Page 20 - IFR Opportunities in Russian capital markets

CHAPTER 01
ifrintelligence reports/Opportunities in: Russian Capital Markets
State Venture Capital Fund
The most recent addition to the family is the Russian Venture Capital (RVC) Fund. Some US$500m has been earmarked from the State Investment Fund to finance about a dozen venture capital funds that are intended to create from scratch a venture capital industry in Russia and at the same time unleash Russia's intellectual capital. (For more on this, see below.)
The state is basing the RVC Fund on Israel's experience, where the state put in US$200m of seed capital and raised US$8bn in private funding for venture capital products.
Three companies were awarded the first venture fund tender in May and gained access to the RVC Fund. The winners were the fund set up by Russia's VTB bank jointly with the European Bank for Reconstruction and Development (EBRD), the fund established by Bioprocess Capital, a Russian pharmaceuticals group, and Israeli Tamir Fishman Group's fund with Russian partners.
State Future Generations Fund
The next fund in the works is a state social fund that will be used to make ad hoc payments in the social sphere, such as one-off payments to pensioners. This latest fund is slated to appear in the second half of 2007 and the government says it will eventually be worth 10% of GDP.
Inflation
Despite Russia's impressive macroeconomic fundamentals, there are still some nasty problems to fix. One of the most difficult is curbing inflation, which has been stubbornly high.
After the government missed its self-imposed inflationary target of 10% in 2005 with an end-of- year 10.9% inflation rate, the Kremlin was buoyed by coming inside the 9% target in 2006 – the first time in modern history that the Russian economy has enjoyed inflation in single digits (see Figure 1.9). Hitting the target is important, as one of the components that drives inflation is the expectation of rising prices, so missing targets is in itself inflationary.
The government has been holding down inflationary tariff hikes to prices for essential services such as gas and electricity in recent years as an administrative means of containing inflation. However, economists say that in the last few years the drivers of inflation are increasingly crossing over to the market where the state has no ability to reduce inflation by administrative means.
Traditionally, the CBR's only monetary policy tool has been intervention in the foreign exchange (FX) market as a way of injecting cash into the financial system. The CBR has used this tool to pursue the twin policy of reducing inflation and holding back ruble appreciation against the dollar. However, economists say that it is impossible to control these two variables with only one tool – and a crude one at that.
Interest rate control
The race is now on between the CBR and the growing economy. The CBR is working towards bringing inflation down to the point where its overnight interest rates are greater than inflation and so ‘turn on’ the traditional tool of central bank money management – interest rate hikes. It is a slow process, as hiking interest rates fast affects liquidity in the still fragile banking sector and could spark another bank crisis, but economists say the CBR is within a year or so of making the key overnight interest rates a real tool of monetary policy. (For more on this, see the Chapter 4.)
The CBR was off to a good start in the first month of 2007, with inflation rates coming in signifi- cantly under target. On the back of this good news the government has revised its inflation projections and expects inflation to be 8% over 2007, 7% in 2008, 6.8% in 2009 and 6.5% in 2010.
A testament to the robustness of Russia's economic growth is the fact that the state has begun to raise tariffs more quickly, as the priority shifts from containing inflation to creating badly-needed investment capital for the likes of Gazprom and United Energy Systems, which provide Russia with its essential gas and power.
In December 2006, the government announced a plan to gradually deregulate gas and electricity tariffs for industrial customers. The domestic price of gas will rise from US$44 per thousand cubic metres at the end of 2006 to US$125 by 2011, according to Andrei Klepach, the head of the macro- economic forecasting department at the Ministry of Economic Development and Trade.
These figures may be revised upwards again, Klepach said in the first week of January. "A new mechanism of regulation of the power market is required. If no such mechanism is found, infla- tionary risks are likely to increase greatly." Analysts were surprised by the accelerated increases in tariffs, coming in an election year.
13