Source: estimates by the Institute for theEconomy in Transition based on RF Finance Ministry data

The principal amount of the debt onmunicipal bonds was reduced by Rb1.7 billion and the debt on loans receivedfrom a higher-level budget, by Rb3.2 billion. The local budgets' balances atcommercial banks rose by Rb1.04 billion. But the principal amount of the debton commercial bank loans increased by Rb2.3 billion, mainly due to theconversion of interest arrears into the principal and the use of bank loans tomake the payments of loan bonds. Even when the local budget showed a surplus,commercial banks found themselves obliged to increase their lending to it(Table 1.24).

It should be noted that the use of loans tofinance extrabudgetary funds is not usually captured in budgetary statistics.This is why the growth of bank lending to territorial budgets while the overallvolume of commercial banks' claims on local authorities remained practicallythe same indicates a reduction of loan-based financing of the regions'extrabudgetary programs.

The issue of loan bonds

The year 1998 witnessed the registration ofissue prospectuses for domestic bonds of 23 RF constituent members to theamount of Rb12.6 billion and nine municipal entities to the amount of Rb417.24million, as well as four foreign bonds of two RF constituent members to theamount of $800 million, DM500 million, and ITL750 billion.

The crash of demand for Russian securitiesas a result of the financial crisis sharply reduced the volume of issue: inSeptember, there were no new issues, in October, loan bonds were issued in theKhabarovsk Krai (to the amount of Rb277.84 million); in November, in Yaroslavl(Rb18.285 million); and in December, in the Rostov Oblast (Rb190 million). Ascompared to the pre-crisis period, the overall volume of new issues in thefourth quarter of 1998 dropped to almost one ninth, this not countinginflation.

One can identify four basic types ofsubfederal loans issued during 1997-1998: external Eurobond loans, agrobondsand energy bonds, bonds circulating on the exchange market, and securitiesunlisted on stock markets.

Foreign regional loans. In 1997, on the crest of a "favorable wave" more than 20 Russianregions were getting ready to enter the Eurobond market. A number of them weregiven an international credit rating by Moody's, Standard & Poor's, andIBCA Fitch at RF level. The Finance Ministry registered issue prospectuses forfour RF constituent members: Moscow, St. Petersburg, the Nizhny Novgorod Oblastand the Moscow Oblast (Table 1.25). By June 1998, the RF President's decreesgave permission to issue foreign loan bonds to 12 constituent members of theFederation, including the Republic of Komi, Tatarstan, the Krasnoyarsk Krai,and the Leningrad, Orel, Samara, Sverdlovsk and Chelyabinskoblasts.

Table 1.25

Subfederal external bondissues
registered with the RF Ministry of Finance

1 A ITL400аbillionportion has been floated

2аNotfloated

Source: RF Ministry of Financedata.

An intention to issue Eurobonds wasannounced by at least 10 other constituent members of the Federation, which hadnot by that time been authorized to do so, including the republics ofSakha-Yakutia and Bashkortostan, the Khanty-Mansi and Yamal-Nenets okrugs, andthe Astrakhan and Perm oblasts. The planned overall volume of regional Eurobondloans in 1998 was to reach at least $4 billion.

However, by May 1998, due to the foreigninvestors' undermined confidence the floating of regional Eurobonds was in factfrozen. The $500 million Moscow loan denominated in US dollars provedimpossible to float.

Failing to float three-five year foreignloans and extremely high nominal interest rates on domestic borrowing, a numberof Russian regions, including the Republic of Sakha (Yakutia), Tatarstan, theYamal-Nenets Okrug and the Leningrad Oblast resorted to foreign short-term bankloans. It should be noted that unlike the issue of Eurobonds, such loans do notrequire authorization from the federal authorities.

The credit rating of Russian regions wasgoing down simultaneously with that of the country generally, and as atSeptember 16 it did not rise above the CCC- level on the Standard & Poor'sscale, which effectively banned their access to the market for untied privateloans. Despite the Russian regions' timely servicing of foreign bonds, the 1998yields on subfederal Eurobonds (maturing in 2000-2002) on the secondary marketwere over 100 per cent per annum in US dollars, exceeding by several dozenpercentage points the yields on federal securities with the samematurity.

