Clsa Russia

R U S S IA R E S EA R C H
RUSSIAN INVESTMENT ATLAS
September
1998

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
FIGURE 1: RUSSIA: KEY FACTS

Land area
17,075,400sq km
(45% forest, 4% water, 13% cultivated land)
Capital
Moscow
Population
147.9m
Population density
Urbanisation rate (% of population)
Life expectancy (1996)
Language
Russian
US$1 = 11.3 Rbl

(as at 14 September 98)
1997 inflation (year-end)

Average inflation rate (1992-98)
Crude oil
17
Oil products
Coal and electricity
Metals
21
Machinery & equipment
10
65.9 years
Exchange rate
1997 GDP per capita
19
75%
Rouble
Cagr real GDP (1992-98)
Natural gas
8.7 (per sq km)
Currency unit
1997 GDP
Main exports (%)
US$445bn
(29%)
US$3,033
11%
Chemical products
Timber products
Other
10
Main imports (%)

Food
26
Metals
Clothing & household goods
15
Machinery and equipment
35
Chemicals
15
Main trading partners
Ukraine, Germany, Eastern Europe
533%
Present equity market capitalisation
1997 Unemployment
US$20bn
10%
1997 Equity market PE ratio
1997 Private sector % of GDP

1997 Current account % of GDP
1997 Net debt to exports
8.1x
70%
1%
Next elections
Dec 1999 - parliamentary
134%
1997 Foreign exchange reserves
US$17.8bn
1997 Budget balance % of GDP
(7.5%)
1997 Trade balance % of GDP
4.4%
No. of months of import cover
2.5
June 2000 - presidential
Credit rating
Standard & Poors
CCC
Moodys
B3
Source: CLSA Global Emerging Markets
This report is produced by Credit Lyonnais Securities Asia for private circulation. All information, views and advice are given in good faith but without legal responsibility. Credit Lyonnais Securities Asia or
companies or individuals connected with it may have used research material before publication and may have positions in or may be materially interested in any of the stocks in any of the markets mentioned.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
Contents
Its a riddle wrapped in a mystery inside an enigma
- Winston Churchill
Overview - Why an atlas? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Geography - The 21 Club . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Politics - A democracy of sorts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Economy - The once and future problem . . . . . . . . . . . . . . . . . . . . . 29
Investment - Finding value in Russia . . . . . . . . . . . . . . . . . . . . . . . . . 46
Russia sector by sectore . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Power generation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Oil production, refining and gas industries . . . . . . . . . . . . . . . . . . . . . 66
Telecoms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
Banking and Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Automotive Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
Cement and Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86
Metals and Metallurgy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
Pulp and Paper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
14 September 1998
Analyst : Paulina McGroarty
: (44) 171 214 5427
e-mail : Paulina.McGroarty@creditlyonnais.co.uk

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
FIGURE 2: RUSSIAN EQUITY MARKET STATISTICS

Year to 31 December
Earnings (Rbl m)
Total equity (Rbl m)
Mkt cap (Rbl m)
Mkt earnings growth (%)
PE (x)
ROE (%)
P/Book (x)
1994A
15,035
362,918
22,040
12.20
4.10
0.51
1995A
41,882
679,358
46,317
178.60
4.38
6.20
0.27
1996A
46,008
831,531
164,584
9.90
3.99
5.50
0.22
1997A
32,066
859,856
503,425
35.00
5.72
3.70
0.21
1998CL
24,457
n.a.
183,497
(23.7)
7.5
n.a.
n.a.
1999CL
44,171
n.a.
183,497
(6.0)
4.2
n.a.
n.a.
FIGURE 3: RUSSIAN GDP STATISTICS

Year to 31 December
GDP nominal (Rbl bn)
YoY % real
GDP nominal ($ bn)
GDP per capita ($)
1992A
19
(15)
83
562
1993A
172
(9)
184
1,242
1994A
611
(13)
277
1,873
1995A
1,630
(4)
357
2,421
1996A
2,256
(5)
440
2,972
1997A
2,675
1
446
3,022
1998CL
6,286
(6)
419
2,857
1999CL
7,962
(5)
398
2,708
2000CL
5,852
(2)
390.1
2,645
FIGURE 4: AVERAGE RUSSIA WEIGHTINGS IN EASTERN EUROPEAN EQUITY FUNDS

(%)
(%)
530
42
480
37
430
32
380
27
330
22
280
17
230
12
180
130
80
Sep 95
Dec 95
Mar 96
Jun 96
Sep 96
Dec 96
MOSCOW TIMES (US$ return, rebased)
Mar 97
Jun 97
Sep 97
Dec 97
Mar 98
Jun 98
Weighted avg weightings (RHS)
Simple avg weightings (RHS)

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
OVERVIEW - WHY AN ATLAS?

Investors are attracted to Russia not for its reality but its potential. Along with India
and China, the other sleeping behemoths of the emerging world, Russia has the
potential to become again what it once was: a world superpower. However, the
events of recent weeks have again relegated Russia to the status of the Sick Man
of Europe. Investor interest in Russia has fallen to a nadir, but as with all things
financial, the cycle will turn and brokers will one day start calling clients about
Russias Renaissance. Even now, the country is still of great interest to direct
investors because of its vast natural resources and its huge and untapped consumer
base, and it is still freely investable by portfolio investors. There are still investments
to be made, by the brave - or the patient.
Russia is in a league of its own in Emerging Europe. Inside its sheer physical mass,
bridging Europe and Asia, could fit Western Europe several times over. The
countrys $445bn 1997 GDP was more than that of all its Eastern European
neighbours combined, although its 0.8% growth was hardly impressive. In part, this
poor growth represents Russias slow escape from the long shadow of communism.
If one figures that it has taken China 20 years of slow steps and a mainly closed
economy to restructure itself towards capitalism - and that China is still only halfway
there - it puts into perspective just how far parts of Russia have come in a short
time. However, under the veneer of capitalism remains an economy with vast
numbers of companies that could not survive in a wholly capitalist system and,
in fact, a very distant understanding of basic capitalist principles. One need only
look at the support for Communist Party Chief Zyuganovs post-crisis comments
that the government should re-impose a command economy.
Russias eventual rise will occur as the country develops an economically viable
manufacturing industry and banking system. We believe that an economy of 150m
people cannot be expected to prosper based on the export of primary commodities
to finance the import of manufactured goods and food. And Russian manufacturing
cannot grow quickly without a real banking system, based on retail loans and
deposits, not foreign exchange punting, to finance it. This is where the money is
to be made in Russia, and judging by the experience of other emerging markets
the potential for gains when a market is deeply nascent is tremendous. The rise
in the RTS from 100 to 600 in the space of two short years demonstrates the potential
that exists if a proper recovery can be maintained. Even now, the price of Russian
equities post the financial crisis has been reduced to option money, with Russian
oil companies shares selling for less than 50 cents per barrel of reserves, vs $8/
bbl for most Western oil majors. However Russia - despite being a market which
now more than ever is in the initial stages of emerging - is an ex-superpower
with a long and complicated history. Understanding the country is further
complicated by its massive size and unique mix of Asian and European mindsets.
The Atlas is our effort, via focusing on the countrys economics, politics, geography
and industries, to help investors understand the complex beast that is Russia - a
country that, someday, can be great again.
POTENTIAL
VS REALITY
IT TOOK CHINA 20 YEARS TO

