coupon tied to the RUONIA rate; OFZ-N - federal loan bonds for retail investors ('people's bonds').
Fig. 45. The value volume of GKO-OFZ offering over the period from 1993 through
March 2020, billions of rubles.
Source: own calculations based on data released by the RF Ministry of Finance and Cbonds.
In 2019, OFZ-PKs with a variable coupon accounted for 19.1% of the total OFZ market value, and their market share, which stood at 30.9% in 2016, was on the decline. The coupon rate of these bonds is tied to RUONIA (interbank benchmark), which is largely determined by the Bank of Russia's key rate. Since 2015, OFZ-PKs have been popular with non-residents due to the situation of general financial instability and the rising key rate. However, as the key rate was reduced from 11% in 2016 to its current level of 6% and the inflation rate declined, OFZ-PKs have been losing their popularity, because their coupon yield basically depends on the key rate level.
A promising segment of the government securities market is that of OFZ-INs due to the indexation of their face value depending on the level of inflation, as measured by the consumer price index (CPI). In 2019, they accounted for 4.1% of the total OFZ market value. Their market share increased from 2.8% in 20152 to 4.5% in Q1 2020. Due to their protection against inflation, OFZ-INs are in demand among domestic institutional and individual investors.
In 2019, the smallest OFZ market share of 0.7% was taken up by OFZ-N, often referred to as 'people's bonds' because they target individuals and are promoted by the RF Ministry of Finance mostly as an over-the-counter instrument designed to improve the financial literacy of the general population.3 On September 2, 2019, investors were offered a new issue of OFZ-N
1 Lu Y., Yakovlev D. Exploring the Role of Foreign Investors in Russia's Local Currency Government Bond (OFZ) Market. IMF Working Paper, No WP/17/28, February 2017,
2 The first OFZ-IN issue appeared in 2015 during a period of high ruble volatility.
3 Butrin, D., Kassin, P. (2019). To buy an experience: the RF Ministry of Finance has made OFZ-N part of the family financial planning system. Kommersant Money. September 25, No 39.
to the total value of RUB 15.0 billion, which should be placed within 6 months. The distinctive features of this issue, in which it differed from the previous ones, were the absence of a commission charged by the agent banks, their lower minimum purchase amount set at RUB 10,000, and the active advertising campaign. In addition to Sberbank and VTB, the new bonds were made available for purchase through Promsvyazbank and Post Bank.1 However, because of the fierce competition with bank bonds, the placement OFZ-N was proceeding at a fairly moderate pace: according to media reports, as of the end of February 2020, out of the total issue value of RUB 15.0 billion, only bonds to the value of RUB 8.8 billion,2 or 58.7%, had been sold. Meanwhile, that according to the Bank of Russia, the value volume of bank bonds issued in 2019 was RUB 0.6 trillion.3
In 2019, one of the main growth factors in the OFZ market were the declining yields of government bonds against the backdrop of a stable macroeconomic situation in this country (Fig. 46). The yield to maturity of government bonds (OFZ Cbonds-GBI portfolio index) dropped from 8.53% per annum in December 2018 to 6.21% per annum in December 2019, and to 6.09% per annum in January 2020, thus hitting its record low on the time horizon under consideration (since January 2010). However, from February 2020, the OFZ yield began to rise significantly, to 6.38% in February and to 6.71% in March, which is why the RF Ministry of Finance was forced to cancel its OFZ auctions to be held in March 2020.
From 2016 through February 2020, with some rare exceptions, the OFZ yields were staying above the inflation rate (CPI), thus increasing the attractiveness of government securities in the eyes of domestic investors.
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Inflation, % per annum — — — • Yield to maturity of OFZ Cbonds-GBI portfolio - right-hand side axis
Fig. 46. Inflation (CPI) and yield to maturity of OFZ Cbonds-GBI portfolio over the period from January 11, 2010 through February 28, 2020, % per annum4
Source: own calculations based on data released by Rosstat and CBonds.
1 Gaidaev, V. (2019). People's OFZ for wealthy clients. The Kommersant. December 17.
2 Smorodskaya, P., Ladygin, D. (2020). Government bonds will be turned towards the people by the marketplace. It is suggested that OFZ-N should be placed through the Central Bank platform. The Kommersant. February 20.
3Bank of Russia. (2020). Review of Key Indicators of Professional Securities Market Participants. 2019. No 4. Moscow. P.8.
4 The high inflation rate in January 2015, which stood at 58.3% per annum, can be explained by the specificity of the chain method of calculating the CPI, based on the month-to-month price growth in a current year. In January 2015, in response to the forex market shock, price growth jumped to 103.9% of its level in December 2014, which amounts to 58.3% when recalculated in per annum terms.
The opening, by Russia's central depository in February 2013, of nominal holder accounts for foreign clearing and settlement systems triggered an inflow of foreign investment into the domestic government debt market. The relative share of non-residents in the secondary market for OFZ increased from 6.5 percent in July 2012 to 28.1 percent in May 2013 (Fig. 47). 1 Later on, about a quarter of OFZs on average was held by non-residents; however, this indicator was changing significantly in response to the cash flows of non-residents, with due regard for the financial and geopolitical risks. Thus, for example, on the back of fears of possible sanctions to be imposed in April 2018 on those global investors who purchased Russian government bonds, the OFZ market share of non-residents shrank from 33.1% in 2017 to 24.4% in 2018. However, in absence of any sanctions against OFZ buyers and in view of the favorable market conditions in 2019, foreign investors returned into this market segment, and their relative share in the structure of OFZ holders in February 2020 rose to its historic peak of 34, 9%.
40 -,
35 -
30
25
20 -
15 -
10
5
Liberalization of OFZ market
"Taper Tantrum"
Sectoral
I
sanctions I
Oil price plunge
Expectations of sanctions against Russia's sovereign debt
RF rating downgraded by S&R and Moody's
10000 9000 8000 7000 6000 5000 4000 3000 2000 1000
0
2020
2012 2013 2014 2015 2016 2017 | 2018
□ OFZ market volume (outstanding value), billions of rubles (right-hand side axis)
□ Relative share of non-residents in ОFZ market, % (left-hand side axis)
Fig. 47. The ОFZ market share of non-residents from February 2012 through February 2020 Source: own calculations based on data released by the Bank of Russia and Cbonds.
0
1 Based on expert estimates, one cannot rule out the fact that prior to the liberalization of the OFZ market in February 2013, the real OFZs market share of non-residents was higher than the official figure of 6.5%. The problem is that before correspondent deposit accounts of Clearstream and Euroclir were opened with the National Settlement Depository (NSD), the depository accounting system existing at that time did not allow the disclosure of information on the non-resident investments in OFZs carried out via depository banks servicing foreign investors.
Thus, so far the OFZ market has been one of the most dynamically growing segments of the domestic financial market, through which the RF Ministry of Finance has been successfully attracting a significant amount of net financing needed to replenish the budget. The existence of diverse OFZ issues coupled with financial stability made government bonds attractive for a wide range of domestic and foreign investors. As before, there were some problems with the investor base, which had to do with the freeze on pension savings, the inadequately developed collective investment schemes targeting government bonds, and the low share of individual investors willing to buy them. In the context of the 2020 crisis, the RF Ministry of Finance may be faced with a surge in interest rates for government securities.
3.1.9. The derivatives market
The economic role of the derivatives market is to increase the transparency of forecasts and investment asset pricing, as well as to provide market participants with opportunities of hedging against sharp fluctuations in asset prices in the future. A surge in derivatives market liquidity is often observed during the periods of increased volatility of investment asset prices. As shown in Fig. 48, the monthly volumes of futures transactions in 2017, 2018, and 2019 were displaying a volatile pattern; however, the average volumes of transactions closed over one month remained almost stable, amounting to RUB 6.5 trillion, RUB 6.9 trillion, and RUB 6.4 trillion, respectively. However, in March 2020, in response to signs of an impending financial crisis, the volume of futures transactions increased to RUB 15.2 trillion, which is 2.4 times higher than the average monthly index for 2019. Most of this growth was accounted for by forex and stock index futures.
The options market in 2017-2020 was demonstrating a slow decline, as the average monthly transaction volume in 2017 amounted to RUB 573 billion, in 2018 to RUB 572 billion, and in 2019 to only RUB 416 billion. In March 2020, the value volume of options on the exchange rose to USD 479 billion, which is 15.1% above its average level in 2019, but is still incomparable with the growth rate of futures transactions.
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
■ Options □ Futures
Fig. 48. The value volume of futures and options transactions on the Moscow Exchange from January 2009 through March 2020, billions of rubles
Source: own calculations based on data released by the Moscow Exchange.
In 2019, no major breakthroughs were observed in the futures exchange. As before, the major role in this segment of the derivatives market was played by forex futures; the financial situation in 2019 was relatively stable, and so the share of forex futures in the total value volume of exchange transactions shrank from 42.6% in December 2018 to 40.1% at year-end 2019, and then jumped to 49.5% in March 2020 (Fig. 49). The market share of stock index futures increased from 21.9% in 2018 to 24.2% in 2019, and to 24.3% in March 2020. The market share of transactions in stock market instruments over the same period increased from 4.2% to 5.8%, and then in March 2020 it plunged to 3.7%. In 2019, the growth of commodity-based futures (secured by assets like oil, gold, etc.) slowed down; their share in the overall structure of transactions shrank from 31.3% in 2018 to 29.9% in 2019, and to 22.6% in March 2020.
In 2019, similarly to the situation in the previous years, in spite of the increasingly significant interest-rate risks in the financial markets, no progress could be achieved in the sector of interest rate futures and options. The main obstacles to their development had to do with the absence of reliable indicators of the movement of interest rates in the interbank market, as well as of large investors who would be ready to accept the risks associated with changing interest rates. Although many financial and non-financial organizations strongly need to hedge their contracts against the rising interest rates, there are practically no market participants willing to buy these risks.
□ Index instruments □ Commodity instruments
Fig. 49. The futures market structure on the Moscow Exchange over the period from January 2009 through March 2020, % of value volume
Source: own calculations based on data released by the Moscow Exchange.
The options market was probably used to a lesser degree for hedging against investment risks, which was the reason for its relatively moderate liquidity on the stock exchange. The
structure of the Moscow Exchange options market in 2019 demonstrated an increase in the relative share of stock index options: from 53.0% in 2018 to 57.2% in 2019, and then to 58.7% in March 2020 (Fig. 50). The relative share of commodity transactions shrank from 7.2% in 2018 to 6.9% in 2019, and then in March 2020 it increased to 10.3%. The share of forex transactions shrank from 39.4% in 2018 to 34.7% in 2019, and to 30.7% in March 2020.
100,0 90,0 80,0 70,0 60,0 50,0 40,0 30,0 20,0 10,0 0,0
202
ID Forex instruments □ Equity instruments B Index instruments □ Commodity instruments
Fig. 50. The options market structure on the Moscow Exchange over the period from January 2009 through March 2020, % of value volume
Source: own calculations based on data released by the Moscow Exchange.
3.1.10. Financial intermediaries and exchange infrastructure
In 2019 and early 2020, the number of professional securities market participants and that of licenses for various types of professional activities continued their decline (Fig. 51). The number of brokerage license holders shrank by 12.4% - from 331 in 2018 to 290 in 2019, and then to 284 in Q1 2020. The number of dealer licenses in 2019 decreased by 12.8% - from 366 to 319, and then to 312; that of equity trust management licenses - by 12.6%, from 230 to 201, and then to 200.
A long-term downward trend in the number of licenses of professional securities market participants has been observed since the 2008 crisis, reflecting the general slowdown in the Russian economy and the shrinking role of the stock market. The creation of a financial megaregulator in September 2013 slightly sped up this natural process by increasing the administrative costs incurred by market participants. As before, the main reason for the revocation or annulment of professional licenses has remained the licensee's application with
a statement of their desire to discontinue their business activity, and not the prudential measures enforced by the regulator.
A more serious problem has to do not with the revocation of expired licenses of professional securities market (PSM) participants, but a sharp reduction in the number of new PSM participants entering the market, because they exert a positive competitive pressure on the financial services market and its performance level. As shown in Fig. 51, since 2012 there has been a significant slowdown in the entry of new players onto the market, the reason being the creation and operation of the mega-regulator. The number of newly issued licenses to PSM participants in 2017, 2018 and 2019 was 33, 22 and 12, respectively; in other words, in 2018, it decreased by a third, and in 2019 - by another 45.4%. The existence of such statistics may point to barriers imposed on the fintech sector, where new technologies and business models are being developed.
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Feb
2020
■ ■ Brokerage activity
■ 1 Equity trust management
Dealer activities
^ New licenses issued to PSM participants (right-hand side axis)
Fig. 51. The number of brokerage, dealer, equity trust management, and professional securities market participant licenses over the period from 2007 through February 2020
Source: own calculations based on data released by NAUFOR and the Bank of Russia.
Alongside the meagre inflow of new market players, there was a noticeably higher concentration of brokerage and equity trust management activities in the major banks and nonbank financial institutions. The relative share of the top 5 brokers in the total number of individual clients increased from 57.2% in 2018 to 60.8% in Q1 2020, while for the top 10 brokers this index slightly declined from 70.5 to 68.1% (Table 7).
In the total number of active clients of brokers, i.e. individuals who effect at least one transaction per month on the exchange, the relative share of top 5 brokers over the same period increased from 70.5% to 83.6%, and that of the top 10, from 93.3 to 96,5%. The relative share of brokerage accounts in the total number individual investment accounts (IIAs) also increased sharply from 84.6% in 2018 to 88.8% for the top 5 brokers, and from 94.4% to 96.3% for the top 10 brokers.
Table 7
The relative shares of top 5 and top 10 brokers in the total number
of client accounts, %
2007 2012 2013 2014 2015 2016 2017 2018 2019 Q1 2020
1. Share in the total number of brokers' clients, %
Top 5 brokers 41.6 62.2 62.3 61.0 58.8 59.1 58.3 57.2 60.2 60.8
Top 10 brokers 51.0 78.5 78.2 76.3 72.3 71.4 68.6 70.5 68.3 68.1
2. Share in the number of active clients, %
Top 5 brokers 41.9 66.8 69.1 66.0 67.6 65.9 76.7 70.5 80.1 83.6
Top 10 brokers 57.9 84.1 85.8 80.0 79.9 76.5 88.5 93.3 95.8 96.5
3. Share in the total number of individual investment accounts (IIAs), %
Top 5 brokers 84.2 82.3 84.0 84.6 87.5 88.8
Top 10 brokers 91.2 92.2 95.9 94.4 96.0 96.3
Source: own calculations based on data released by the Moscow Exchange.