The financial crisis entailed a default onforeign bank loans in a number of regions, including the republics of Tatarstanand Sakha (Yakutia). However, no Russian region was in arrears on Eurobondredemption.

Agrobonds and energy bonds. Agrobonds and energy bonds were issued by RF constituent membersto restructure their debts to the federal budget on the 1996 loans grantedagainst goods to enterprises of the agro-industrial complex, and 1993-1995loans given to energy and electricity producers. The RF constituent members'authorities guaranteed repayment to the federal budget, which acted as thelender. A specific feature of the agrobonds is their unified issue: they arefloated in equal tranches for a term of one, two or three years; they are issuein paperless form; their coupon yields amount to 10 per cent per annum. Thefloating of agro- and energy bonds was (for some tranches, still is) done byauctioning at a discount.

The floating and circulation of these bondson the secondary market takes place within the trading system of the MoscowInterbank Currency Exchange. It is worth noting the extremely low liquidity ofthe secondary market for this type of bonds due to the relatively small size ofeach individual tranche.

The year 1997 saw the registration of 193agrobond issue prospectuses for the total amount of Rb6.6372 trillion, andeight energy bond prospectuses for the amount of Rb795.18 billion. In the firsthalf of 1998, the overall volume of the 18 registered issues of agrobonds andenergy bonds was 722.61 million redenominated rubles.

The long maturity of the agrobonds, thanksto which under the Russian law nonresidents can count on repatriation of theexpected revenues, promoted their floating among foreign investors in thefavorable situation of 1997. The Federal Commission for the Securities Marketestimates that nonresidents purchased over 70 per cent to 75 per cent ofindividual issues of agrobonds with a two- or three-year maturity issued byRussian regions with a view to restructuring their debts to the federalgovernment.

Since agrobonds were not issued on theinitiative of regional administrations but under pressure from the RF FinanceMinistry, they were floated among outside investors (registered outside thegiven region's territory), and some issues were not floated but remained at thedisposal of the Finance Ministry. Many issuers do not regard the redemption ofthese securities as a priority task. however. The regions have to repay theloans to the agro-industrial complex which they guaranteed and which used to bewritten off and, consequently, were usually employed inefficiently.

After the federal government declared adefault on domestic bonds, the overwhelming majority of regions refused to maketimely payments on agrobonds.

By end-1998, only 10 (out of more than 60)regions that had issued agro- and energy bonds managed to meet theirobligations on these securities on time: Karelia, the Krasnodar Krai, theLeningrad Oblast, Orenburg Oblast, Sakha (Yakutia), the Tomsk Oblast, RostovOblast, Khakassia and Chuvashia.

Investors won several court cases involvingregions' failure to service "agrobonds". However, the execution of judicialdecisions is often impossible due to crises in the execution of regionalbudgets. Since in most regions noncash tax revenues (through netting-outoperations) constitute more than 50 per cent of the budgets' own revenues,administrations of the RF constituent members are negotiating the possibilityto meet their "agrobond" obligations through deliveries of goods manufacturedby taxpayer enterprises.

The market for subfederal securities.As at the beginning of July 1998, apart from therelatively non-liquid agro- and energy bonds, securities issued by 17 RFconstituent members were circulating on the Russian securities market (Table1.26).

The largest issuers of bonds floated on thesecurities market were Moscow, St. Petersburg, the Republic of Sakha (Yakutia),the Omsk and Sverdlovsk oblasts, and Tatarstan. Trade in subfederal securitieswas concentrated mainly on three exchanges: the St. Petersburg InterbankCurrency Exchange, the Moscow Interbank Currency Exchange, and the Moscow StockMarket.

Table 1.26

Issue of subfederal domestic securities
1997 to 19981

Issuer	Sizeof issue	Exchange
	1997 in blns ofRbs	1998 in millions of Rbs
RF constituent members
Moscow	4а600	2а800	SPCEX, MICEX, MSE,MCSE
St. Petersburg	1а250	2а840	SPCEX, St. PetersburgSE
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