OPEN ITS ECONOMY AND IT S
STILL ONLY HALFWAY THERE.
RUSSIA
WILL TAKE AS LONG
RUSSIA
NEEDS A VIABLE
BANKING SYSTEM AND

MANUFACTURING BASE

Norilsk Nickel
East Siberian
Sea
Bering Sea
N V E S T M E N T
St. Petersburg
Telephone
Gazprom
UES
Sberbank
Lukoil
Rostelecom
Mosenergo
Laptev Sea
Barents Sea
Kara Sea
Kaliningrad
St. Petersburg
Magadan
Arkhangelsk
Norilsk
Sea of
Okhotsk
Vorkuta
Surgutneftegaz
Yakutsk
Moscow
nt
Nizhny Novgorod
al
Kazan
Ufa
Sakhalin
Island
Surgut
Siberia
Uralmash
Kurili Islands
Yekaterinburg
Tyumen
Samara
ou
Ur
Nizhnovsvyazinform
Saratov
n
ai
U S S I A N
Arctic Ocean
Chelyabinsk
Khabarovsk
Omsk
Tomsk
T L A S
Krasnoyarsk
Novosibirsk
Irkutsk
Tatneft
Vladivostok
Bashneft
Caspian
Sea
Aral Sea
Irkutsk Energo
Fesco
CLSA
September 1998
FIGURE 5: THE MARKET PLACE

CLSA
Norwegian
Sea
Kara Sea
FINLAND
East Siberian
Sea
Barents
Sea
RUSSIAN FEDERATION
St. Petersburg
Novgorod
Moscow
Baltic
Sea
SWEDEN
U S S I A N
Yakutsk
NORWAY
Nizhny Novgorod
St. Petersburg
Novosibirsk
Sea of
Okhotsk
Irkutsk
Volgograd
Tallinn
Novgorod
Vladivostock
ESTONIA
Moscow
Riga
LATVIA
Nizhny Novgorod
KAZAKHSTAN
LITHUANIA
Minsk
Vilnius
Bishkek
KYRGYSTAN
Samara
Tashkent
BELARUS
Aral Sea
Warsaw
Kiev
POLAND
Volgograd
CZECH REPUBLIC
SLOVAK REPUBLIC
Kishinev
Odesa
CROATIA
BOSNIA
GEORGIA
Bucharest
Tbilisi
Baku
PAKISTAN
ARMENIA AZERBAIJAN
Black Sea
Yerevan
Caspian Sea
BULGARIA
Skopje
TiranaMACEDONIA
TURKEY
ALBANIA
GREECE
Aegean
Sea
IRAN

T L A S
Sofia
Varna
SERBIA
Adriatic
Sea
TURKMENISTAN
Grozny
Ashkhabad
Belgrade
Sarajevo
ITALY
Krasnodar
ROMANIA
Ljubljana
TAJIKISTAN
Dushanbe
MOLDOVA
Bratislava
Budapest
HUNGARY
Zagreb
UZBEKISTAN
UKRAINE
Lviv
Prague
SLOVENIA
N V E S T M E N T
Akmola
Kaliningrad
AUSTRIA
Kazan
North Sea
September 1998
FIGURE 6: THE BORDERS OF THE FORMER SOVIET UNION
U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
FIGURE 7: RUSSIAs 89 ADMINISTRATIVE DIVISIONS

Republics
Krays (territories)
Oblasts (regions)
Autonomous regions
Autonomous areas
Districts
Cities and towns
21
6
49
1
10
1,869
1,092
GEOGRAPHY - THE 21 CLUB

VAST, WEALTHY TERRITORY; FEW INHABITANTS
RUSSIA CONTAINS THE
BIGGEST MINERAL RESERVES
OF ANY COUNTRY IN THE
WORLD
EAST
THIRD
VS
Russia can be separated into two large geographic areas, then further into 12 distinct
geographical regions. European Russia, which stretches from its borders in Easter
Europe to the Ural Mountains, is densely populated, with a predominance of
consumer and military industries. On the other side of the Urals, Siberia and the
Far East are the sources of commodities, especially oil, gas and ores. Transportation,
communication and power transmission infrastructure are much more developed to
the west of the Urals. While European Russia is likely to benefit from a move
towards a consumer-oriented, small-business driven economy, raw commodities
extraction is likely to support the economies of Siberia and the Far East for at least
another five years.
WEST
LARGEST COUNTRY BY
LANDMASS, BUT ONLY

PEOPLE
Russia is the third largest country in the world, occupying more than 11% of the
worlds land area and spanning 11 time zones. Yet it represents a little over 2%
of the worlds GDP and has a population of only 148m people. Formerly one of
the largest states of the Union of Soviet Socialist Republics (USSR), Russia as it
is today was established in 1991, but the history of the Russian empire extends
back more than a thousand years. Vast plains constitute nearly 70% of Russias
landmass, and below them lie some of the greatest mineral reserves of any country
in the world. It is especially rich in mineral fuels, including oil (6% of world
reserves), natural gas (35% of world reserves) and coal (nearly 12% of world
reserves). Other important resources include iron ore, nickel, cobalt and
molybdenum. The country is a dominant producer of platinum and palladium, and
also has some of the worlds largest gold reserves, as well as significant deposits
of copper, silver and mercury.
148M
Although the urbanisation rate in Russia is more than 75%, the average population
density is just 8.7 people per sq km, well below the European average of 67. More
than four-fifths of the population is concentrated in the European part of the country.
The annual population growth averaged 1% in the 1980s, but turned negative in
mid-1990, influenced by large-scale emigration and low living standards. Thirteen
Russian cities have over a million inhabitants. The largest are Moscow (8.9m), St
Petersburg (4.9m) and Nizhny Novgorod, Novosibirsk and Yekaterinburg (1.4m
people each). There is a huge gap in life expectancy between the sexes, with male
life expectancy at just 59 years and female life expectancy at over 72 years.
FIGURE 8: POPULATION AND POPULATION GROWTH

Year to 31 Dec
Population (m, year end)
Annual growth (%)
1993A 1994A 1995A 1996A 1997A 1998CL 1999CL 2000CL

148.2 148.0 147.6 148.1 147.5
146.7 147.0 147.5
(0.1)
(0.1)
(0.3)
0.3
(0.4)
(0.5)
0.2
0.3