In 2019, the Bank of Russia published a draft framework for public consultations titled 'The Bank of Russia Approaches to the Development of Competition in the Financial Market"1, which included a set of measures designed to promote competition in the financial market. In our opinion, this document does not provide a comprehensive solution to the competition issue. The main problem with the measures proposed by the Bank of Russia was that they were not oriented to maintaining a competitive environment that could move ahead of the development of fintech and the modern methods of selling financial products by intermediaries based on competing investment platforms with an open architecture of sales.2 Instead, the proposed measures had more to do with the implementation, by the Bank of Russia, of its own commercial infrastructure projects in the form of online marketplace, digital citizen profile, and quick payment system.3
Competition in the financial market could be boosted by legislative measures aimed at promoting competition between investment platforms; by creating favorable conditions for the implementation of private fintech projects; by reducing the administrative barriers that make it more difficult for new companies to enter the market; by introducing fiduciary standards for the sale of investment financial products;4 and by a more distinct orientation of significant infrastructure development projects to the needs of financial intermediaries and their clients.5
In early 2020, the Audit Chamber of the Russian Federation published a report on the results of its expert-analytical study 'Analysis of the implementation of the Guidelines for the development of the Russian financial market in 2016-2018 and assessment of the Guidelines
1 Bank of Russia. (2019). Approaches of the Bank of Russia to the development of competition in the financial market. Report for public consultations. November. Moscow. URL: https://www.cbr.ru/Content/Document/ File/90556/Consultation_
Paper_191125.pdf
2 An open architecture for sales of financial products means that financial products of various manufacturers are sold through a financial intermediary and its information platform, with due regard for the needs of each consumer of financial services.
3 For more detailed comments on the Bank of Russia Report (2019) prepared by the Center for Institutions Analysis and Financial Markets (IAES RANEPA), see URL: https://ipei.ranepa. ru/images/2019/FR/komentarii-_ k_CBR_o_konk.pdf.
4 These standards imply imposing restrictions on the conflicts of interest that arise between financial intermediaries when they sell financial products to their clients.
5 For further details concerning the development of investment platforms and fintech, see Abramov, A. (2019). To stake out the platform. The Expert, No 44, October 28 - November 3, pp. 64-68.
for the development of the Russian financial market in 2019-2021'.1 The main problems of the domestic market and its regulation outlined in the report were as follows: inadequate level of cooperation between the RF Government and the Bank of Russia in elaborating and implementing the policy for developing and ensuring the stability of the performance of financial markets; a significant decrease in the level of competition in the financial market, in combination with a 1.5-2 times shrinkage of financial market institutions in certain sectors; the low growth rate in the banking sector; an accelerated growth of capitalization due to the secondary market growth, and not that of public offers of new stocks; the level of insurance sector development that was inadequate to the needs of the economy. The provision of proper solutions to these problems could greatly contribute to the development of the domestic financial market and boost competition between its participants.
In 2011, the two largest Moscow-based exchanges - MICEX and RTS - were merged, and this had some important positive consequences for the development of Russia's stock market. After the merger, the transactions on the stock and futures markets became easier, and all the liquidity necessary for carrying on exchange trade could now be concentrated in the accounts of participants in trading in the exchange's single clearing and settlement system. The diversification of the new Moscow Exchange in servicing transactions in different types of monetary and investment assets improved its financial sustainability. Alongside these positive changes, the merger of MICEX and RTS also has some controversial consequences. First of all, now there was no competition between the two exchanges, whilst previously this competition had been a powerful incentive for developing exchange activities in the interests of domestic investors and financial intermediaries.
In 2019, the downward trend in the total volume of trading in various financial instruments (securities, forex and money market instruments, derivatives, commodity instruments) that had first emerged on the Moscow Exchange in 2018, became even more obvious. The total exchange trading volume in 2017, 2018 and 2019 amounted to RUB 888 trillion, RUB 861 trillion, and RUB 798 trillion, respectively; its shrinkage in 2018 amounted to 3.0, and in 2019, to 7.3% (Fig. 52).
1 000 800 600 400 200 0
850
888
861
798
a
a
a
Fig. 52. The volume of trading in all instruments on the Moscow Exchange from 2009 through March 2020, trillions of rubles
Source: own calculations based on data released by the Moscow Exchange.
1 The Audit Chamber of the Russian Federation (2020). 'Analysis of the implementation of the Guidelines for the development of the Russian financial market in 2016-2018 and assessment of the Guidelines for the development of the Russian financial market in 2019-2021'. Approved by the Collegium of the RF Audit Chamber on December 10, 2019. URL: http://audit.gov.ru/checks/9603
One of the advantages of the Moscow Exchange over its global competitors is the diversification of its market segments. However, this business model also gives rise to additional risks, namely lower market incentives for the development of less marginal trading segments. At present, this is manifest in the decreasing importance of the stock and derivatives market in the total volume of exchange turnover. As shown in Table 8, starting from 2012, when the combined exchange was launched, the stock market share in the overall structure of exchange transactions shrank from 6.5% to 5.1% in 2019, including that of transactions in shares from 3.1% to 1.6%; over that period, the derivatives market share also shrank, from 13.5% to 10.3% in 2019.
The share of the forex market, on the contrary, increased from 31.6% in 2012 to 38.6% in 2019; that of lending market - from 2.5 to 6.7%. The growth of the foreign exchange segment was facilitated by the instability of the ruble exchange rate and the access to operations on the forex market granted to individual clients of brokers and banks. The money market share over the period under consideration shrank from 48.3% to 45.9%, which was probably due to some reduction in the scale of refinancing of the banking system by the monetary authorities.
With the growing volatility in the domestic financial market in March 2020, the share of transactions in stocks and derivatives (mainly currency and stock index futures) in the overall structure of transactions on the Moscow Exchange also increased.
Table 8
The market structure on the Moscow Exchange from 2010 through March 2020, %
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Q1 2020
Stock market, 13.2 10.3 6.5 5.2 3.6 3.0 2.8 4.0 4.7 5.1 6.1
including:
Shares, Russian depository receipts (RDR), investment fund units 8.0 6.6 3.1 1.9 1.8 1.4 1.1 1.0 1.3 1.6 2.8
Bonds 5.2 3.7 3.4 3.3 1.9 1.6 1.7 3.0 3.5 3.5 3.4
Secondary turnover 3.4 2.9 2.8 2.7 1.5 1.2 1.1 1.2 1.2 1.3 1.5
New offering 1.8 0.8 0.6 0.6 0.3 0.4 0.6 1.7 2.3 2.2 1.9
Forex market, 72.0 70.6 80.0 84.3 85.6 83.3 83.6 86.5 84.8 84.5 79.0
including:
Money market 33.9 41.3 48.3 50.7 45.7 38.0 44.8 47.3 44.3 45.9 43.2
REPO operations 31.5 38.3 45.8 44.8 32.0 26.4 34.8 38.3 36.0 36.7 35.7
Lending market 2.4 3.1 2.5 2.8 3.7 4.8 4.4 4.2 6.3 6.7 6.4
Forex market 38.1 29.3 31.6 33.7 39.9 45.4 38.8 39.2 40.5 38.6 35.8
Spot trades 18.0 15.8 16.6 12.4 13.6 15.1 12.6 8.8 10.1 8.4 10.8
Swap trades 20.1 13.4 15.0 21.3 26.3 30.3 26.2 30.3 30.4 30.2 25.0
Derivatives market 14.8 19.1 13.5 10.5 10.7 13.7 13.6 9.5 10.4 10.3 14.8
OTC 0.0 0.0 0.0 0.0003 0.0002 0.001 0.002 0.01 0.1 0.1 0.0
Commodity market 0.001 0.003 0.006 0.005 0.003 0.02 0.02 0.01 0.02 0.01 0.00
TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Source: own calculations based on data released by the Moscow Exchange.
Thus, in 2019 and early 2020, the financial market continued to display a trend towards a reduction in the number of intermediaries and a higher concentration of brokerage services. The ongoing discussions of possible approaches to regulating competition in the financial markets have not yet produced any valid results. With the exception of some short-term upsurges in Q1 2020, the stock and derivatives markets continued to play a secondary role in the structure of exchange transactions, while their share in the structure of exchange transactions was on the decline. There was also an adverse downward trend in the total volume of trading on the Moscow Exchange.
3.1.11. Investors Private investors
The main event of the financial market in 2019 and early 2020 was a massive inflow of individual investors. As shown in Fig. 53, the total number of brokerage accounts of registered investors on the Moscow Exchange increased from 2.0 million in 2018 to 3.9 million in 2019, or 95.0%, and to 4.6 million in March 2020, which represents an increase of 18.0% on December 2019. The number of active individual investment accounts, where the clients effected at least one transaction per month, over the same periods increased from 190,000 to 392,000, or 2.2 times, and then to 607,000, jumping 1.5 times over the course of just one quarter. In Q1 2020, the inflow of new clients into the market accelerated in spite of the falling stock and oil prices, a weakening ruble, and other risks.
The growth in the number of unit holders in open-end mutual funds was more moderate: from 467,000 in 2018 to 493,000 in 2019, or by only 5.6%.
As shown in Fig. 54, the competition in the brokerage services market between biggest retail banks for attracting individual clients on a massive scale began to surge in May 2018, when Tinkoff Bank entered this market segment as an independent player. The aggressive marketing methods of the new broker, in combination with the latest click-through technologies for dealing in securities by simply pushing a button on a smartphone, which provide any client with opportunities of buying small blocks of shares in foreign companies, triggered an explosive growth in its client base. The other competing banks (Sberbank, VTB, Otkritie) quickly adopted the new technologies to attract their clients into the stock market, thus further spurring the growth of their respective active client base.
5 000,0 -| 4 500,0 -
4 0
3 (
,0
,0
■Unit holders in UIFs* □Brokers' clients □Active brokers' clients
2 500,0 2 000,0 1 500,0 1 000,0 500,0 0,0
* No data on the number of retail unit holders in UIFs are available for Q1 2020.
Fig. 53. The number of retail clients of trust managers and brokers
a
Source: own calculations based on data released by the Moscow Exchange and Expert RA.
3
0
1 600
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
----VTB Sberbank of Russia---BCS -Finam — — «Tinkoff
Fig. 54. The number of registered brokerage accounts of the top 5 brokers on the Moscow Exchange, thousands
Source: own calculations based on data released by the Moscow Exchange.
The economic factor behind this phenomenon was the desire of banks, in the situation of a reduced key rate, to offset their lost income generated by deposits by selling to their traditional customers some products with a good profit margin, such as classic bank bonds, structural and insurance products, unit investment funds, and other financial instruments and services.
The number of registered brokerage accounts with Sberbank increased from 544,000 in 2018 to 1,262,000 in 2019, and 1,559,000 in March 2020, with a 2.9-times increase over the period from December 2018 through March 2020. The corresponding indicators for Tinkoff Bank amounted to 286,000, 1,120,000, and 1,435,000, respectively, which represents an increase of 5.0 times over the same period. The third top bank, VTB, had 319,000, 650,000, and 778,000 accounts, respectively, and a 2.4-times increase.
For big non-bank brokerage companies, the movement pattern of brokerage accounts was different. The total number of accounts with BCS was 330,000 in 2018, 420,000 in 2019, and 459,000 in March 2020; thus, over 15 months, their number jumped 39.0%. The corresponding Fig.s for Finam Investment Company were 208,000, 234,000, and 245,000, respectively, with an increase of only 4.7%.
A roughly similar picture was observed with regard to the accounts of active investors, the only difference being that in this segment, it was Tinkoff Bank that held the uppermost position (Fig. 55). The number of accounts of active investors with Sberbank rose from 38,000 in 2018 to 97,000 in 2019, and 171,000 in March 2020, thus increasing 4.5 times over the period from December 2018 through March 2020. The corresponding indicators for Tinkoff Bank were
33,000, 118,000, and 196,000, respectively, with overall growth by 5.9 times. VTB has 21,000, 58,000, and 109,000 accounts, and a total increase by 5.2 times.
The number of accounts of active investors with BCS was 23,000 in 2018, 32,000 in 2019, and 45,000 in March 2020, with an increase of 96.0% over the course of 15 months. The corresponding indicators for Finam Investment Company were 22,000, 29,000, and 38,000, with a total increase of 73.0%.
200 ---------------------------------------------------------------------------
180 1
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
----VTB Sberbank of Russia---BCS -Finam ......Tinkoff
Fig. 55. The number of the registered brokerage accounts of active clients of the top 5 brokers on the Moscow Exchange, thousands
Source: own calculations based on data released by the Moscow Exchange.
The most remarkable event in the segment of private savings over the past 5 years was the introduction of individual investment accounts (IIAs), with some personal income tax exemptions and no serious restrictions on investing the monies kept in these accounts. According to data released by the Moscow Exchange, the number of IIAs in 2018 was 598,000, in 2019, 1,650,000, and in March 2020, 2,060,000, thus increasing 3.4 times over the period from December 2018 through March 2020. Over the same period, the number of IIAs opened in the form of individual trust accounts totaled 84,000 (as of January 2018), 222,000, and 269,000, respectively, with an increase of 3.2 times over the period from January 2018 through March 2020 (Fig. 56).
The principal factor pushing up the number of IIAs was the activity of banks engaged in brokerage activities. Over the said 15-month period alone, from December 2018 through March 2020, their relative share in the total number of these IIAs increased from 73.9% to 86.7%, while that of non-bank financial institutions providing brokerage services plunged from 24.8% to 12.9%.
100,0 90,0 80,0 70,0 60,0 |-50,0 40,0 30,0 20,0 10,0 0,0
"3
2015 □ Banks C
"3
2016
h -
"3
2017
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: -
H
598
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82,9
2 060
2500
2000
1500
1000
500
Js S
"3
JS S
"3
2018
2019
2020
□ Non-bank financial institutions
I Unknown
»Number of IIAs - total (right-hand side axis)
Fig. 56. The movement of the number of individual investment accounts (IIAs) over the period from May 2015 through January 2019, thousands
Source: own calculations based on data released by the Moscow Exchange.