Chukotka
Koryakia
Yakutia
(Sakha)
Yamal
Evenkia
Tatarstan
Bashkortostan
Tuva
A
T L A S
September 1998

N V E S T M E N T
Aga
(Aginskiy Buryat)
Dagestan
Jewish
Buryatia
Adygea
U S S I A N
Nenetsia
Ust-Orda
Khakassia
North Ossetia
Ingushetia
Chechnya
Kalmykia
Karachay-Cherkessia
Kabardino-Balkaria
Khantia-Mansia
Udmurtia
Mordovia
Permyakia
Mari EI
Chuvashia
Komi
Moscow
Taymyria
Karelia
CLSA
Autonomous republic
Autonomous okrug
Gorno-Altay
FIGURE 9: REPUBLICS & AUTONOMOUS AREAS
U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
ETHNIC RUSSIANS
ARE BY FAR
THE MAJORITY GROUP
FIGURE 10: NUMBER OF RUSSIANS

IN THE FORMER SOVIET UNION REPUBLICS (%)
Kyrgyzstan
Uzbekistan
Tajikistan
Turkmenistan
Kazakhstan
Azerbaijan
Armenia
Georgia
Moldova
Ukraine
Belarus
Lithuania
Latvia
Estonia
21
8
8
9
38
6
2
6
13
22
13
9
34
30
10
20
30
40
% Russians
50
60
70
80
90
100
Major Ethnic
ethnic group
Major
Group
Source: Goskomstat
FIGURE 11: NATIONALITIES IN THE RUSSIAN FEDERATION (%)

Armenians
Jews
Kazakhs
Maris
Udmurts
Germans
Chechens
Mordovians
Belorussians
Bashkirs
Chuvashs
Ukrainians
Tatars
Russians
Z
Z
Z
Z
Z
Z
Z
Z
Z
Z
82
Source: Goskomstat
ETHNICALLY DOMINATED BY
RUSSIANS
People of more than 100 nationalities inhabit Russia. According to the latest (1989)
census, about 82% of the population is ethnically Russian. Tatars, at 3.8% of the
population, are the second largest ethnic group. They primarily live in Tatarstan,
although large groups also reside in Siberia, Kazakhstan and the Far East. Ukrainians
(3%), Chuvashi and Belorussians (1% and 0.8%, respectively) are the other main
minorities. The region with the most heterogeneous population is the North Caucasus,
which has historically been a trouble-spot for Russia, even in the 19th century. Russians,
Ukrainians, Osetini, Balkari, Kolmiki, Chechens and many others live there. The
comparatively small native populations that live in Siberia and the Far East, like Yakuti,
Nenets, Evenki and Tuvininas, are spread over vast territories, often exceeding the size
of large European states. Although over 100 languages are spoken in the region, Russian
is the most commonly used language in business, government and education. Russian
Orthodox Christianity is the primary religion, with an estimated 35m adherents.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
REGIONS: A LOOSE AND VARIED ALLIANCE

Russia is divided into 89 regions. The 1993 constitution states that the Russian
Federation consists of 21 republics, 66 provinces of varying status and two cities
with an autonomous provincial status (Moscow and St Petersburg). Independence
from the centre varies, but all have directly elected governors or presidents. The
treaty with Tatarstan declared it a sovereign state, associated with Russia on the
basis of the constitutions of the two states. A peace agreement was negotiated with
Chechnya in August 1996, according to which the future political status of the region
will be decided in five years time.
21 MAIN REPUBLICS
Russias 21 republics, regardless of their various sizes and populations, are the most
politically developed and active jurisdictions in the country. Although their boundaries
were drawn up only in the 1920s to give political recognition to a variety of ethnic
groups, they have remained in place. Each republic has a separate constitution, anthem
and flag, as well as executive and legislative institutions.
REPUBLICS
Krays were unique administrative entities, something in between a republic and

an oblast (see next category), whose boundaries were drawn primarily for
administrative purposes. There are six krays in Russia.
KRAYS
Oblasts were originally administrative subdivisions in Russia, without any power of

their own. However, the ever-changing Russian constitution gave them equal status
with the republics, and so they have gained further political and economic powers. Now,
each of the oblasts has its own administration, with elected and appointed officials.
OBLASTS
Autonomous areas were created to give political recognition to relatively small

ethnic groups. Because of the small populations in the regions of Siberia and the
Far East, the role of the autonomous areas was very limited. According to the new
constitution, however, their importance will gradually increase, helped by the fact
that these regions control the largest reserves of minerals and ores. Clearly, newly
elected local politicians will be fighting for more independence from the federal
government in solving their economic problems.
AUTONOMOUS AREAS
The regions vary greatly not only in terms of population and economic potential, but
also in terms of income and infrastructure development. One of the main problems
in Russia is the distribution of wealth from region to region. Regional differences in
Russia are similar to those in India. Measured by income per capita, the two most
prosperous regions are the resource-rich Tyumen Region (including the autonomous
okrugs of Yamalo-Nenetski and Khanti-Mansisk) and Moscow, which as a capital has
attracted huge inflows of capital and businesses. Its neighbours - 12 other oblasts in
the Central Region of Russia - have per capita incomes of barely 16% of Moscows.
There is a disparity between investment conditions and real investment activity in a
number of Russian regions. The Moscow and Saint Petersburg regions have over 30%
of the national wealth and received almost 75% of foreign capital inflows between
1993 and 1997. The regions with low investment risk are home to more than 50%
of the Russian population, account for 50% of industrial and rural production volume,
and receive 65% of foreign investment and approximately 50% of domestic capital
investment. At the same time, these regions occupy only 17% of the territory and have
27% of the natural resources. Besides the large industrial regions and capital regions
(Moscow and Saint Petersburg), heavy foreign investment is also seen in the following
areas: Khantu-Mansiysky, Yamalo-Nenetski regions and Komi Republic (commodities);
Tatarstan Republic and Nizhny Novgorod region (heavy manufacturing areas); and St
Petersburg, Primorye and Khabarovsk regions (border regions). Highly underinvested
are the Central European part of Russia, the Urals and Western Siberia, including
Saratov, Voronezh, Rostov, Chelyabinsk, Orenburg and Novosibirsk.
HIGHLY VARIED WEALTH

BETWEEN REGIONS
HIGH
DISPARITY IN
INVESTMENT

10
5
A
T L A S
Urals
North Caucasus

12 Kaliningrad
7
CLSA
Note: Income figures as at end-1997

Lower Volga
6
Black Earth Belt

5
Upper Volga
4
11 Far East
10 Eastern Siberia
North West
Western Siberia
2
Central Russia
Far North
N V E S T M E N T
11
1
3
Moscow
U S S I A N
12
over US$ 901

under US$ 901
3
1
over US$ 1,200
over US$ 2,000
September 1998
FIGURE 12: WEALTH IN RUSSIA IS NOT EVENLY SPREAD (AVG INCOME PER CAPITA IN US$)
CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 13: FOREIGN INVESTMENT BY REGION IN 1997

Region
Far North
North-West
Central
Volga-Vyatka
Black Earth
Lower Volga
North Caucasus
The Urals
Western Siberia
Eastern Siberia
Far East
Kaliningrad
US$m
83.9
329.7
4,801
143.9
26.8
189.7
68.1
60.7
406
14.6
359.7
22.2
% of total
1.3
5.1
73.8
2.2
0.4
2.9
1.0
0.9
6.2
0.2
5.5
0.3
FINANCIAL & POLITICAL RELATIONS WITH THE KREMLIN

The balance of power between the federal, regional and local levels is central to
Russias policymaking process, but the balance is extremely weak and unregulated.
While federal authorities have determined and designed the principal features of
Russias reforms, it is only now that they are getting financial control over the
implementation of reforms. Prior to 1992, regional governors (usually the heads
of local party organisations) were appointed by the Kremlin. Now, however,
governors are elected in democratic local polls. However, no federal legislation exists
to govern the relationship between the federal government and regional
administrations. Hence Moscows ability to persuade regional governors of its policy
goals is still built on personal relations.
Arranged in a loose feudal system, the regions contribute part of their total tax
revenues to the centre. The federal government then redistributes the wealth from
the richer regions to the less wealthy ones. In 1996, regional governments collected
revenues equivalent to 14.7% of GDP, while the federal governments revenues
reached 12.8% of GDP. In 1997, these figures altered sharply, with regional
governments increasing their grip on the economy with revenues reaching 15.6%
of GDP, while the federal governments revenues fell to only 12.4% of GDP. The
regional governments are likely to come under increasing pressure to pay more to
the federal government, while also receiving fewer handouts from Moscow. The
new tax code and the 1999 budget, yet to be approved by the Duma, aims to simplify
the way tax revenue is allocated, but this is a political minefield.
Currently, regional budgets receive about two-thirds of federal revenue allocations
and the remainder stays with the federal government. The government is seeking
to rebalance that proportion by keeping a greater percentage of tax revenues for
federal coffers. The two largest revenue earners are VAT and profit tax. Regions
keep about 75% of total VAT earnings, while the 35% profit tax is usually divided
between the regional (22%) and the federal (13%) governments. Under the proposed
new tax code, the regions will transfer all VAT receipts to Moscow, which could
cause a significant revenue loss for local budgets. VAT, which is the easiest tax
to collect, is set to rise from 10% currently to 20% on a variety of goods. At the
same time, the new budget will allow regional governments to levy a 5% sales
tax. As the implementation of the sales tax will be left to the discretion of regional
administrations, they will keep the entire revenue from it. Theoretically, this will
compensate the regions for the loss of the VAT income.
REGIONS HAVE LITTLE DIRECT

ACCOUNTABILITY TO MOSCOW
WEALTH REDISTRIBUTED
TO
POORER REGIONS VIA TAX
FEDERAL GOVERNMENT KEEPS

ONLY A THIRD OF TAX
REVENUES

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
FIGURE 14: THE ONES TO WATCH

Area
Area as % of Population
Rural Countrys Telephone Cars per Income per
000sq km Russian Federation
(000) Density Population (%) GDP (%) density (%)
1,000 capita ($)
Bashkortostan
144
0.8
4,100
28
35
2.3
13
86
953
Chelyabinsk
88
0.5
3,700
42
19
2.3
15
98
1,350
Irkutsk
768
4.5
2,800
4
21
2.7
13
113
1,915
Krasnoyarsk
2,340
13.7
3,106
1
26
2.8
12
107
1,865
Moscow Region
47
0.3
8,664
184
19
10.9
50
154
6,916
Nizhny Novgorod
77
0.5
3,727
48
22
2.6
18
64
1,298
Sakha (Yakutia)
3,103
18.2
1,023
0
36
9.6
19
113
2,624
Samara
54
0.3
3,300
61
19
3.3
16
110
1,586
Saratov
100
0.6
2,739
27
26
1.6
13
96
1,005
St Petersburg Region
86
0.5
4,883
57
34
3.2
39
119
2,155
Tatarstan
68
0.4
3,760
55
26
2.8
13
72
1,403
Tymen
1,435
8.4
3,200
2
24
8.6
14
120
4,033
Yekaterinburg
195
1.1
4,750
24
12
4.2
19
77
1,599
Russia total/avg
17,045
100
147,900
9
27
100
19
93
3,033
Source: Goskomstat
FIGURE 15: REGIONAL VARIANCES ARE LARGE AND GROWING

Contribution to
Industrial
state revenues (%) output ($bn)
Bashkortostan
n.a.
8.32
Chelyabinsk
1.8
9.1
Irkutsk
2.5
5.5
Krasnoyarsk
2.8
7.8
Moscow Region
27.0
10.7
Nizhny Novgorod
3.5
6.3
Sakha (Yakutia)
n.a.
2.7
Samara
4.6
9.2
Saratov
n.a.
2.44
St Petersburg Region
4.6
4.9
Tatarstan
3.5
7.7
Tymen
8.0
18.4
Yekaterinburg
3.1
11.2
Russia total/avg
248.4
As % of
Russian total
3.3
3.7
2.2
3.1
4.3
2.5
1.1
3.7
1.0
2.0
3.1
7.4
4.5
100.0
Surfaced roads Exports as

(km per sq km) % of output
111
21
90
27
15
46
5
28
317
12
139
12
2
30
123
27
93
13
111
13
152
15
5
19
50
14
102
Governor
Orientation
Alexander Lebed
Yuri Luzhkov
Ivan Sklyarov
Reformer
Reformer
Populist
Konstantin Titov
Reformer
Vladimir Yakovlev
Reformer
Mintimer Shaimiyev Reformer
Source: Goskomstat
10

Moscow
Yekaterinburg
Omsk
Stavropol
A
T L A S
11

N V E S T M E N T
Khabarovsk
Tyumen
September 1998
Western Siberia
7
Lower Volga
6
Black Earth Belt

Urals
North Caucasus
11
1
12 Kaliningrad
11 Far East
10 Eastern Siberia
Upper Volga
4
Central Russia
3
North West
Far North
2
1
Krasnoyarsk
8
7
Kursk
Chelyabinsk
Saratov
6
Krasnodar
9
Samara
Sakhalin
10
Nizhny
Novgorod
4
5
Yakutsk
Norilsk
Arkhangelsk
St. Petersburg
U S S I A N
Kaliningrad
12
CLSA
Murmansk
FIGURE 16: RUSSIAN ECONOMIC REGIONS
U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
A REGION-BY-REGION GUIDE
FAR NORTH:
VAST, COLD AND A FISHING
AND TIMBER CENTRE
1) Far North Region

The Far North comprises six jurisdictions - the Karelian and Komi Republics, the
Archangelsk, Murmansk and Vologda oblasts, as well as Nenets Ethnic Okrug, which
is positioned in the territory of Archangelsk Oblast.
Territory 1,466,000sq km.