The indisputable leader in competition in the IIA market segment has been Sberbank (Fig. 57). The number of IIAs opened with Sberbank soared from 291,000 in 2018 to 827,000 in 2019, and 1,034,000 in March 2020, with a 3.5-fold increase over the period from December 2018 through March 2020.
1 000
1 034
800
600
400
200
337 257
91
67
rt O V rt rj o HHCS 3 ^Ví O V rt rj o HHCS 3 ^Ví O V rt rj o HHCS O V rt rj o HHCS 3 ^Ví O V rt rj c
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2015
•VTB
2016 2017
Sberbank of Russia • — BCS
2018 ■ Finam
2019
2020
• Tinkoff
> Otrkitie
Fig. 57. The number of IIAs with the top 6 brockers, thousands Source: own calculations based on data released by the Moscow Exchange.
0
0
The corresponding indicators for VTB were 38,000, 263,000, and 337,000, respectively, with a 8.9-times rise. The number of IIAs with Tinkoff Bank was 19,000, 172,000, and 257,000, increasing by 13.5 times due to the low starting base; for Otkritie Bank, the corresponding Fig.s were 59,000, 84,000, and 91,000, which represents a 1.5 times increase.
The number of IIAs with BCS was 63,000 in 2018, 98,000 in 2019, and 111,000 in March 2020, with growth by 1.8 times over 15 months. For Finam Investment Company, the corresponding indicators were 56,000, 66,000, and 67,000, with an increase of 19.6%.
The experience of involving individuals in trading on the stock exchange and the movement of IIAs point to the willingness of individual investors to more actively enter the stock market. According to the Bank of Russia, in 2019 the volume of assets kept in IIAs doubled to RUB 197.3 billion, of which RUB 131.1 billion was held in IIAs, and RUB 66.2 billion in individual trust accounts. The average volume of assets held in an IIA shrank from RUB 127,000 in 2018 to RUB 92,000 in 2019, and that held in an individual trust account, from RUB 409,000 to RUB 301,000.1 This means that against the backdrop of a rapid rise in the number of IIAs, these accounts are being opened to an increasingly small investor category.
According to the same data source of data provided by the Bank of Russia, the structure of IIAs (of both types) in 2019 was demonstrating a shift from government bonds towards corporate bonds, and particularly bank bonds. The relative share of government securities in the structure of assets held in IIAs shrank from 21% in 2018 to 15% in 2019; that of investments in corporate bonds, on the contrary, increased from 13% to 21%, respectively. The relative share of stocks in the structure of assets kept by clients in their IIAs remained stable, at about 23% both in 2018 and 2019. The biggest category of investments kept in IIAs was represented by units in UIFs; however, their share slightly decreased from 27% in 2018 to 25% in 2019. The asset structure in IIAs demonstrated a more noticeable shift towards stocks by comparison with individual trust accounts, where the shift was in favor of bonds.
A new trend that emerged in the domestic stock market in 2018-2019 was the rapid increase in the number of investors who traded on the St. Petersburg Exchange (SPB Exchange), specializing in listed securities of reliable foreign issuers. By purchasing, on the SPB Exchange, the stocks issued by major US and European companies, individuals can improve the diversification of their portfolios at moderate transaction costs. The number of active clients of brokers on the SPB Exchange increased from 3,000 in 2017 to 26,000 in 2018, or 8.7 times; in 2019, it reached the level of 72.500, which represents an increase of 2.8 times over the past year (Fig. 58).
In early 2020, the Center for Institutions Analysis and Financial Markets (RANEPA IAES) examined2 the economic and financial factors influencing the movement patterns of the numbers of individual investors trading on Russian exchanges. There were 4 categories of individual investors: passive investors on the Moscow Exchange, determined on the basis of the total number of client accounts opened by individuals with brokers over the period from December 2006 through December 2019; active investors on the Moscow Exchange, determined on the basis of the total number of individual accounts of active clients of brokers opened over the period from May 2007 through December 2019; the owners of IIAs with the Moscow Exchange in the category of passive investors with a longer horizon for making their investment decisions thanks to their individual income tax exemptions,
1 Bank of Russia (2020). Review of Key Indicators of Professional Securities Market Participants. 2019. No 4. Moscow.
2 The results of the research are scheduled to be published.
determined for the period from May 2015 through December 2019; and the active individual investors on the St. Petersburg Exchange (SPB Exchange) targeting the securities of foreign issuers, determined for the period from November 2014 through December 2019.
Note. The corporate bond yield is the effective yield of the IFX Cbonds index; the government bond yield is the effective yield of the Moscow Exchange's RGBI index; the stock yield is a 12-month moving average of the MOEX Russia Index.
Fig. 58. The number of active clients trading on the St. Petersburg Exchange (thousands) and the stock and bond yield on the domestic stock market (%), 2010-2019
Source: own calculations based on data released by Bloomberg, Cbonds, and the St. Petersburg Exchange.
Table 9 demonstrates an example of a simple model that reflects the dependence of the monthly growth rate of the total number of registered investors on the Moscow Exchange on several variables, such as real personal income growth, volatility of the ruble exchange rate, the dividend and forex constituents of the MOEX Index, its volatility, the risk premium on domestic bonds,1 the interest rate on individual deposits,2 the dividend yield of foreign stocks, and the entry of Tinkoff Bank3 on the brokerage services market in May 2018.
Based on the data shown in Table 9 and similar models built for the other indicators that influence the number of individual investors in the stock market, we came to the following conclusions.
The movement of the total number of accounts opened by brokers' clients on the Moscow Stock Exchange was more strongly influenced by those factors that created the potential for deriving passive income in rubles (the ruble deposit interest rates offered by banks and the size of bond risk premiums, the dividend yields on Russian stocks, the ruble exchange rate volatility), the personal income level, and the surge in brokerage activity that coincided with the entry of Tinkoff Bank into the brokerage services market. The changes in the number of investors in this category did not significantly depend on factors like the returns of Russian and foreign stocks as estimated by the S&P 500.
1 The yield spread of government bonds and interest rates on bank deposits.
2 The average interest rates on bank deposits of 181 days to a year, calculated by the Bank of Russia.
3 The launch of brokerage services by Tinkoff Bank in May 2018 sharply increased the competition between biggest retail banks for new clients in the brokerage services market.
Table 9
Models for the growth in the number of individual clients of brokers
on the Moscow Exchange
Dependent variable:
growth in number of individual clients of brokers on Moscow Exchange
(1) (2) (3)
Constant 1.963** -1.067** 0.938***
(0.847) (0.533) (0.2 58)
Real income growth (3 month lag) 0.106*** 0.115***
(0.026) (0.026)
Dividend yield of MOEX Index 0.655***
(0.103)
MOEX Index volatility 0.276** 0.267* 0.414***
(0.125) (0.149) (0.1 03)
Premium on bonds (1 month lag) 0.228*
(0.128)
Deposit interest rate (12 month lag) -0.156*
(0.093)
MOEX Index, change of last year 0.022
(0.023)
Dummy (Tinkoff) 4.306***
(0.359)
Ruble exchange rate volatility -0.613* -0.518**
(0.323) (0.223)
Observations 152 155 155
R2 0.168 0.292 0.508
Note. The standard deviation of the coefficients is shown in brackets. The significance levels are as follows: * - p <0.1, ** - p <0.05, *** - p <0.01.
The behavior of holders of individual investment accounts (IIAs) could be explained by similar motives, which are typical of passive investors. The movement pattern of IIAs was shaped by the factors associated with passive income, like the ruble deposit interest rates, government bond yields, dividend yields of Russian stocks, and real personal income growth. Some of these variables had a 12-month lag, which reflects the more inert nature of decisionmaking by the owners of IIAs compared to that of ordinary passive clients of brokers. The movement pattern of IIAs was not influenced by the return on investments in foreign stocks. The tax exemptions granted to IIAs translated into a higher propensity of their holders to invest in risky assets, which was manifest in the way that the size of stock premiums was influencing the movement pattern of IIAs, in contrast to government bond yields.
Private investors with active portfolio strategies, which are estimated using the movement of the number of active accounts of brokers' clients on the Moscow Exchange, are prone to resort to speculative forms of income. The number of these accounts grew in proportion to the variables describing a higher propensity to take risks, namely the size of equity risk premium and the volatility of the MOEX Index, the prices of foreign stock and the ruble exchange rate. At the same time, the dividend yield of the MOEX Index and the fact of Tinkoff Bank obtaining a brokerage license were the only two factors that uniformly influenced the movement patterns of both passive and active private investors on the Moscow Exchange.
The movement pattern of the number of accounts held by active clients of brokers on the St. Petersburg Exchange (SPB Exchange), where foreign securities are mainly traded, was most strongly influenced by a limited range of factors that had to do with the comparative returns of Russian and foreign securities. Meanwhile, both the composition of these variables and the vectors of influence differed significantly from the factors that influenced the number of individual investors in the MOEX Index.
Unlike the Moscow Exchange market, the individual investors trading on the St. Petersburg Exchange attach greater importance to the return indices of foreign securities and the returns on Russian stocks recalculated in foreign currency. The ruble return of the S&P 500 with a 2-month lag has a significant and positive effect on the number of investors on the St. Petersburg: an increase in that index is followed, as a rule, by an inflow of individual investors onto the St. Petersburg Exchange. The return of the RTS Index denominated in US dollar, with a 2-month lag, significantly and negatively influenced the number of clients of brokers on the St. Petersburg Exchange: the prospect of receiving a higher return on Russian stocks when the ruble strengthens, as a rule, produced an outflow of investors from the St. Petersburg Exchange.
Thus, the two exchanges were interconnected. The growth of Russian bond and stock premiums increased the attractiveness of the MOEX Index in the eyes of individual investors and made less attractive the foreign securities market of the St. Petersburg Exchange. And vice versa, an increasing exchange rate volatility and a weakening ruble translates in a lower attractiveness of the ruble securities market for domestic investors, who then have to seek an alternative in the form of foreign securities.
Domestic institutional investors
The entry of individual investors into the domestic market made it possible to compensate, in part, for the outflow of foreign investments. However, the positive changes in this direction were not followed by positive developments in the segment of mandatory pension savings and pension reserves. As shown in Fig. 59, in 2019, after the pension savings freeze, the pension reserves and savings management sector was growing at a very slow pace. The value of pension savings held by non-governmental pension funds (NPF), state asset managers (SAM) and private asset managers (PAM) increased from RUB 4.3 trillion in 2018 to RUB 4.7 trillion in 2019, or by 8.8%; that of pension reserves held by non-governmental pension funds increased over the same period from RUB 1.3 trillion to RUB 1.4 trillion, or by 12.3%.
In terms of share of GDP, the total value of pension savings increased from 4.2% in 2018 to 4.3% in 2019, and that of pension reserves held by non-governmental pension funds from 1.2% of GDP to 1.3% of GDP, respectively.
7,0 6,0 5,0
CLc
Q 4,0
0 ^
1 3,0 2,0 1,0 0,0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 □ Pension savings held by NPFs, SAMs and PAMs □ Reserves held by NPFs
Fig. 59. The movement of pension savings and reserves in 2005-2019, % of GDP Source: own calculations based on data released by Rosstat, the Bank of Russia, and the RF Pension Fund.
The absence of a properly functioning mandatory corporate pension savings system or voluntary retirement plans for the employed population, stimulated by tax benefits for employees and employers, is currently one of the key constraints on the domestic stock market development. In 2019, the attempts by the RF Ministry of Finance and the Bank of Russia to offer some new promising systems of supplementary retirement programs in the form of individual pension capital (IPC) and guaranteed pension plans (GPP) did not yield any concrete results.1
In 2019 and early 2020, another collective investment mechanism - open-end mutual funds and interval funds - was demonstrating a more dynamic pace of development. As shown in Fig. 60, net asset value (NAV) of open-end mutual funds in 2018, 2019 and in March 2020 amounted to RUB 315 billion, RUB 454 billion, and RUB 477 billion, respectively, and their NAV over the period from 2018 through March 2020 amounted to 51.4%. The NAV of interval funds over the same periods amounted to RUB 31 billion, RUB 7 billion, and RUB 6 billion, respectively, thus shrinking by 80.6%.2 So far, the GDP share of the NAV of these two types of investment funds has amounted only 0.44%, but it continues to grow steadily.
500 -| 450 -400 -350 300 250 200 150 100 50 0
1 Open-end mutual funds, billions of rubles
] Interval funds, billions of rubles
Open-end mutual and interval funds, % of GDP
0,56 ../........
477
454
315
"2218"
135
131
91
0,0 0,00,2
0,4 5 1 8
.
iri^mFl
38
60
75
95 82 89
113 110
44 47 13
1
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20
0,44
0,6
0,5
0,4
0,3
0,2
0,1
0,0
-0,1
2222
2222
2222
a
Fig. 60. Net asset value of open-end mutual funds and interval funds from 1997 through March 2020, billions of rubles (left-hand side axis), and their share of GDP, %
(right-hand side axis)
Source: own calculations based on data released by Investfunds and Rosstat.
7
6
1 For the commentary of the Center for Institutions Analysis and Financial Markets (IAES RANEPA) concerning the draft law on GPP presented by the RF Ministry of Finance, see URL: https://ipei.ranepa. ru/images/ 2019/FR/com_FZ_GGP.pdf
2 At present, interval funds are not very popular with investors, because they offer low liquidity.
In Fig. 61, the results of an analysis of several important and interesting trends in the development of open-end mutual funds are shown. Fig. 61a demonstrates that, on medium-term horizons of 2-3 years, growth of the RTS Index is usually followed by a net inflow of investment into open-end mutual funds, while a long-term decline in the index value triggers an investment outflow. In 2019, the RTS Index gained 44.9%, which resulted in an inflow of investor money into the funds in the average amount of RUB 1.5 billion per month. On short-term horizons of several months, investors can resort to an opposite strategy of market timing in order to increase the amount of their shares in open-end mutual funds during the periods of temporary stock price decline. This is exactly what happened in January-February 2020: at a moderate decline of the RTS Index by 16.1%, the stock mutual funds were receiving on average RUB 3.8 billion per month. However, after the stock market crash in March 2020, shareholders withdrew RUB 0.5 billion from these funds.