Population: 7m.
The climate is very cold and winter lasts up to six months.
Forests cover two-thirds of the regions territory (1.5m sq km); as might be
guessed, the region is one of the largest wood producers in the country.
Murmansk is one of the largest fishing and trading ports in Russia.
The Barents Sea is rich fishing territory.
The region has substantial export potential and easy access to Northern Europe
through a common border with Finland.
NORTH-WEST:
ENCOMPASSES
2) North-West Region
This region includes St Petersburg, Pskov, Novgorod and their oblasts.
HEAVY
INDUSTRY AREAS AROUND
ST
PETERSBURG
CENTRAL RUSSIA:
MAJOR AGRICULTURAL AND
INDUSTRIAL CENTRE
Territory: 200,000sq km.

Population: 8m.
St Petersburg is second only to Moscow in economic importance and size. It
is also the industrial centre of the region, with an international port and several
large enterprises.
The region is noted for specialising in military defence, high technology,
shipbuilding, chemicals and refining.
Historically, the region has maintained excellent economic relations with its
neighbours Finland and Sweden.
3) Central Russia
This region is the most important political and economic region of Russia. Situated
in the centre of the European part of the country, it includes 12 jurisdictions Bryansk, Ivanovo, Kaluga, Kostroma, Moscow, Oryol, Ryazan, Smolensk, Tver,
Tula, Vladimir and Yaroslavl.
Population: 30m.
Moscow usually tops the lists of Russian regions. The city contributes
significantly to the federal budget. It is also considered to be the most dynamic
city in the country, with construction booming and the service sector expanding
rapidly.
The regions natural resources are limited; the most significant of them is
Moscows coal basin.
A cool climate and short summers have allowed agriculture to develop (potatoes,
oats and hay).
Central Russia is one of Russias most important industrial centres. Electronics,
space, defence and other labour-intensive industries dominate.
UPPER VOLGA:
INDUSTRIAL BELT AROUND
NIZHNY NOVGOROD, RUSSIAS
THIRD CITY
12
4) Volgo-Vyatski Region (Upper Volga)

The Volgo-Vyatka Economic Region includes Chuvashi, Mary El, Mordovian
Republics and Kirov and Nizhny Novgorod Oblasts.
Population: 9m.
The region is limited in mineral and other natural resources. Potential oil reserves
may exist, but no large deposits have so far been found.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
Nizhny Novgorod, called the pocket of Russia, is the third largest city after
Moscow and St Petersburg. It is the largest centre for heavy industry, with
shipbuilding, auto and defence dominant.
Some of the better known public companies are situated here Nizhnovsvyazinform, Nizhnovenergo and GAZ Auto Plant, to name three.
Wood processing, chemicals and textiles are also important regional production
industries.
5) The Black Earth Belt
This area is located to the west of the Volga River and to the south of the Central
Economic Region. It shares a boarder with Ukraine and is composed of Belgorod,
Kursk, Lipetsk, Tambov and Voronezh.
BLACK EARTH BELT:

HEAVILY AGRICULTURE-BASED
ECONOMY

Population: 8m.
The regions economy is largely based on agriculture, particularly wheat, and
also sugar beets, sunflower and potatoes. The regions grain yield is higher than
the Russian average.
Livestock production is the second most important agricultural activity in the
region.
Because of rich agriculture production, food processing plays an important role
in the local economy. Especially prominent are sugar refining, dairy and meat
processing.
The region is also rich in iron ore. The Novo-Lipetsk plant produces about 80%
of all electrical steel in the country.
6) Lower Volga
Lower Volga contains eight jurisdictions - the Kalmykia, Bashkortostan and Tatarstan
Republics, the Astrakhan, Penza, Samara, Saratov, Tsaritsin and Ulyanovsk Oblasts.
LOWER VOLGA:
WEALTHY, INDEPENDENT
AND
HEAVILY RELIANT ON OIL AND

Population: 17m.
The region has substantial oil and gas reserves. Tatarstan and Bashkortostan are
the largest producers of oil in the region. Natural gas comes from fields in Saratov
and Astrakhan.
Bashkortostan, an autonomous republic, is Russias largest oil refiner and one
of the ten net donors to the federal budget. While the republic is known for
its oil, petrochemicals and engineering industries, Bashkirnenergo and
Bashinformsvyaz are considered to be among the top picks in the Russian utility
sector.
Today the region is one of the largest refining centres. It enjoys considerable
independence from Moscow. Its economic growth is most likely to be restricted
by its over-reliance on oil, as crude oil prices remain at 10-year lows.
Other noteworthy industries include textile production, wood processing, and the
production of synthetic rubber and fibres.
Fishing has always been a significant industry for the region. Black caviar from
sturgeon caught in the Caspian Sea is the regions most prominent food product.
Unfortunately, because of the decreasing water levels in the Volga River and
Caspian Sea, the catch has fallen by over half in the last 40 years.
GAS EXPLORATION AND

REFINING
13

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
NORTH CAUCASUS:
THE MOST ETHNICALLY
DIVERSE AREA OF RUSSIA
7) North Caucasus
The territory of this region reaches form the Sea of Azov and the Black Sea to
the Caspian Sea. It includes the Adygey, Chechen, Ingush, Dagestan, Kabardi-Balkar,
Karachay-Cherkess and north Ossetia republics, as well as Krasnodar and Stavropol
Krays and Rostov Oblast.
Population: 15m.
This is the most ethnically diverse region in Russia. Most of the ethnic territories
in the region were incorporated into Russia starting from the 18th century. Several
ethnic conflicts have occurred since then, including the recent war in Chechnya.
Tourism could be a potentially important sector of the economy, as it has some
renowned spas and alpine ski resorts.
The region is one of the largest cement producers in the country
It has significant energy resources, in particular the coal reserves in Rostov oblast,
and oil and gas reserves in Chechnya. The region has several large refineries
located in Stavropol and Krasnodar.
The regions ports of Novorossisk and Tuapse on the Black Sea have been
developed into large oil-exporting facilities.
THE URALS:
S TEEL CENTRES
8) The Urals
This region forms the border between European and Asian Russia. It consists of
eight jurisdictions, including Kurgan, Orenburg and Perm, and the Chelyabinsk and
Yekaterinburg oblasts.
Territory: 829,000sq km
Population: 20m.
The level of urbanisation and industrialisation varies substantially.
The Ural Mountains are a rich mineral site with significant deposits of nonmetallic ores, such as salt and asbestos, as well as gems, such as emeralds, jasper
and malachite.
Oil and gas are also produced here, however the fields are mature and production
is decreasing.
Yekaterinburg and Chelyabinsk are the two main industrial cities. Both benefit
from a concentration of engineering and metallurgical companies in their
economies. The two regions make up a Urals transportation centre and have
demonstrated reasonable financial discipline. Yekaterinburg is a net contributor
to the federal budget.
Huge steel plants in Magnitogorsk, Chelyabinsk and Nizhny Tagil continue to
be some of Russias largest enterprises. The region has also several large
engineering plants, such as Uralmash in Yekaterinburg.
WESTERN SIBERIA:
RICH RESOURCES , POOR
PEOPLE
14
9) Western Siberia
This region is located to the west of the Ural Mountains.
Territory: 2,427,000sq km.
Population: 13m.
The region includes the Altay republic, the Tyumen Region (including the
autonomous okrugs of Yamalo-Nenetski and Khanti-Mansisk), Kemerovo,
Novosibirsk and Omsk.
The discovery of large deposits of oil and gas in Tyumen Oblast in the mid1960s dramatically increased the economic development of the region. The region
contains the largest known oil and gas fields in Russia. A network of pipelines
that transport oil to port facilities and refineries also covers it. However, rapid
and poorly organised development of petroleum resources has left the region
with economic conditions that are some of the worst in the country. Now the
regions economic growth is restricted by its dependence on oil revenues.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
In addition to the extraction industry, Kemerovo, Tomsk and Novosibirsk have