In Fig. 61b, it is shown that also on medium-term horizons, the investor cash inflows into bond mutual funds depend on the size of interest rates on bank deposits. The reduction in interest rates on deposits for a period of 181 days to a year from 12.4% in December 2014 to 4.8% in January 2020 gave rise to a stable investment inflow into bond mutual funds. The average monthly cash inflow into these funds amounted to RUB 4.6 billion in 2018, RUB 1.4 billion in 2019, and RUB 8.4 billion in January - February 2020, while a massive cash outflow from bond mutual funds occurred from July 2018 through March 2019, when the interest rate on bank deposits increased from 5.1% to 6.4%. In March 2020, amid fears of corporate defaults, shareholders withdrew a total of RUB 4.5 billion from open-end mutual funds.
In Fig. 61c, alongside an individual investment outflow demonstrated by the foreign funds specializing in Russian stocks (Russia-EMEA-Equity), the accumulated volume of domestic investment in Russian stock mutual funds was gradually approaching a level which was comparable with that of the said foreign investment funds. From December 2004 through February 2020, the accumulated investment in Russia-EMEA-Equity amounted to USD 1.5 billion, while the corresponding index for Russian mutual funds amounted to USD 0.3 million. When the attractiveness of the Russian stock market for these foreign funds peaked in April 2011, their accumulated investment amounted to USD 14.1 billion, while the similar indicator of open-end mutual funds was only USD 0.3 billion.
Fig. 61d illustrates the differences in the behavior of foreign and domestic individual investors when they invested in one and the same Russian stock through mutual funds. Essentially, they differ in that foreign individual investors were eager to invest during the periods of low prices for Russian stocks, and withdrew their money from the funds in advance at the first signs of potential risks of stock revaluation and the national currency weakening. Therefore, during the 2019 surge in shares, they were mainly withdrawing their own funds from Russia-EMEA-Equity. But Russian investors, as noted above, rely on more procyclical investment strategies, and so they were investing more as stock prices were climbing, giving practically no regard for the risks of the ruble depreciation. In 2019, their new investment in stock mutual funds amounted on average to RUB 1.5 billion per month.
From the point of view of long-term investments, the Russian stock market is cyclical, and so investors should pay more attention to the possible global diversification of their individual portfolios.
Thus, the year 2019 saw a variety of collective investment trends. The development of the domestic pension savings and reserves is constrained by a number of fundamental unresolved legislative problems. In the mutual fund industry, a tentative domestic savings growth can be
observed, which, unlike that of brokerage accounts, is not accompanied by aggressive sales in big retail banks. However, the retail mutual fund industry has remained rather small because of the high investment costs and low attractiveness for a really wide range of investors.
a) Open-end stock mutual funds and RTS Index
6 000
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-4 000
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I Open-end stock mutual funds (left-hand side axis)
■ RTS Index, points (right-hand side axis)
b) Open-end bond mutual funds and bank deposit interest rate
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■Interest rate on deposits of 181 days to year, % per annum (right-hand side axis)
0
0
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c) Investor cash flows in Russian stock mutual funds and Russia-EMEA-Equity
(running total)
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900 700 500 300 100 -100
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and Russia-EMEA-Equity
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□ International equity funds specializing in Russian stocks (left-hand side axis)
□ Stock open-end mutual and interval funds (right-hand side axis)
Note. Fig. (a): monthly net investor cash flows in stock open-end mutual and interval funds, billions of rubles (left-hand side axis) and the RTS Index, points (right-hand side axis). Fig. (b): monthly net investor cash flows in open-end bond mutual funds, billions of rubles (left-hand side axis) and average interest rates on deposits of 181 days to year, % per annum (right-hand side axis). Fig. (c): monthly net investor cash flows in stock open-end mutual and interval funds and foreign equity funds specializing in Russian stocks, running total, millions of US dollars (December 2004 = 0). Fig. (d): monthly net investor cash flows in Russian stock open-end mutual and interval funds (right-hand side axis) and foreign equity funds specializing in Russian stocks (left-hand side axis), millions of US dollars.
Fig. 61. Analysis of the specific behaviors of individual investors in Russian stocks and bonds under different collective investment mechanisms
Source: own calculations based on data released by Investfunds.ru and Emerging Portfolio Fund Research (EPFR Global)1.
2
0
1 URL: https://www.epfrglobal.com/
Foreign investors
In many emerging markets, foreign portfolio investors frequently operate under very similar scenarios. Their decisions concerning investing in or withdrawing from investment funds depend on the general cyclical patterns and the weight of each country in terms of global stock indices, and not on the individual characteristics of each national economy or national issuers.1 As follows from the data presented in Fig. 62, according to EPFR, the Russian stock market was faced with a massive withdrawal of foreign funds from mid-2011 onwards. A comparison with the other top 5 emerging equity markets (Brazil, India, China, South Korea and Indonesia) has revealed that almost all of them, at about the same time, had to deal with a similar phenomenon, but most of them managed to reverse this trend in 2018. The investment outflow from the Russian stock market, which continued in 2018-2019 despite a reduced risk premium, is an upshot of the uncertain economic growth prospects and unfavorable investment climate in this country in face of persisting geopolitical risks.
.........Russia -Republic of Korea ^ ^ Indonesia
-25 000 -----------------------------------------------------------------------------
Fig. 62. The cumulative cash flows of foreign investment funds specializing in stocks on some developing markets, from January 2000 through February 2020
Source: own calculations based on data released by EPFR.
The Russian financial market's attractiveness for foreign investors largely depends on the investment climate. Russia has made significant progress in her Global Competitiveness Index ranking by the World Economic Forum (WEF). This, Russia climbed from 67th place in in
1 For more information on the investment strategy of these funds in Russia, see Abramov, A. The difference in the behaviour of domestic and foreign private investors in the Russian stock market. Russian Economic Developments, No 11, 2014.
2013 to 43rd in 2018 and 2019 (Fig. 63). Relative to the other BRICS, Russia rose above Brazil, South Africa and India, and is now second only to China.
Fig. 63. BRICS members' rankings in the World Economic Forum's Global Competitiveness Index in 2007-2019
Source: own calculations based on data for several years from The Global Competitiveness Report released by the World Economic Forum.
Thanks to the availability of long-term data series, we selected three criteria for assessing the investment climate in Russia based on the WEF Global Competitiveness Rankings. If we take the 2013 indices as the base level, it can be concluded that in these three areas, Russia has managed to improve its investment climate quality (Table 10). Thus, for example, by the judicial system independence criterion, Russia moved from 119th place in 2013 to 91st in 2018, by that of compliance with international reporting and audit standards - from 107th place to 97th, and by that of the banking system's reliability - from 124th to 115th place. However, in 2019, by two out of these three criteria (audit and reporting standards, and banks' reliability), Russia's ranking worsened compared to 2018.
Thus, in spite of the macroeconomic and financial sustainability achieved by 2019 and the reduced risk premiums, the Russian stock and bond market, with the exception of the OFZ segment, remained insufficiently attractive for foreign investors, as evidenced by the cash outflow from the foreign equity funds specializing in Russian securities. The developments in March 2020, including the drop in global prices for many financial assets and oil, the slide of many economies into a deep recession in response to the coronavirus pandemic, and the increasing probability of defaults in the risky corporate bond markets of some countries, demonstrate that the Russian market has strengthened its image of one of the world's most risky places for investment.
Table 10
The most problematic aspects of Russia's investment climate according to the rankings in the World Economic Forum's Global Competitiveness Index
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019
Judicial system independence
Russia 106 109 116 115 123 122 119 109 108 95 90 92 91
China 82 69 62 62 63 66 57 60 67 56 46 45 47
India 26 43 37 41 51 45 40 50 64 54 53 41 51
Brazil 89 68 78 76 71 71 65 76 92 79 59 79 94
South Africa 23 30 38 44 35 27 22 24 24 16 36 48 33
Audit and reporting standards
Russia 95 108 119 116 120 123 107 106 102 103 100 89 97
China 102 86 72 61 61 72 80 82 80 68 71 75 78
India 27 30 27 45 51 44 52 102 95 64 69 63 67
Brazil 63 60 70 64 49 42 31 41 70 72 58 65 71
South Africa 6 4 2 1 1 1 1 1 1 1 30 55 49
Banks' reliability
Russia 108 107 123 129 129 132 124 118 115 121 121 114 115
China 128 108 66 60 64 71 72 63 78 79 82 90 95
India 46 51 25 25 32 38 49 101 100 75 78 83 89
Brazil 36 24 10 14 16 14 12 13 27 38 26 22 19
South Africa 16 15 6 6 2 2 3 6 8 2 37 62 29
Source: own calculations based on data for a number of years from The Global Competitiveness Report published by the World Economic Forum.
3.1.12. The Russian financial market risks
One of the key obstacles to the formation of domestic savings in Russia has been the periodically emerging risk of the national currency depreciation. The ruble depreciation usually always follows the same scenario. The decline in oil prices and the intensification of capital outflows trigger an abrupt depreciation of the ruble, followed by a period of 6-8 years when the ruble remains stable and even rebounds slightly (Fig. 64). The depreciation lowers the incentives for making domestic savings. The measures undertaken in recent years to liberalize the ruble exchange rate and the introduction of a fiscal rule have helped reduce the risks of national currency depreciation, but in order to properly manage these risks, structural changes in the economy are urgently needed.
As shown in Fig. 64, from September 1995 until the present, three ruble devaluation waves were observed in Russia. During the first one, from September 1, 1995 to August 31, 1998, the average exchange rate for the period was RUB 5.7 per USD. After the August 1998 crisis until August 2008, the average exchange rate rose to RUB 27.5 per USD. Beginning from the 2008 crisis, during the period of lower oil prices until September 2014, the average rate stayed at RUB 31.1 per USD. The forex crisis of 2014, followed by long-term decline in the average level of oil prices until the end of 2019, resulted in the national currency's average exchange rate hovering near RUB 61.7 per USD.
The ruble weakening in Q1 2020 in response to the shocks of the pandemic and the intensified competition between oil exporting countries led to the ruble plunging to the level of RUB 80.16 per USD (as of March 20, 2020). It is still unknown at what level oil prices are going to stay when the acute phase of the current crisis is over, but it can be assumed that if the average oil prices should plummet over the next period, this may give rise to yet another wave
of ruble depreciation followed by the emergence of disincentives for households and organizations to keep ruble savings.
90,0
■ 1 RTS Index -USD-to-ruble exchange rate ------ Mean USD-to-ruble exchange rate
Fig. 64. The movement of the RTS Index and the USD-to-ruble exchange rate over the period from September 1, 1995 through March 20, 2020
Source: own calculations based on data released by the Bank of Russia and the Moscow Exchange.
The stock prices of Russian companies strongly depend on oil prices. The coefficient of determination (R2) between the absolute monthly values of the RTS Index and the price of Brent crude oil over the period from September 1995 through March 2020 (Fig. 65) is equal to 0.8, which points to a very close interdependence of these two indicators. To a large extent, the price of oil continues to influence the national currency's exchange rate, especially when certain price shocks occur in the market.
The economic sanctions continue to pose significant risks to the financial market, although their impact on the behavior of market participants is still limited. The main channels whereby the sanctions are influencing the financial market are the restrictions on the amount of lending to Russian companies, the cost of borrowed funds, and the outflow of foreign investment from the stock market. Although the available estimates of the effects of sanctions on the financial market vary significantly, they all mostly have to do with the expected slowdown in GDP growth. There are few studies that analyze directly the consequences of sanctions for the financial market. Thus, according to E. Gurvich and I. Prilepskiy, the total additional net capital outflow resulting from the sanctions is estimated to have been at the level of USD 58 billion in 2014, and USD 160-170 billion in 2014-2017. 1
1 Gurvich, E., Prilepskiy, I. The impact of financial sanctions on the Russian economy, No 1, January 2016, p.33.
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150
Brent crude oil, USD per barrel
Fig. 65. The dependence of the RTS Index on the price of Brent crude oil, from September 1995 through March 2020
Source: own calculations based on data released by Finam and the Moscow Exchange.
The economic sanctions and the current expectations of their possible toughening limit, for big companies and the government, the possibilities to borrow in global markets, and thus suppress the investment activity of the business community, which has a negatively effect on economic growth.
In the context of an impending global financial crisis, one of the most serious threats to financial sustainability in Russia and elsewhere is posed by defaults in the high yield bond market. The massive work stoppages of businesses in their response to the coronavirus epidemic have made it more difficult for companies to fulfill their obligations to creditors. In Russia, this problem is further aggravated by the fact that, unlike many countries, the government has not yet decided to implement large-scale relief programs to compensate businesses for their losses incurred from staying idle.
In addition, as has been shown above, the bond markets of many countries, Russia including, for many years have been displaying a trend towards an underestimation, by investors, of the risks associated with junk bonds. Due to the increased demand, the yield spreads for these instruments were close to those of investment grade bonds, and did not adequately offset the real risks for investors. According to Kenneth Rogoff, who is one of the most eminent financial crisis experts, the corporate debt sector is one of the most vulnerable sectors of the US financial market, as he notes in his interview with Barron's on March 30, 2020. In his opinion, the measures that have been taken there by way of supporting the financial market could prevent defaults in the US debt market. However, the most serious problems can be expected to occur in the developing markets, where the current capital outflows exceed in scale those observed during the Asian financial crisis. Perhaps indeed 'we will see one after another emerging market restructure debt.'1
The specific risk typical of the Russian financial market in the context of an impending crisis may be the disappointment of the mass investor in the stock market. The soaring number of
1 Kapadia R. (2020). The Coronavirus Crisis Could Be as Bad as Anything We've Seen in the Last 150 Years: Harvard Economist. Barron's. March 31.
brokerage accounts and the scale of activity of their owners in 2019 and early 2020 was the upshot of aggressive marketing by the 3-4 biggest retail banks, which had been aiming at reorienting their traditional client towards brokerage services. At the same time, banks gave preference to direct investments by novice investors, instead of the more secure collective investment mechanisms. This practice did not result in any significant improvements in the standards of sales of financial products and instruments, for example, the reliance on the principles of open sales architecture, or fiduciary duties for sellers and investment consultants. All this was fraught with increased risks of misselling of financial products, which will probably happen in the medium term.
* * *
Overall, 2019 was a successful year. The positive changes that took place over the course of that year can be described in brief as follows:
- the returns of the Russian stock indexes were among the highest in the world; on the back of a stronger ruble, the return of 44.9% of the RTS Index (denominated in foreign currency) was significantly above the return of the ruble-denominated MOEX Index, which stood at 26.6%;
- Russian corporate stocks demonstrated nearly the highest dividend yields around the world, while the equity risk premiums dropped to their record lows of many years;
- in the wake of the Bank of Russia key rate reduction from 7.75% to 6.25%, there was a real boom in the bond market: OFZ issues jumped 90.9% to RUB 2.1 trillion, and corporate bond offer increased by 68.7% to RUB 2.7 trillion;
- while bank deposits were losing their attractiveness, there occurred a massive inflow of individual investors into the stock market; over one year, the number of registered brokerage accounts of individuals on the exchange almost doubled, reaching 3.9 million;
- in the domestic stock market, the inflow of individual investors largely offset the outflow of foreign portfolio investments, while the relative share of individual investors in exchange-traded market transactions increased to 31.7%;
- the returns on the OFZ market fell 6.09%, which is their record low of the entire post-crisis period since 2008; after the recession in 2018, which was caused by the expectation of sanctions, foreign investors returned to this market, their share in the OFZ structure in early 2020 increasing to its historic high of 34.9%;
- the number of individual investment accounts (IIAs) jumped severalfold, to 1.9 million; increasingly, these accounts are becoming important mechanisms for long-term individual savings;
- in the collective investment market, the monies of individual investors were actively flowing into open-end stock and bond mutual funds, which began to play an increasingly prominent role in the financial market.
- At the same time, many domestic financial market issues have remained unresolved, of which the following ones can be pointed out:
- Russian stock indexes remain in the category of the world's riskiest; on long-term time horizons, they are significantly inferior to the stock indexes of many developed and developing stock markets;
- the level of development of the domestic stock market still does not match the scale of the Russian economy, and it is behind the majority of competing markets by certain parameters like capitalization, the stock market liquidity, volume of IPO transactions, and the number of issuers listed on the exchange;
- in 2018-2019, the Moscow Exchange demonstrated a decline in the total volume of exchange trading, while low liquidity was observed in the segment of market transactions in stocks and bonds, and in the futures and options market;
- the equity and corporate bond markets are characterized by a high level of concentration; the top 10 issuers account for 70.1% of the total stock market cap, and for 53.5% of new corporate bond offer, respectively;
- from year to year, the relative share of state-owned companies (SOE) in the stock capitalization index and the value volume of bonds outstanding has been on the rise; in 2019, it stood at 53.5% in the stock market, and at 71.8% in the corporate bond market;
- the corporate bond market remains insufficiently transparent from the point of view of credit and interest rate risks; the relative shares of high risk bonds and high yield bonds in its structure amounted to 39.5% and 11.6%, respectively;
- the soaring number of individual investors was not associated with any qualitative improvements in the standards for sales of investment and financial products, or an increased transparency of information about the issuers and their financial instruments;
- since 2014, the freeze of the system of compulsory pension savings has continued, and there is still legal uncertainty in the sector of voluntary corporate and individual pension plans;
- as demonstrated by the stock market downfall in March 2020, the risks of ruble depreciation have remained high, which has negative effects on long-term savings.
The first signs of the upcoming financial crisis that appeared in March 2020, alongside a slowdown of the global economy caused by the coronavirus pandemic, have given rise to new risks in the high yield bond and individual savings markets.
3.2. Municipal and sub-federal debt market1
3.2.1. Market development dynamic
At year-end 2019, the regional consolidated budgets and local government off-budget funds' budgets ran a surplus of RUB 17.4 billion or 0.02 percent of GDP (contraction by around 30fold over the year).
To compare, in 2018 the regional consolidated budgets and local government off-budget funds' budgets ran a surplus of RUB 512.9 billion or 0.49 percent of GDP.
In 2019, the budgets of the subjects of the Russian Federation ran a surplus of RUB 15.5 billion, urban districts' budgets ran a deficit of RUB 16.3 billion, federal-status cities' innercity municipalities' budgets ran a surplus of RUB 0.5 billion, municipal areas' budgets ran a surplus of RUB 16.0 billion, urban settlements' budgets ran a surplus of RUB 0.9 billion, local government off-budget funds' budgets ran a surplus of RUB 12.7 billion.
In 2018, the budgets of the subjects of the Russian Federation ran a surplus of RUB 491.5 billion, urban districts' budgets ran a deficit of RUB 0.8 billion, federal-status cities' inner-city municipalities' budgets ran a deficit of RUB 0.4 billion, municipal areas' budgets ran a surplus
1 This section was written by Shadrin A.E., senior director on innovation policy of NRU HSE; researcher, Center for Macroeconomics and Finance, Gaidar Institute.
of RUB 6.7 billion, urban settlements' budgets ran a deficit of RUB 0.2 billion, rural settlements' budgets ran a deficit of RUB 0.6 billion, local government off-budget funds' budgets ran a deficit of RUB 2.7 billion.
Table 11
Ratio of surplus (deficit) of the consolidated regional and regions' budgets to budget expenditure in 2007-2019, percent
Year Regional consolidated budget * Regions' budgets
2019 0.11 0.13
2018 3.7 4.7
2017 -0.5 -0.2
2016 0.003
2015 -1.6 -1.3
2014 -4.6 -4.9
2013 -6.4 -8.1
2012 -3.0 -3.5
2011 -0.2 -0.3
2010 -1.4 -1.6
2009 -5.3 -5.3
2008 - 0.7 -0.7
2007 0.8 0.6
* With account of state extrabudgetary funds.
Source: own calculations based on the data released by the Federal Treasury.
Table 12
Ratio of surplus (deficit) of territorial budgets to budget expenditure
in 2007-2019, percent
Year Inner-city municipalities Urban districts' Municipal areas' Urban and rural
budgets in federal-status cities budgets budgets settlements' budgets
2019 1.5 -0.7 0.4 -0.2
2018 -1.2 0.04 1.0 1.0
2017 -1.9 1.6 0.4 - 0.3
2016 1.3 -0.9 0.8 -1.5
2015 6.7 -3.0 -0.7 -0.6
2014 6.0 -2.2 -1.4 0.7
2013 - 3.47 -2.61 -5.59 2.24
2012 2.26 -2.01 -0.08 1.34
2011 6.15 -2.10 1.13 0.64
2010 -1.12 -1.16 -0.11 1.72
2009 -0.63 -3.32 -1.88 2.63
2008 -1.47 1.09 -0.26 2.72
2007 5.34 1.23 -0.04 2.34
Source: own calculations based on the data released by the Federal Treasury.
As of January 1, 20209, the consolidated budget (including local government off-budget funds) of 33 subjects of the Russian Federation (16 regions and the city of Baikonur in 2018). The total deficit amounted to RUB 227.5 billion, or 2.6 percent of the revenue side (RUB 64.0 billion in 2018, or 2.8 percent of the revenue side of the regions' budgets that ran a deficit).
The median budget deficit value stood at 1.3 percent relative to a given budget revenue. The highest ratio of budget deficit to budget revenue was recorded in the Moscow region (8.7 percent), Republic of Bashkortostan-5.4 percent, and the city of Sebastopol-5.3 percent.
Moscow region accounted for nearly a third - 32.7 percent of the total regions' consolidated budget deficit or RUB 74.4 billion, Moscow accounted for 22.9 percent or RUB 52.2 billion, Republic of Bashkortostan accounted for 7.0 percent or RUB 16.0 billion, Sverdlovsk region accounted for 6.0 percent or RUB 13.8 billion (Table 13).
Table 13
Execution of the consolidated budgets of the subjects of the Russian Federation (including state extrabudgetary funds) in 2019
Budget revenues, rubles in billions Budget deficit (surplus), rubles in billions Deficit (surplus) to revenues ratio, percent Borrowing to revenues ratio, percent Net borrowing to revenues ratio, percent Redemption costs to revenues ratio, percent Net borrowings to deficit (surplus), percent
1 2 3 4 5 6 7 8
Central Federal District
Belgorod Region 141.9 0.9 0.6 5.4 -0.2 5.6 -32.7
Bryansk Region 88.8 -1.1 -1.2 6.5 -0.3 6.8 25.9
Vladimir Region 95.5 -0.7 -0.7 1.4 -0.4 1.8 60.1
Voronezh Region 169.7 -1.8 -1.0 32.7 -2.7 35.4 261.9
Ivanovo Region 63.4 -1.4 -2.2 10.9 -2.1 13.0 94.0
Tver Region 96.1 -4.1 -4.2 12.9 -1.1 14.0 25.8
Kaluga Region 98.1 -1.0 -1.0 2.8 -0.9 3.7 90.4
Kostroma Region 50.0 -2.0 -3.9 23.6 -3.5 27.1 90.1
Kursk Region 90.1 -1.2 -1.3 22.5 -0.1 22.6 5.7
Lipetsk Region 90.4 3.8 4.2 3.9 -2.3 6.2 -55.9
Moscow Region 858.5 74.4 8.7 13.2 5.0 8.2 57.4
Orel Region 50.8 0.0 0.1 54.8 -0.6 55.4 -618.2
Ryazan Region 84.8 -0.5 -0.6 6.1 0.0 6.1 -6.9
Smolensk Region 65.5 -0.7 -1.0 42.9 0.1 42.7 -14.6
Tambov Region 67.0 2.7 4.0 23.9 3.2 20.7 81.4
Tula Region 118.7 1.5 1.3 7.6 -1.0 8.7 -80.0
Yaroslavl Region 98.1 0.6 0.6 54.7 0.5 54.1 92.4
City of Moscow 2 909.9 52.2 1.8 0.0 0.0 0.0 0.0
City of Baikonur 4.8 0.0 0.7 0.0 0.0 0.0 0.0
Total 5 241.9 121.8 2.3 7.3 0.6 6.7 25.7
North-West Federal District
Republic of Karelia 70.6 -1.1 -1.5 29.2 -2.2 31.4 142.6
Republic of Komi 117.6 -3.6 -3.1 5.6 -2.1 7.6 67.6
Arkhangelsk Region 130.6 -4.0 -3.0 66.3 -1.1 67.4 36.5
Vologda Region 121.7 -9.8 -8.1 6.6 -4.2 10.8 52.2
Kaliningrad Region 143.2 -0.9 -0.6 8.9 -0.3 9.2 47.3
Leningrad Region 197.8 -2.0 -1.0 0.0 -0.1 0.1 12.7
Murmansk Region 118.5 -3.5 -2.9 46.8 -4.1 50.9 140.3
Novgorod Region 50.2 0.3 0.6 9.6 0.3 9.3 49.1
Pskov Region 48.7 0.7 1.4 39.7 2.2 37.5 155.4
St. Petersburg 743.7 10.4 1.4 0.0 0.0 0.0 0.0
Nenets
Autonomous 26.2 -0.3 -1.0 1.8 -1.6 3.3 159.6
District
Total 1 768.9 -13.6 -0.8 12.1 -0.9 13.0 112.0
Southern Federal District
Republic of Kalmykia 21.6 0.4 1.7 25.5 3.1 22.5 176.0
Krasnodar Territory 434.9 -31.8 -7.3 4.6 -9.0 13.6 123.1
Astrakhan Region 71.3 -5.0 -7.0 1.0 -12.3 13.2 175.7
Volgograd Region 161.6 -1.9 -1.1 9.1 -2.4 11.5 209.1
Rostov Region 271.2 4.9 1.8 2.7 0.2 2.6 9.7
City of Sevastopol 43.6 2.3 5.3 0.0 0.0 0.0 0.0
Republic of Crimea 215.4 -1.2 -0.6 0.0 -0.1 0.1 15.6
Republic of Adygea (Adygea) 33.6 0.4 1.3 1.6 -0.2 1.8 -12.1
Total 1 253.2 -31.9 -2.5 3.9 -4.1 8.0 159.8
Cont'd
1 | 2 | 3 | 4 | 5 | 6 | 7 | 8
North-Caucasus Federal District
Republic of Dagestan 166.3 -6.0 -3.6 0.0 -0.3 0.3 7.8
Kabardino-Balkar Republic 50.4 -2.5 -4.9 52.0 -4.5 56.5 91.8
Republic of Northern Ossetia-Alania 47.4 -1.0 -2.2 19.8 -1.4 21.1 61.8
Republic of Ingushetia 32.1 -0.6 -1.8 4.0 -0.4 4.3 19.6
Stavropol Territory 172.4 -0.2 -0.1 17.8 -0.4 18.3 377.6
Karachay-Cherkess Republic 35.5 -0.3 -0.9 12.6 -0.5 13.1 54.8
Chechen Republic 114.7 0.2 0.1 0.0 -0.2 0.2 -113.0
Total 618.9 -10.5 -1.7 11.6 -0.7 12.4 44.2
Volga Federal District
Republic of Bashkortostan 293.9 16.0 5.4 0.4 -1.7 2.1 -31.2
Republic of Mariy-El 45.2 -1.7 -3.7 13.4 -2.8 16.1 75.5
Republic of Mordovia 56.1 -1.4 -2.5 32.0 -5.9 37.9 236.8
Republic of Tatarstan (Tatarstan) 382.6 -15.1 -3.9 1.5 -0.1 1.6 2.0
Udmurt Republic 115.0 1.6 1.4 40.8 0.5 40.3 34.0
Republic of Chuvashia-Chuvashia 82.3 -4.9 -6.0 7.8 -3.1 10.9 51.5
Nizhniy Novgorod Region 254.2 0.7 0.3 19.0 0.1 19.0 22.4
Kirov Region 90.4 -1.8 -2.0 31.0 -0.8 31.8 39.1
Samara Region 252.5 -7.5 -3.0 19.5 -2.1 21.6 71.3
Orenburg Region 146.6 -1.6 -1.1 2.2 -1.6 3.8 146.0
Penza Region 83.8 0.9 1.1 5.3 0.4 4.9 34.2
Perm Territory 219.3 -9.7 -4.4 6.9 -0.2 7.0 4.3
Saratov Region 151.4 0.5 0.3 16.8 -0.5 17.4 -155.0
Ulyanovsk Region 84.3 2.5 2.9 14.6 0.4 14.2 14.0
Total 2 257.5 -21.5 -1.0 12.0 -0.9 12.9 96.2
Urals Federal District
Kurgan Region 66.7 -0.2 -0.3 18.5 0.8 17.7 -235.5
Sverdlovsk Region 372.5 13.8 3.7 5.5 1.2 4.3 31.7
Tyumen Region 262.2 -19.5 -7.4 0.0 0.0 0.0 0.0
Chelyabinsk Region 262.6 0.5 0.2 3.0 0.1 2.9 63.0
Hanty-Mansiysky Autonomous District - Yugra 353.4 -7.0 -2.0 0.6 -0.3 0.9 14.8
Yamal-Nenets Autonomous District 274.1 -31.8 -11.6 0.0 0.0 0.0 0.1
Total 1 591.4 -44.1 -2.8 2.7 0.3 2.4 -9.5
Siberia Federal District
Republic of Tyva 40.4 0.4 1.0 5.7 0.0 5.7 -0.1
Altai Territory 159.6 -0.6 -0.4 0.0 0.0 0.0 13.1
Krasnoyarsk Territory 381.1 -38.3 -10.1 5.1 -5.7 10.8 57.0
Irkutsk Region 269.6 12.7 4.7 3.7 2.1 1.7 43.9
Kemerovo Region 232.6 2.1 0.9 0.4 -1.3 1.7 -146.5
Novosibirsk Region 235.6 8.2 3.5 29.5 0.7 28.8 19.1
Omsk Region 138.4 -0.6 -0.4 65.1 -0.2 65.3 51.7
Tomsk Region 98.2 3.5 3.5 53.3 3.7 49.6 103.6
Cont'd
1 2 3 4 5 6 7 8
Republic of Altai 29.9 -0.7 -2.3 3.3 -0.1 3.5 5.1
Republic of Khakassia 46.6 -1.3 -2.7 5.7 -1.7 7.5 62.9
Total 1 632.0 -14.6 -0.9 15.2 -0.9 16.1 104.8
Far East Federal District
Republic of Buryatia 96.9 0.4 0.4 36.4 0.4 36.0 97.7
Republic of Sakha (Yakutia) 283.1 2.7 0.9 9.8 -0.2 10.0 -21.2
Primorsky Territory 194.4 -2.3 -1.2 3.2 -0.2 3.3 13.2
Khabarovsk Territory 158.8 3.9 2.5 18.6 1.9 16.7 75.8
Amur Region 97.8 -5.3 -5.4 8.1 -0.4 8.5 7.7
Kamchatka Territory 104.1 1.3 1.2 1.2 -0.7 1.9 -56.3
Magadan Region 49.2 0.0 0.0 62.7 0.1 62.7 198.2
Sakhalin Region 217.1 -1.5 -0.7 0.0 0.0 0.0 0.0
Jewish Autonomous Region 18.2 0.1 0.7 21.5 1.0 20.5 140.1
Chukotka Autonomous District 58.6 -0.4 -0.6 0.0 -0.8 0.8 124.0
Zabaikalsky Territory 107.4 -2.0 -1.8 8.3 -0.2 8.5 11.4
Total 1 385.6 -3.0 -0.2 10.9 0.1 10.9 -29.4
Total Russian Federation 15 749.4 -17.4 -0.1 9.1 -0.4 9.5 404.4
Source: own calculations based on the data released by the Federal Treasury.