many large industrial enterprises, including steel, chemical and machine
construction.
10) Eastern Siberia
The region has 10 jurisdictions - Krasnoyarsk Krai, which includes the Khakas
Republic and the Taymirsky and Evenkiyski Autonomous Okrug, the Bruit and Tuva
republics, the Chita and Irkutsk oblasts, as well as the Ust-Ordinsky and Aginsky
Buryat autonomous okrugs.
EASTERN SIBERIA :
VAST AREA , TINY POPULATION
Territory: 4,123,000sq km.

Population: 8m.
The climate is extremely continental: winter is very cold and summer late but
very hot. The land is limited to cultivating reindeer.
The region contains enormous mineral resources. The largest coal deposit in the
country was discovered on the territory of Taymyrskiy Okrug. Local ore deposits
contain nickel, copper, iron, gold, silver and so on.
Deposits of copper, nickel and platinum are located near Norilsk. Norilsk Nickel
is one of the largest non-ferrous metallurgical plants in the world.
The region has considerable hydroelectric capacity. As a result, energy intensive
industries, such as aluminium plants and cellulose processing, are prominent in
the region. Three of the largest aluminium plants are located in Krasnoyarsk,
Irkutsk and Bratsk.
Trade with China is playing an increasingly active role in the region.
11) Far East
The Far East Region consist of 10 jurisdictions, including the Sakha Republic
(Yakutia), the Yevreiskaya, Koryake and Chukotka Autonomous Oblasts, the
Primorsky Krai, and the Amur, Kamchatka, Khabarovsk, Magadan and Sakhalin
Oblasts.
FAR EAST:
EVEN VASTER AND
METAL
EVEN
FEWER PEOPLE
MINING AND
FISH
Territory: 6,216,000sq km, 30% of Russias land mass.

Population: 7m.
Trade with China, Japan and the US is becoming increasingly important.
The region is famous for fishing and sea products. Vladivostok, Nakhodka and
Magadan are the largest ports. Kamchatka accounts for about 60% of all Russias
salmon catch.
The Republic of Sakha (Yakutia) is the largest and one of the most prosperous
regions in Russia. The Republic comprises 2% of the earths total landmass.
It produces 98% of Russias rough diamonds and over 26% of Russias gold,
and possesses more than 30 known oil and gas fields. Coal accounts for more
than 90% of total exports with Japan, its largest trading partner.
Magadanskaya oblast contains the Russian Far Easts only nuclear power station.
Major mineral reserves include gold, silver and tin, whilst agriculture centres
on reindeer and mink farms, as well as fishing.
Kamchatskaya Oblast accounts for about one-third of the Russian Far Easts total
fish catch, and leads in the output of salmon roe caviar. Shipbuilding is the largest
industry.
Khabarovsky Kray boasts the Russian Far Easts only iron and steel plant, and
both its oil refineries which have a capacity of 8-10m tonnes per year. Major
export items include timber, ferrous metals and oil products.
Sakhalin Islands economy revolves around fish and fish processing,
Primorsky Krays timber industry yields approximately 3 million cubic meters
a year. The province is the largest coal producer in the Russian Far East and
generates more electricity than the other Far East provinces, although power
shortages are common.
15

10
4
A
T L A S
North West
Central Russia
North Caucasus
Urals
Western Siberia
CLSA

12 Kaliningrad
11 Far East
10 Eastern Siberia
Lower Volga
6
Black Earth Belt

5
Upper Volga
Far North
4
1
N V E S T M E N T
Moscow
U S S I A N
12
9
5
less than 2.5%

from 2.5% to 3.5%
from 3.5% to 5%
more than 5%
11
1
September 1998
16
FIGURE 17: UNEMPLOYMENT BY REGION
CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
12) Kaliningrad
Territory: 15,100sq km, of which 1,800sq km is water.
Population: 932,200.
The region includes 22 small cities, but Kaliningrad is the largest.
An old Prussian capital of Kningsberg is now a genuine Russian county. Cut
off from Russia by Lithuania, Poland and Belorus, it is separated from the rest
of Russia by over 400km. It has large nuclear facilities, a huge Russian defence
base (one of the few warm water ports) and a largely forgotten Russian
population. Yet road, rail and air access are rapidly being developed, amid the
Governors intentions of making Kaliningrad the Hong Kong of the Baltics.
KALININGRAD:
AN ISLAND OF RUSSIA IN
BALTIC
THE
FIGURE 18: REGIONAL INDUSTRIAL

PRODUCTION GROWTH IN 1997
>10%
Vladimir
Ulyanovsk
Altai
Chukotka
7-9%
Astrakhan
Samara
Perm
Nentsk
Kostroma
Ryazan
4-6%
Moscow Region
Tambov
St Petersburg
Yaroslavl
Orel
2-2.9%
Nizhny Novgorod
Ivanovo
Chuvashiya
1-1.9%
Saratov
Chelyabinsk
Byratiya
Krasnoyarsk
Khanty-Mansiisk
less than 1%
Kurgan
Kursk
Belgorod
Tatarstan
FIGURE 19: SOCIAL INDICATORS - LIFE EXPECTANCY

Life expectancy at birth
Males
Females
Total population
Per 1,000 of population
No. of births
No. of deaths
Natural increase/(decrease)
Marriages
Divorces
1992
62
73.8
67.9
1993
58.9
71.9
65.1
1994
57.6
71.2
64
1995
58.3
71.7
64.6
1996
59.6
72.7
65.9
10.7
12.2
(1.5)
7.1
4.3
9.4
14.5
(5.1)
7.5
4.5
9.6
15.7
(6.1)
7.4
4.6
9.3
15.0
(5.7)
7.3
4.5
8.8
14.3
(5.5)
5.9
3.8
WOMEN LIVE A LOT LONGER

RUSSIA
THAN MEN IN
Source: Goskomstat
17

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
POLITICS - A DEMOCRACY OF SORTS

ALWAYS A STRONG
LEADER
People tend to turn to history to interpret todays events. Russia is no exception.