In 2019, the consolidated budgets of 50 subjects of the Russian Federation ran a surplus (compared to 69 regions in 2018). These regions ran the total budget surplus of RUB 244.9 billion, or 1.9 percent of their budgets' revenue side (RUB 576.9 billion, or 3.6 percent of the budget revenue side, in 2018). The median budget surplus value stood at 2.0 percent relative to the budget revenue side.
The biggest ratio of surplus to the consolidated budget revenues was recorded in Yamal-Nenets AD - 11.6 percent, Krasnoyarsk krai - 10.1 percent, Vologda region - 8.1 percent, and in Krasnodar krai-7.3 percent.
In 2019, Krasnoyarsk krai accounted for 15.6 percent of the total surplus of the regional budgets or RUB 38.3 billion, Yamal Nenets AD and Krasnodar krai-13.0 percent each or RUB 31.8 billion each, Tyumen region - 7.9 percent or RUB 19.5 billion, and Republic of Tatarstan -6.1 percent or RUB 15.1 billion.
3.2.2. Borrowing structure
According to the data released by the Russian Finance Ministry, the debt piled up by the subjects of the Russian Federation in 2019 contracted by RUB 93.3 billion or by 4.2 percent totaling RUB 2,113.0 billion as the debt accumulated by municipalities rose by RUB 8.6 billion or by 2.3 percent amounting to RUB 380.5 billion (Table 14)
Table 14
Volume and structure of public debt of the subjects of the Russian Federation and debt of municipalities as of January 1, 2019 and 2020
Types of debt instruments State debt volume of RF subject, RUB million Municipalities debt volume, RUB million
2019 2020 increase/decrease 2020 to 2019, % 2019 2020 increase/decrease 2020 to 2019, %
Government bonds 551 363.6 588 530.4 6.7 18 123.9 21 295.4 17.5
Loans issued by credit institutions, foreign banks and international financial organizations 636 015.2 575 767. 8 -9.5 256 539.0 259 464.8 1.1
Public budget loans from other budgets of the budgetary system of the Russian Federation 939 977.0 886 190.6 -5.7 86 464.1 92 085.7 6.5
Government guarantees 71 504,9 55 358,1 -22,6 10 730,9 7 606,4 -29,1
Other debt instruments 7 452,7 7 127,7 -4,4 5,5 5,4 -1,8
Total 2 206 313,3 2 112 974,6, -4,2 371 863,4 380 457,6 2,3
Source: own calculations based on the data released by the Federal Treasury.
Regions and municipalities borrowed in 2019 a total of RUB 1,769.8 billion. The top-ranked borrowers were Moscow region - RUB 113.4 billion, Omsk Region - RUB 90.1 billion, Arkhangelsk Region - RUB 86.6 billion, and Novosibirsk Region - RUB 649.4 billion.
Bond issues accounted for 8.0 percent of the total consolidated regional budgets, loans from higher-level budgets (fiscal credits) constituted 26.9 percent thereof, loans from commercial banks amounted to 65.2 percent thereof.
Total net debt of the consolidated regional budget in 2019 was negative and constituted -RUB 70.5 billion (RUB -86.0 billion in 2018). The highest ratio of net debt to budget revenues was recorded in Moscow - 5.0 percent, Tomsk region - 3.7 percent, and Tambov region -3.2 percent.
The largest net borrowers were: Moscow region - RUB 42.7 billion, Irkutsk - RUB 5.6 billion, Sverdlovsk - RUB 4.4 billion, and Tomsk regions - RUB 3.6 billion.
Table 15
Regional and local budgets net borrowing, as percent of GDP
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Net borrowing by sub-federal and local governments Including 0.17 0.29 0.74 0.51 0.21 0.33 0.61 0.53 0.33 0.10 -0.01 -0.08 -0.06
repayable loans from budgets of different levels -0.01 0.03 0.33 0.37 0.15 0.01 0.06 0.24 0.21 0.21 0.02 -0.07 -0.05
Sub-federal (municipal) bonds 0.08 0.17 0.24 0.07 -0.11 0.06 0.12 -0.01 -0.01 0.04 0.11 0.04
Other borrowings 0.10 0.09 0.17 0.07 0.17 0.26 0.43 0.30 0.13 -0.15 -0.14 -0.01 -0.05
Source: own calculations based on the data released by the Federal Treasury.
Regions had their accumulated debt reduced to the maximum by repaying more for outstanding debt instruments compared to new fundraising, were: Krasnodar krai - by RUB 39.2 billion, Krasnoyarsk krai - by RUB 21.8 billion, Astrakhan region - by RUB 8.7 billion, and Voronezh region - by RUB 4.6 billion.
3.2.3. Domestic bonded debt
Thirteen subjects of the Russian Federation and 2 municipalities had their bonded debt prospectus registered in 2019 (as compared to 21 regions and 3 municipalities which issued bonded debt in 2018). The following regions had their bonded debt prospectus registered with Russia's Ministry of Finance in 2019: St. Petersburg, Krasnoyarsk and Krasnodar krais, Republic of Sakha (Yakutia), Belgorod region, Ryazan region, Sverdlovsk region, Magadan region, Samara region, Novosibirsk region, Yaroslavl region, Nizhny Novgorod region, Moscow region, Lipetsk region, the city of Novosibirsk and the city of Tomsk.
In 2019, the amount of bonded debt issuance went up from 0.08 to 0.10 percent of GDP (TTable 16).
Table 16
Amount of issued sub-federal and municipal bonded debt, as percent of GDP
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Issuance 0.26 0.43 0.41 0.25 0.10 0.19 0.23 0.16 0.12 0.19 0.23 0.08 0.10
Redemption 0.18 0.26 0.16 0.18 0.21 0.13 0.12 0.17 0.13 0.15 0.13 0.08 0.07
Net financing 0.08 0.17 0.24 0.07 -0.11 0.06 0.12 -0.01 -0.01 0.04 0.11 0.04
Source: own calculations based on the data released by Russia's Ministry of Finance.
The top-ranked bonded debt issuers were: Moscow region - RUB 51.5 billion or 27.6 percent or 45.2 percent of the total domestic bond issuance), Republic of Sakha (Yakutia) - RUB 12.0 billion or 10.5 percent), Krasnodarsky Territory and Nizhniy Novgorod region - RUB 10.0 billion each or 8.8 each.
Hence, the top-5 issuers accounted for 82.3 percent of the total regional and municipal bonded debt placed (Table 17).
Table 17
Sub-federal and municipal bond placement in 2019
Subject of the Russian Amount issued, rubles in Issuer's percentage of total amount issued, percent Amount issued to domestic
Federation millions borrowing ratio, percent
Central Federal Okrug
Belgorod region 4 000.0 3.5 52.2
Lipetsk region 2 500.0 2.2 71.3
Moscow region 51500.0 45.2 45.4
Yaroslavl region 3 000.0 2.6 5.6
South Federal Okrug
Krasnodar krai 10 000.0 8.8 50.2
Volga Federal Okrug
Nizhny Novgorod region 10 000.0 8.8 20.6
Urals Federal Okrug
Sverdlovsk region 5 000.0 4.4 24.6
Siberia Federal Okrug
Novosibirsk region 5 750.8 5.0 8.3
Tomsk region 10 239.5 9.0 19.6
Far-East Federal Okrug
Republic of Sakha (Yakutia) 12 000.0 10.5 43.4
Russian Federation, total 113 990.3 100.0 8.0
Source: own calculations based on the data released by Russia's Federal Treasury.
The highest level of securitization was observed in Lipetsk region - 71.3 percent, Belgorod region - 52.2 percent, and Krasnodar krai - 50.2 percent.
In 2019, the amount of bonds issuance by subjects of the Russian Federation and municipalities exceeded by RUB 40.55 million the amount of redeemed bonds, while in 2018 -
RUB 97.0 billion. That said, the volume of placed bonds went up by over 31 percent totaling RUB 114.0 (Table 18).
Table 18
Net borrowing in the domestic market for sub-federal and municipal bonds, RUB billion
Consolidated regional budget Regional budgets Municipal budgets
2019
Net borrowings 40.4 37.2 3.2
Raised funds 114.0 107.9 6.1
Principal repayment 73.6 70.7 2.9
2018
Net borrowings 0.02 2.96 -2.94
Raised funds 86.95 86.84 0.11
Principal repayment 86.92 83.88 3.04
2017
Net borrowings 97.03 91.43 5.60
Raised funds 215.33 205.21 10.12
Principal repayment 118.30 113.77 4.53
2016
Net borrowings 31.98 26.70 5.29
Raised funds 160.50 153.66 6.85
Principal repayment 128.52 126.96 1.56
2015
Net borrowings -5.81 -7.11 1.29
Raised funds 98.45 94.25 4.21
Principal repayment 104.27 101.36 2.92
2014
Net borrowings -9.24 -7.41 -1.83
Raised funds 111.49 110.09 1.40
Principal repayment 120.73 117.50 3.23
2013
Net borrowings 77.61 75.45 2.16
Raised funds 154.64 149.64 5.00
Principal repayment 77.03 74.19 2. 84
2012
Net borrowings 38.17 36.80 1.38
Raised funds 119.85 115.95 3.90
Principal repayment 81.68 79.16 2.52
2011
Net borrowings -58.20 -57.11 -1.09
Raised funds 55.05 53.37 1.68
Principal repayment 113.25 110.48 2.77
2010
Net borrowings 29.77 28.61 1.16
Raised funds 111.11 105.85 5.25
Principal repayment 81.33 77.24 4.09
Источник: расчеты автора на основе данных Федерального казначейства.
Most of the regions that issue bonded debt on a regular basis continued doing so in 2019 (Table 19).
Table 19
Sub-federal and municipal bonds prospectus registration in 2007-2019
Issuer 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
1 2 3 4 5 6 7 8 9 10 11 12 13 14
Subjects of the Federation
Krasnoyarsk krai * * * * * * * * * * * * *
Nizhniy Novgorod Region * * * * * * * * * * * * *
St. Petersburg * * * * * * * * * * * *
Cont'd
1 2 3 4 5 6 7 8 9 10 11 12 13 14
Republic of Sakha (Yakutia) * * * * * * * * * * * *
Yaroslavl Region * * * * * * * * * * * *
Samara Region * * * * * * * * * * * *
Belgorod Region * * * * * * * * *
Novosibirsk Region * * * * * * *
Sverdlovsk Region * * * * * * * *
Moscow Region * * * * * *
Krasnodar krai * * * * * * *
Lipetsk region * * * * * * * *
Рязанская область * * *
Tomsk Region * * * * * * * * * * *
Orenburg region * * * * * * *
Republic of Karelia * * * * * * * * * * *
Irkutsk region * * * * * * * *
Magadan region * * * *
Udmurt republic * * * * * * * * * *
Khabarovsk krai *
Kirov region *
Kamchatka krai *
Komi republic * * * * * * * *
Khanty-Mansi aut district * * * * *
Omsk region * * * *
Yamal-Nenets aut district * *
Tambov region * *
Volgograd region * * * * * * * * * *
Republic of Chuvashia * * * * * * * *
Republic of Mari-El * * * *
Kemerovo region * *
Ivanovo region * * *
Ulyanovsk region * * *
Nenets aut district *
Kursk region *
Kaliningrad region *
Saratov region *
Orel region *
Karachaevo-Cherkassia republic *
Republic of Mordovia * * * *
Republic of Khakassia * * * * * *
Stavropol krai * * * * * *
Tyumen region *
Tver region * * * * * * * *
Voronezh region * * * *
Smolensk region * *
Leningrad region * *
Republic of Bashkortostan * * * * * *
Tula region * * * *
Kostroma region * * *
Moscow * * * *
Kaluga region * * * *
Vologda region * *
Republic of Buryatia *
Murmansk region *
Penza region * *
Kurgan region *
Republic of Kalmykia *
Kabardino-Balkar republic * *
Briansk region *
Sakhalin region *
Primorsky krai *
Cont'd
1 2 3 4 5 6 7 8 9 10 11 12 13 14
Municipalites
City of Novosibirsk * * * * * *
City of Tomsk * * * * * * * * * *
City of Nizhniy Novgorod *
City of Omsk * *
City Volzhsky, Volgograd region *
City of Krasnoyarsk * * * * * *
City of Kazan * * * *
City of Krasnodar * *
City of Ufa *
City of Elekrostal, * *
Moscow region
Smolensk *
Lipetsk * *
Magadan * *
Bratsk *
Novorossiysk *
Ekaterinburg *
Klin district, Moscow * * *
region
Noginsk district, Moscow region * *
City of Blagoveshensk * *
City of Cheboksary * *
City of Balashikha,
Moscow region
Odintsovo district,
Moscow region
City of Astrakhan *
City of Briansk *
City of Voronezh *
City of Orekhovo-
Zuyevo, Moscow *
region
City of Yaroslavl *
City of Voronezh *
City of Yuzhno-Sakhalinsk *
City of Novocheboksarsk *
City of Angarsk *
Vurnarsky district, Republic of Chuvashia *
City of Shumerlia, Republic of Chuvashia *
City of Barnaul
City of Perm
City of Kostroma
City of Arkhangelsk
City of Dzerzhinsky
Source: Ministry of Finance of Russia.
3.2.4. Prospects for the development of market of regional and municipal borrowing
The outbreak of the crisis developments in the Russian economy directly related to putting in place lockdown orders in 2020 create preconditions for the expansion of the regional and municipal budgets' deficit.
This is due both to the contraction of the tax returns and to the need for additional spending aimed at expansion of the social assistance to households and businesses, to the need of the
implementation of anti-epidemiological measures. That said, capacities for the reduction of expenditure budget items are restricted by a significant volume of the non-reducible commitments on financing state and municipal organizations by legally fixed social payments.
In the meantime, the dynamic of deficit growth of the consolidated budget in the regions will depend on the following factors:
- on the duration and the depth of economic recession;
- on the selected support model from the federal budget (ration between additional direct fiscal transfers and reimbursable loans extended by the federal budget);
- on the ratio between the additionally provided funds from the federal budget and decline of the revenues in the consolidated regional budget and the volume of additionally popped up expenditure commitments with taking into account the capacity to relatively safely decrease of previously planned budget allocations.
This being said, we should lift legal restrictions applied to the amount of the budget deficit of the subjects of the Russian Federation and municipalities.
For example, in compliance with the Article 92 of the Budget Code of the Russian Federation, budget deficit of a subject of the Russian Federation should not exceed 15 percent of the approved total annual revenues of a subject of the Russian Federation without the approved volume of non-repayable receipts (10 percent - for highly subsidized regions).
Correspondingly, the local budgets' deficit should not exceed 10 percent of the approved total annual amount of revenues without the approved volume of non-repayable receipts and (or) tax returns under the additional normative of contributions (5 percent for highly subsidized municipalities).
The bank of Russia capacity for extending loans to commercial banks backed by bond issuance by regions positively affects the accessibility of borrowings for the regions' budgets.
From January 1, 2020, for bonds issued by the subjects of the Russian Federation the Bank of Russia raised the lowest level of the credit rating for inclusion on the Lombard list by 4 levels in the framework of countercyclical regulation - for the level "A+(RU)'7"ruA+" along the classification of the credit rating agencies AKPA (AO)/AO "Ekspert" (from "ruBBB").
As on April 14, 2020, 24 subjects in the Russian Federation boasted by this ratings (Table 20).
Furthermore, upon the inclusion of these bonds on the Lombard list in addition to ratings the Bank of Russia will take into consideration the conditions of bonds placement and circulation as well as other important factors.
Taking into consideration the feasibility of the regions' credit downgrade amid economic crisis and easing of the monetary policy by the Bank of Russia within the implementation of rescue measures, it will be expedient to put in place relaxation of the requirements to the credit level of regional and municipal issuers for the inclusion on the Lombard list.
Table 20
Credit ratings of the subjects and municipalities of the Russian Federation
(as on April, 14 2020)
RF subject / municipality AKRA (JSC) JSC "Ekspert RA"
1 2 3
Central Federal District
Belgorod region AA-(RU)
Voronezh region ruA-
Tver region BBB+(RU)
Kostroma region BBB-(RU)
Kursk region A+(RU)
Cont'd
1 2 3
Lipetsk region AA(RU)
Moscow region AA+(RU)
Ryazan region A-(RU)
Tambov region BBB+(RU)
Tula region ruA+
Yaroslavl region ruBBB+
City of Moscow AAA(RU)
North-West Federal District
Republic of Karelia ruBBB-
Kaliningrad region ruBBB+
Murmansk region A-(RU)
Novgorod region BBB(RU)
St. Petersburg AAA(RU)
Nenets autonomous okrug ruA+
Southern Federal Dstrict
Krasnodar krai A+(RU) ruAA-
Volgograd region ruA-
Republic of Adygea (Adygea) ruBBB
North-Caucasus Federal District
Stavropol krai | | ruA
Volga Federal District
Republic of Bashkortostan ruAAA
Republic of Mordovia B(RU)
Republic of Tatarstan (Tatarstan) AAA(RU) ruAAA
Udmurt republic ruBBB-
Chuvash republic--Chuvashia ruA
Nizhniy Novgorod region ruA
Kirov region ruBBB+
Samara region AA(RU)
Orenburg region A+(RU)
Penza region BBB+(RU)
Saratov region ruA-
Ulyanovsk region ruBBB+
Urals Federal District
Kurgan region
Sverdlovsk region A+(RU) ruAA-
Tyumen region AAA(RU)
Chelyabinsk region AA(RU)
Khanty-Mansi autonomous okrug--Yugra AAA(RU)
Yamal-Nenets autonomous okrug AAA(RU) ruAAA
Siberian Federal District
Altai krai A+(RU)
Krasnoyarsk krai A+(RU)
Irkutsk region ruAA+
Kemerovo region A-(RU)
Novosibirsk region AA-(RU)
Omsk region ruBBB+
Tomsk region BBB(RU)
Far-East Federal District
Republic of Buryatia ruBBB+
Republic of Sakha (Yakutia) ruAA-
Khabarovsk krai ruBBB
Kamchatka krai ruA+
Magadan region BBB-(RU)
Municipalities
Bratsk BBB(RU)
Krasnodar ruA
Krasnoyarsk ruA-
Nizhniy Novgorod A-(RU)
Novosibirsk ruA-
Note. Embolden are the RF subjects with the rating not below "A+(RU)"/"ruA+". Sources: on data released by AKRA (JSC) and JSC "Ekspert RA".
3.3. The Banking sector1
At 2019-end, Russian banking sector numbered 442 lending institutions. Over the year the number of operational lending institutions decreased by 42 (in 2018 - down by 77). Seven years ago in early 2013 the number of operational institutions exceeded one thousand (1094). Consequently, the Central Bank of Russia consistently has been conducting the bank resolution process (Fig. 66).
■ LI □ Subsidiaries ■ Representations
Fig. 66. Number of lending institutions, subsidiaries, and representations Source: Bank of Russia.
As of January 1, 2020, 373 lending institutions' profit hit RUB 2,196.4 billion and losses of 69 banks amounted to RUB 159.6 billion. On the whole, the share of loss-making institutions over the year went down from 29 to 16 percent.
3.3.1. Financial results of the banking sector
Total assets of the lending institutions went up over 2019 by 2.7 percent (up by 10.4 percent over the previous year), and banks' own funds moved up by 7.6 percent (up by 3.8 a year earlier).
In spite of a decline of interest rates on accounts and deposits, over 2019 banks managed to ramp up retail deposits volume by 7.3 percent down from 2018 (8.9 percent). Having said that growth was partially triggered by capitalization of the interest accrued on bank deposits. On the whole, the total growth of the deposits volume reduces the net interest earnings due to the relatively high cost of this type of bank liabilities. Over last year, the share pf deposits in the total volume of bank liabilities rose to 35.3 percent (at the end of 2018 - 33.6 percent).
The situation with attracted funds from legal entities was somewhat different. The growth rate of the aggregate volume of deposits and funds on accounts opened by the corporate clients
1 This section was written by Zubov S.A., Candidate of science (Economics), senior researcher, RANEPA.
over 2019 rose by mere 4.6 percent, which is substantially below the corresponding index of 2018 (up by 29.3 percent).
Regarding the active bank operations, the rise of the corporate lending constituted 1.2 percent against 10.5 percent seen in 2018. The growth rate of the retail lending in the past year also somewhat slowed down: from 22.4 percent in 2018 to 18.5 percent in 2019.
Over 2019, past-due payment on credits extended to non-financial organizations rose by 25.1 percent, however that was due to technical factors: in 2019 this index engulfed outstanding account receivable and overdue acquired receivables (operations on acquiring and assignment of receivables). With respect to retail credits growth of past due payments came to 0.5 percent of the total volume of extended credits, in other words somewhat decreased on the back of the credit portfolio increase. Despite the absolute growth of past due debt, its proportion in the credit portfolio declined as of January 1, 2020 to 4.3 percent (5.1 percent a year earlier).
Important factor impacting the financial results of the Russian financial sector was putting in place the new procedure for reflecting in accounting and reporting of reserves for potential losses which entered into force from January 1, 2019 in compliance with the Instructions issued by the Bank of Russia No. 4555-Y and 2556-Y of October 2, 2017. The new procedure envisages implementation of IFRS 9 standard. According to the new accounting rules received additional balance accounts and symbols "Report on financial results" which reflect reserves adjustments. The changes have also related to the methodology of the interest income accounting.
Decisions taken by the bank of Russia have contributed to the profitability of Russian banks. It has increased even in the context of the pressure brought to bear on the sector's profitability by the interest margin reduction, triggered by the cut in the key rate. At the end of 2019, ROA profitability stood at 2.1% and ROE profitability - at 20.3%. At 2018-end, these indicators constituted 1.4 and 12.4 percent, respectively. Most likely, in the near future bank analysts will include in their practice reserves adjusted profit calculation according to International Accounting Standards.1 To date this index demonstrates stagnation of the banking profitability (as of January 1, 2018, it stood at 13.8 percent and in 2019 - at 13.1 percent).
The structure of financial result of the banking sector compared to the same period of the previous year has undergone certain changes.
Shrinkage of bank margin triggered by the reduction of inflation and the key rate, forces banks to ramp up the fee-based income. In 2019, the fee-based income from private corporate loans increased by 72.1 percent and from the retail loans by 227.3 percent. The net income from operations with securities over the past year increased notably (up by RUB 164.7 billion or by 115.4 percent) which to a large extent was due to the growth of the stock exchange last year.
At the same time, banks are forced to more carefully plan their expenses linked to ensuring activities of credit institution including spending on personnel, on operations with fixed capital and non-material assets, organizational and managerial expenses. Operational effectiveness of the Russian lending institutions on average across sector went up: cost-to-income ratio, CIR over 2019 declined to 41 percent which demonstrates increased effectiveness of these expenses management (in the majority of EU countries this index is below 50 percent).
For the first time in recent years, the interest income generated from retail lending has exceeded that from the corporate clients. This is due to the growth of retail and corporate lending which rates are significantly higher than the crediting rates for legal entities.
1 International financial accounting standards.
3.3.2. Corporate lending
The total volume of loans issued to Russian enterprises of all form of ownership in non-financial and financial (minus banks) sectors and legal entities - non-residents (minus banks) over 2019 rose by RUB 992.7 billion or by 2.6 percent. Over the previous year, the rise was fundamentally higher and came to RUB 4,191.1 billion or 12.4 percent.
Growth of the aggregate corporate loans portfolio to a large extent was due to the increase of the loan volume denominated in the national currency - by 8.2 percent (in 2018 - up by 12.8 percent), meanwhile lending in foreign currency has fallen by 12.0 percent (over the previous year up by 11.4 percent). As a result, the amount of ruble loans as of end of October came to 76.3 percent in the total corporate loans portfolio.
Outstanding debt take-off has somewhat accelerated. Over 2019, total past-due corporate debt rose by 27.0 percent, a year earlier the increment constituted 6.0 percent. At the year-end, past-due debt amounts to 7.1 percent of the credit portfolio, in 2018 this index stood at 5.7 percent.
The government adopts measures aimed at stimulating corporate lending. In late 2018, the RF government adopted Resolution No. 1764 "On the Adoption of Rules for Granting Subsidies from the Federal Budget to the Russian Lending institutions to Offset Shortfall of Income from Loans Extended in 2019-2024 to Small and Medium-sized Businesses at Reduced Rate." In early 2019 the implementation of the program of preferential loans was launched in the framework of the national project "MSE and support of individual entrepreneurial initiative." The RF Ministry of Economic Development has approved a list of 70 banks in 29 regions for preferential loans extended to small and medium-sized businesses at the rate of 8.5 percent (the 2018 program included 15 authorized banks, reduced rate of 6.5 percent).
Owing to programs of preferential loans the amounts of credits extended to small and medium-sized businesses have gone up by 14.5 percent (to RUB 4,695.5 billion). Loans to individual entrepreneurs over 2019 were moving up faster than in the previous year: the increment came to 12.2 percent (a year earlier - 7.1 percent). As of January 1, 2020, the total preferential loans portfolio for MSE totaled RUB 527.0 billion or 11.7 percent of the overall volume of SME credit portfolio. The debt volume on the currency loans extended to individual entrepreneurs is insignificant (below 0.5 percent) and contracted over the year by 21.1 percent (over 2018 reduction came to 16.2 percent).
The rise of the inflationary expectations and the real inflation rate in early 2019 culminated in the nominal interest rates on the ruble loans on average in 2019 somewhat took-of against the previous year. Rates on dollar and euro loans declined following the cut in the FRS rate and zero rate of ECB (Fig. 67).