As Figure 21 shows, Russia has had a chaotic history. The influence of a strong
leader, from Ivan the Terrible to Peter the Great; Lenin, Khrushchev and the
reformers of today have carried Russia through wars and upheavals. As Russia
enters the 21st century, the determination to implement reforms largely rests with
the Kremlin.
FIGURE 20: RUSSIAN HISTORY

FROM TSAR
TO COMMUNIST DICTATOR
862
Beginning of the Russian (Kievskaya) Empire
13th century
Mongol Golden Horde occupation
15th century
Consolidation into centralised state, Ivan IV the Terrible crowned as tsar
1686-1725
Reign of Peter I the Great - significantly modernised the country and established the Russian Empire
1762-1796
Under the rule of Ekaterina the Great, the Russian Empire expanded, becoming a major European state
19th century
Russia played a key role in overthrowing Napoleon I
1855-1881
Alexander II introduces first significant legal, administrative and economic reforms. However, the reforms lagged behind those in the West
1904
Revolts and strikes, followed by Russias defeat in the war with Japan
1905
Tsar is forced to introduce a parliament - the Duma
1917
Revolution. Abdication of Nicholas II and his son, ending the Russian Empire. Socialist state for the next 78 years
1918-1922
The Soviet Union is founded. Lenin heads the first socialist state in the world. Russia becomes one of the 15 Soviet republics
1922-1985
Private ownership of the means of production is outlawed. High economic growth in the first few decades of Communist rule was achieved
by diverting massive resources to strategic projects, especially the military-industrial complex. Consumer goods were neglected and of poor
quality. However, great achievements were made in the education and health systems
1985
Mikhail Gorbachev becomes head of the USSR. Perestroika (including political and economic reforms) is introduced
1991
USSR collapses. Russian Federation becomes an independent country, inheriting the international assets and liabilities of the Soviet Union.
Boris Yeltsin is elected President by popular vote
1992
Campaign of radical economic reforms launched
1993
New constitution replaces Communist-era government structure
1995
Dissatisfaction over weak execution of economic reforms, in particular high inflation and declining living standards, is reflected in the strong
support for the communists in parliamentary elections
1996
Boris Yeltsin is re-elected as President, defeating communist opponent Gennady Zhuganov, making Yeltsin the first democratically elected
head of state in Russias 1,000-year history
1997
GDP growth leaps into positive territory for the first time
1998
New pro-reform cabinet is appointed, led by Sergei Kirienko - Europes youngest PM. However, post the rouble devaluation of 17 August,
the entire cabinet was essentially made the scapegoat for the financial crisis and was dismissed. Ex-prime minister Victor Chernomyrdin has
been re-appointed acting PM, representing a big step back towards Russian cronyism.
18

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 21: HAPPY YESTERDAYS - LIFE WAS BEST UNDER . . .

Dont know
Vladimir Lenin
Michail
Gorbachev
Michail Gorbachov
Nikita Khrushchev
Josef Stalin
Tsar Nicholas II
Yuri
Yuri Andropov
Adnropov
Boris Yeltsin
Leonid Brezhnev
0
Source: Itogi Poll
10
15
20
(%)
25
30
35
40
45
Russia is a federal state with a republican form of government. A new constitution

was adopted in a national vote on 12 December 1993, which replaced the outdated 1978
Soviet constitution. Political power is split between the Executive (led by the President),
bicameral Legislature (the Council of the Federation of the State and the Duma) and
judicial branches (the Courts of the Russian Federation). The population votes for
the President and members of parliament in separate elections. However, unlike most
of his Western counterparts, the Russian President retains enormous powers.
Governmental power in Russia is concentrated in the Executive Branch, which is
headed by the President, who is elected for a four-year term and is not permitted
to serve for more than two consecutive terms. The Prime Minister - who is second
in command - is appointed by the President and approved by the State Duma. The
nominee may take office once approved by Parliament, but may carry out his duties
as acting Prime Minister for a certain period of time. If Parliament votes not to
approve the nominee three times or demands the resignation of the cabinet, the
President may dissolve the Duma and call for new elections. In the event of the
President becoming incapacitated, the PM assumes the presidential functions. New
elections are to be held within three months of this transfer of power.
Russia has universal direct suffrage from the age of 18. Each of Russias 89
constituent units has at least one electoral district. The last elections were in
December 1995 (parliamentary) and June/July 1996 (presidential). The next elections
are due in December 1999 (parliamentary) and June 2000 (presidential).
EXECUTIVE
IS THE STRONGEST
BRANCH
WHO
CONTROLS POLITICAL
POWER?
WILL YELTSIN
LIVE TO SEE
THE NEXT PRESIDENTIAL

ELECTIONS?
THE EXECUTIVE BRANCH

The President, who can be elected for a maximum of two successive four-year terms,
is the most powerful citizen in the country, although the legislature is trying to
dilute his power. He and his staff are essentially responsible for the smooth running
and the maintenance of the political, legislative and economic stability of the country
as a whole. The President also chairs the Security Council, which is responsible
for preserving state security. Apart from that he:
THE PRESIDENT SETS THE

POLICY
proposes candidates for top government posts

has direct control over foreign policy
can issue decrees and call referendums
can dissolve the legislature and call new elections
can reject a vote of no confidence in the government by the legislature
can declare war on other countries and states of emergency in Russia
19

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
FIGURE 22: WHO IS YELTSINs LIKELY SUCCESSOR?

Runners for
President in 2000
Gennady Zyuganov
%
support
20%
Vladimir Zhirinovsky
5%
Victor Chernomyrdin
9%
Gregori Yavlinsky
12%
Boris Nemtsov
8%
Yuri Luzhkov
8%
Alexander Lebed
10%
Strengths
Finished 2nd in 1996 presidential
elections; party is well organised, largest
faction in the Duma
His faction controls 11% of the voting in
the Duma
Weaknesses
Lacks charisma; poor public speaker
Outlook
Strong polls rating
Aggressive, ultranationalist & populist Xenophobia appeal brought LDPR into