From January 1, 2020, ceased to be in force: the Instruction of the RF Central Bank No. 180-H "On Mandatory Statutory Ratios of Banks" and the Instruction No. 112-H "On Mandatory Statutory Ratios of Lending institutions Listing Mortgage-backed Securities." Instead from 2020 was put in force Instruction of the Bank of Russia No. 199-H "On Mandatory Statutory Ratios and Premiums to Statutory Ratios of Sufficiency of Capital of Banks with Universal License." The new approach envisages calculation of compulsory normative across counterparties' classes and allows to release capital for provision of additional resources for lending to the real sector of the economy.
12%
10%
8%
6%
4%
2%
0%
• Rates on ruble loans » Rates on euro loans
• Rates on dollar loans Inflation
Fig. 67. Corporate lending rates
Source: Bank of Russia.
The Instruction No. 199-H sets aside a category of borrowers "investment class" with a reduced risk ratio - 65 percent (to date-100 percent) when identifying them as I and II quality categories to create provisions and admission of the borrower's securities to listing. This decision should contribute to raise attractiveness of the corporate lending sector for banks. It also set a reduced risk rate of 85 percent regarding requirements applied to small and medium-sized businesses evaluated individually (previously risk ration of 100 percent was applied) where the borrowers' financial situation corresponds to the high quality standards (evaluated by banks according to their methodologies in compliance with the Bank of Russia instructions).
According to the requirements applied to small and medium sized businesses evaluated on the portfolio basis corresponding to criteria set by the Instruction a reduced ration of 75 percent is retained.
3.3.3. Retail lending
Analysis of the aggregate retail credit portfolio for 2019 demonstrates run-up of the household debt load: monthly rates of credits advance originated by banks to households vary in the range of 1-2 percent, the total retail loaning debt from the onset of 2019 has moved up by 18.4 percent and as of January 1, 2020 amounted to RUB 17.6 trillion. At the same time, according the Bank of Russia1 the upsurge of unsecure consumer lending positively affects the consumer dynamic and GDP, without this factor the economic growth would have been significantly lower. However, the issue of reducing risks for ensuring financial sustainability remains in the years to come.
1 Evaluation of the contribution of the unsecure consumer lending and auto credits in the consumption growth and GSP. Report of the Bank of Russia "Accelerated growth of consumer loans in the structure of bank lending: reasons, risks and measures of the Bank of Russia" June 2019.
In 2019, households' budgets following their multiyear contraction were in stagnation: cash income (average per capita) amounted to RUB 40.9 thousand per month and went up compared to 2018 by 6.1 percent meanwhile the real disposable income of the population have risen by merely 0.8 percent. Against this backdrop, the positive role of consumer lending consisted both in maintaining the spending volume of the population on final consumption and in sustainability of the households' savings.
A number of factors mark a somewhat improvement of the credit environment in 2019. For example, at Q2 - end 2019, FICO registered the credit health index growth calculated on the data released by the National Bureau of Credit Histories (NBCH). At the year-end 2019 the index hit 96 points and thus to values reported prior to December crisis of 2014, when amid the plunge of the oil prices and collapse of the ruble exchange rate the regulator raised the key rate to 17 percent annualized.1 The index envisages identification of bad debts with 60 days past due over last six months.
According to the Bank of Russia, as of mid-2019 the number of complaints received by the central bank related to "Consumer lending" declined compared to 2018 by 5.4 percent and came to 28.2 thousand. Nevertheless, retail lending remains one of the most acute issues in the banks' activities with clients: the share of consumer and mortgage leans account for 38.1 and 10.2 percent of the total number of complaints (40.5 and 16.7 percent in 2018). Most often citizens' appeals dealt with credit repayment including refusals for their restructuring and refinancing (24.5 percent), with obtrusive automatic notification (14.4 percent), and violation of the rights of citizens on repayment of the past due debt (11.1 percent).
Assessments made by representatives of the banking community regarding the state of the consumer lending market in Russia vary notably. Many see serious risks in the spike of the consumer lending volumes, others speak about the lack of the universal credit overhang of the Russian borrowers. That said, the latter consider that there are no any grounds for the inception of the lending 'bubble' in the near future. Nominal wages growth and reduction of the interest rates serve as arguments in justification of the credit demand rise and simultaneously it is emphasized that the clients' solvency is substantiated by a high level of early payments.
Overstated concerns related to debt overburden of the households are also supported by the ratio between the consumer loans volume and deposits volume, which at the year-end 2019 constituted 57 percent while the acceptable ratio stands at 80-90 percent (as in EU countries) that demonstrates an ongoing potential for the retail lending growth.
Banks are interested in ramping up consumer lending in order to raise their income amid a reduction of the interest margin. Steady growth (and in Q3 2019 - even outstripping) of interest income generated by retail lending compared to corporate lending is a fundamental incentive for the expansion of the credit proposal to the population but carries the risk of subsequent market 'overheating' (Fig. 68).
The central bank, the Ministry of Economic Development and Finance Ministry of Russia time and again expressed their preoccupation with the extension of the consumer lending, and are taking concrete steps in an effort to restrict it.
One of the factors, which had to impact banks' policy was the introduction by the Bank of Russia from October 1, 2019 in regulatory documents debt burden indicator (DBI) designed to introduce premiums on the risk rates depending on the state of the credit portfolio. DBI is calculated as a ratio of monthly average payments across all credits of a borrower to his monthly
1 URL: https://www.nbki.ru/company/news/?id=27458.
average income and is taken into account on extending a loan in excess of RUB 10 thousand at the credit limit discretion on the credit card at prolongation of credit contract life or at the debt restructuring. Previously, credit institutions used this indicator for the similar purposes. This is designed to restrict banks' expansion on the consumer lending market - the majority of lending institutions will have to adjust their procedures to the Bank of Russia requirements and be more inventive in approaching lending in highly risky segments.
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0
QI 2018 QII 2018 QIIII 2018 QIV 2018 QI 2019 QII 2019 QIIII 2019 QIV 2019
□ Individuals □ Legal entity
Fig. 68. Interest income generated from retail and corporate loans, Rb billion Sources: Bank of Russia. URL: http://www.cbr.ru/credit/forms/.
Besides, from January 31, 2019, amendments to the Federal Law "On Credits Histories" entered into force according to which Russians get personal credit rating which is a score constructed on the basis of personal history. The value of the rating is affected by loan delinquencies, level of debt burden, number of requests for credit history inspection and other indicators. Introduction of the personal credit rating should assist banks in proactively take decisions on extending a loan, reduce operational costs. This being said, accessibility of loans for citizens with low rating will be falling, which, in its turn, can affect the divergence of the interest rates and slowdown of growth of the aggregate credit portfolio volume.
According to the Bank of Russia over 2019, the volume of ruble mortgage loans originated to individuals-residents moved up by 17.0% hitting RUB 7.5 trillion. This was driven by systematic reduction of the key rate, which the Bank of Russia carried out 5 times in the course of 2019. Demand hike for mortgage loans in the context of record-low mortgage interest rates was due to the households' demand for the resolution of the residential problem. A certain role in the mortgage demand growth today was also played by a transition to the new procedure of housing purchase by way of application of project financing and escrow accounts according. According to this scheme the developers had to borrow from banks for the construction which will trigger price hikes in newly erected buildings.
In early 2019 the microloan market was affected by the Law No. 554-FZ adopted in late 2018 and envisaging a significant restriction regarding a very expensive type of lending as 'pay day loans.' Putting in place of the new regulation triggered a reduction of the annual interest rate on this type of financial services. Main restrictions were: reduction of the maximum rate on microloan from 1.5 to 1 percent per day and reduction of the maximum asking amount from
2.5-fold of the originally borrowed amount to 2-fold. Owing to those measures at the year-end 2019 the highest annual interest rate on microloans considerably declined to 365 percent against 842 percent seen over the previous year.
Despite this novation, in Q2 2019 the microloan market demonstrated an upward trend of key indexes: microloan portfolio increased by 16 percent, quarterly origination of loans was up by 11 percent. At the same time, past due debt went on growing: NPL indicator 90+ (90+ days past due) hit an all-time high of 27.3 percent in late June, which probably, demonstrates aggressive strategy in an effort to "capture market" to the detriment of its quality ahead of a new round of restrictions which will come into force in 2020 as well as well as the impact of digitalization and expansion of online origination of PDL loans (Pay Day Loans - short-term loans of up to 30 days).
'Business as usual' scenario regarding the situation on the consumer lending market and microloan market in 2020 envisages selected deceleration of the volumes growth rates due to the influence of macro prudential and monetary policies conducted by the Bank of Russia. Forced contraction of supply on the retail lending will tell on the pricing policy of the commercial banks, which can trigger a reduction of rates on accounts and deposits and growth of commissions and tariffs. In the event measures adopted by the government and the Bank of Russia aimed at the cooling of the retail lending market will be materialized then we can expect an increase in corporate lending.
In the event of growing crisis developments in the economy on the back of negative factors (plunge of crude oil prices, inflation rise, and ruble's devaluation), a reduction of lending volumes, growth of interest rates, and decline of banks' income will be conceivable. The outbreak of recession in financial and banking sector can trigger risks of non-payments, which, in its turn, can result in a serious revaluation of banks' credit portfolios, spending growth on reserves build up and capital loss by credit institutions. Under this scenario the situation will depend on the stabilization measures undertaken by the government and the central bank, on their inclusiveness and timeliness.
3.3.4. Banking sector resources
Among the most significant components of the banking sector resources still remain retail deposits (31.6 percent of all bank liabilities), deposits of legal entities minus lending institutions (19.1 percent), organizations' current accounts (11.4 percent), and raised funds from banks including Bank of Russia (11.0 percent).
Retail deposits on ruble and currency bank accounts at 2019-end hit RUB 30.5 trillion, increase over past year amounted by RUB 2.1 trillion or 7.3 percent (in 2018, retail bank accounts grew by 8.9 percent). Slowdown of the retail bank accounts growth over last two years was due to the transition from the savings to consumption and investment models of behavior. Consumption growth rates amid real income stagnation were ensured by an increase of bank loan debt. Meanwhile, moderate revival of interest of the population towards investments in real estate and operations on the stock market has been observed.
Bank deposits growth was ensured, first of all, by the increment of ruble deposits by 9.9 percent (in 2018 - by 7.6 percent). Currency accounts volume in ruble equivalent decreased during the last year by 2.2 percent (the previous year demonstrated growth by 13.7 percent). However, taking into consideration USD exchange rate dynamics (ruble's depreciation in 2018 and its appreciation in 2019) seen over the last year, an increment of the dollar equivalent of
currency accounts by 9.8 percent was observed, meanwhile in 2018 the same indicator fell by 5.7 percent (Fig. 69).
The level of deposits' dollarization1 of the population remains modest: over the year, the share of funds on currency deposits in ruble equivalent in the overall deposits volume decreased from 21.5 to 19.6 percent, which is due to the ruble appreciation in the first place.
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I Currency deposits Rate on USD deposits
Fig. 69. Volumes of raised funds to retail deposits (trillion rubles) and interest
rates on deposits (percent)
Source: Bank of Russia.
Another important component of the Russian banks' resource base are corporate deposits, which went up during 2019 by RUB 0.14 trillion or by 4.6 percent hitting RUB 18.5 trillion. Compared to the last year, growth rates of such deposits have significantly contracted (in 2018 growth amounted to 29.3 percent). This is primarily due to the contraction of currency deposits. However, taking into account the dollar exchange rate, the decline of dollar equivalent of currency deposits slowed down by 1.2 percent in 2019 against 5.8 percent in 2018 (Fig. 70).
Interest rates on ruble deposits declined by 15.8 percent (in 2018 up by 7.1 percent), contraction on dollar deposits was much more significant - 64.7 percent, meanwhile in 2018, growth hit 102.1 percent. At year-end 2019, many banks put an end to accepting euros on corporate deposits due to the fact that interest rates on deposits in the EU were in the red.
Transaction interest-free deposits2 demonstrated last year a sustainable growth: total amount of such accounts during last year went up by 5.7 percent (over 2018 by 7.9 percent) hitting RUB 11 trillion.
Banks' debt commitments remain not too attractive financial instruments for the clients: compared to interest-bearing deposits their issuance volume is insignificant. Total volume of bonds at 2019-end hit RUB 1.9 trillion (in 2018 - RUB 1.3 trillion) up by 41.1 percent during
1 Deposits in all currencies are taken into consideration.
2 Funds of legal entities and retail operating and current accounts, resources in settlements, factoring and forfaiting transactions.
the year (up by 9.7 percent over past year). The volume of issued promissory notes came to RUB 0.38 trillion down by 12.8 percent (over 2018 - up by 2.5 percent). The total volume of issued debt securities and savings certificates contracted by 75.8 percent (down by 61.0% percent during 2018) and stays at a low level - RUB 0.04 trillion
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Interest rate on deposits in USD
Fig. 70. Volumes of funds raised on corporate deposits (trillion rubles) and interests on deposits (percent)
Source: Bank of Russia.
Decrease of borrowing on the interbank market demonstrates a reduction of dependence on the most volatile sources of funding. During the year, the volume of loans and deposits originated by the resident banks went down by 8.3 percent (down by 3.3 percent in 2018).
Alongside this, the volume of funds raised from the non-resident banks continued a downward trend, over the year it decreased by 32.3 percent in the ruble equivalent (up by 20.7 percent in 2018).
As far as borrowings from the Bank of Russia go, they decreased over the past year by 6.0 percent, meanwhile in 2018 a significant growth was observed - by 29.3 percent. Taking into consideration the short term of borrowings, one can draw a conclusion on the improvement of the bank liquidity.
The level of the bank resources concentration remains high. The share of five major banks as for the size of assets of lending organizations account for 65.5 percent of retail deposits (in 2018, this indicator stood at 65.1 percent), and 59.2 percent of corporate deposits (61.2 percent). The share of raised funds by way of credits from the Bank of Russia decreased slightly - by 24.7 percent (in 2018 - 32.9 percent).
In 2020, under the escalation of the crisis developments related to the oil prices and the outbreak of the coronavirus pandemic, surge of inflation and ruble's devaluation are feasible, which will lead to an increased demand for foreign currencies and contraction of ruble savings. In case of this scenario implementation the stability of the banks' resource base will be dependent of the timeline of the crisis development and measures undertaken by the government and the Bank of Russia.