views
2nd and 3rd places in 1993 & 1995
elections, respectively
Skilful at political games in Kremlin; five Poor public speaker; does poorly in the Likely to form an alliance with Luzhkov,
who is rated at the top of opinion polls
years experience as PM; strong financial opinion polls; lacks appeal
& business backing
Has been acting as an economic adviser Limited by the small size of the liberal Yablokos popularity has been steadily
growing from 8% in January to 12% in
to Gorbachev, opposes both the electorate
July this year
communists and moderate Yeltsins
government
Featured at the top of the opinion polls Young liberal reformer; sometimes too Widely tipped to be Yeltsins chosen heir;
last year; represents a serious challenge idealistic; failure to win allies in the likely to succeed if Kremlin and powerful
Moscow bureaucracy since moving from business circles unite behind him
to more moderate candidates
Nizhny Novgorod last year
Proved himself to be an efficient & tough Promotes apparatchiks capitalism Repeatedly stated his intention not to run
Moscow mayor; re-elected with huge principles; threat to the financial elite, for presidency, although expected to form
who became wealthy from the cheap an alliance with another candidate such
majority populist backing
sell-off of state properties; popularity is as Chernomyrdin
limited to Moscow
Won nearly 15% of the 1996 presidential Lacks support of wealthy financiers & Still rated high in opinion polls; extra
strength having won the governors seat
elections; law and order principles likely strong party organisation
at Krasnoyarsk region
to boost votes
Note: Second round takes place if nobody gets over 50% of the votes
PRIME
MINISTER APPOINTS THE
GOVERNMENT
20
The Prime Minister, on the other hand, appoints the government. The federal
government consists of a presidium, the ministries, state committees and other
governmental agencies. The Prime Minister has four deputy prime ministers,
appointed by him in agreement with the Parliament and President. The latest
government was formed in April/May 1998. The ministers were young, energetic
and independent of the financial and political establishment. Each carried
responsibilities for a particular sector or industry of the economy. However,
Chernomyrdin failed to have his position confirmed by the Duma. On the following
pages we have provided an outline to who was who in the previous government,
as well as a do-it-yourself fill-in guide to the new cabinet when announced. If Yeltsin
steps down, the Russian constitution mandates new Presidential elections within three
months. The expected main contenders would be Siberian governor Alexander
Lebed, Communist Party leader Gennady Zyuganov, Moscow mayor Yuri Luzkov
and Chernomyrdin. Instead, the Duma favoured Yevgeni Primakov, a former
chairman of the Foreign Intelligence unit. Although his career in Russian public
service is long, few clues exist as to how he can rescue Russia from its economic
free-fall. The appointment of the new cabinet remains up in the air.

Committee against drug abuse
Head of Government Administration

Nikolai Khvatkov
Defence
Minister
Igor Sergeev
Federal medical insurance fund
Civil Defence, Emergencies & Natural

Disasters Minister
Sergei Shoygu
Educational grants committee
Goskomsport
Leonid Tyagachev
Commission
on Economic
Reforms
Social insurance fund
Pension fund
Minister for Education

Alexander Tikhonov
N V E S T M E N T
Corporate credit control council
Interdepartmental committee the

disabled
Goskomprint
Ivan Laptev
State Tax Service DPM

Boris Fyodorov
Federal TV/radio agency
Health Minister
Oleg Rutkovski
Promexport
Interdepartmental committee on
underage crime
Goskomkino
Armen Medvedev
Foreign Policy Minister

Evgeni Primakov
Federal migration agency
Federal archive agency
Labour Minister
Oksana Dmitrieva
Russian
Technologies
Coordination committee for

teenage Olympic games in
Moscow 1998
Federal industrial control agency
Heritage Minister
Natalia Dementieva
Science & Technology Minister

Viktor Bulgak
Patents & trademarks agency
Commonwealth Ministry
Boris Berezhovsky
Disarmarment
Committee
Evgeni Ananiev
Organisation committee for

celebrations of historic war
events and veterans
Goskomsever
Vladmir Goman
Deputy Prime-Minister
Victor Khristenko
Federal agency for bankruptcy and

financial improvements
Federal tax collection agency
Committee on State
Reserves
Sergei Novikov
Minister for Regional and ethnic issues

Evgeni Sapiro
Organisational Committee on the

structure of Russian Federation
GTK
Valeri Graganov
Federal currency and export control

agency
Minister for Trade & Industry

Georgi Gabuniya
U S S I A N
National organisation committee

for international 10th anniversary
of native peoples of the world
Goskomstat
Sergei Urkov
State tax agency
Minister for Economics

Yakov Urinson
Council on regional autonomy
Federal committee on Central Bank
Boris Nemtsov
Federal nuclear radiation safety agency
Transport Minister
Sergei Frank
Justice Minister
Pavel
Krashennikov
Customs & excise committee
Monetary policy committee
Russian space agency
Energy Minister
Sergei Generalov
Minister for
Privatisation
Farit Gazizullin
Budget revenue committee
Committee on information and

technology
Alexander Krupnov
Agriculture
Minister
Viktor
Semyonov
Federal department of regulation of

transport monopolies
Minister for Railways

Nicolai Aksenenko
Minister for Natural Resources

Victor Nekrutenko
Minister for Land Policy, Construction

and Municipal Services
Ulya Yuzhanov
Organisational committee for

celebration of 300th anniversary
of the mining law
Committee supporting the

entrepreneurs
Irina Khamada
Committee on protecting the

environment
Victor Danilov-Danilyan
Antimonopoly Committee
Natalia Fonareva
Finance Minister
Mikhail
Zadornov
Federal department on regulation of

communications monopolies
Federal forestry department
Federal road department
Federal aviation department
Federal power committee
Minister for Atomic

Energy
Evgeni Adamov
Council for agro-industrial

strategy
socio-economic problems of
coal mining regions
Government committee on
operational Procedures
CLSA
T L A S
September 1998
FIGURE 23A: GOVERNMENTAL BUREAUCRACY - THEN

Prime Minister Sergei Kirienko
Interdepartmental
Committee on Social
Problems of the coalmining regions
Presidium
Interior Minister
Sergei
Stepashin
Oleg Sisyev
Green Colour - Block of Vice-Prime Minister Boris Nemtsov

Orange Colour - Block of Vice-Prime Minister Victor Hristenko
Blue Colour - Block of Vice-Prime Minister Oleg Sisyev
Thick Line - Indirect Control or Supervision
Dotted line - Limited Supervision
21

22
Federal medical insurance fund

Head of Government Administration
T L A S
Committee against drug abuse
Educational grants committee
Civil Defence, Emergencies & Natural

Disasters Minister
Sergei Shoigu
Minister for Education
Defence
Minister
Igor Sergeyev
Goskomsport
Goskomprint
Commission
on Economic
Reforms
Social insurance fund
Pension fund
Federal TV/radio agency
State Tax Service DPM
Interdepartmental committee the

disabled
Health Minister
Promexport
underage crime
Goskomkino
Foreign Policy Minister

Andrei Ivanov
Federal migration agency
Labour Minister
Russian
Technologies
Federal archive agency
Coordination committee for

teenage Olympic games in
Moscow 1998
Heritage Minister
Commonwealth Ministry
N V E S T M E N T
Federal industrial control agency
Goskomsever
Minister for Regional and ethnic issues
Science & Technology Minister
Patents & trademarks agency
Federal agency for bankruptcy and

financial improvements
Federal tax collection agency
GTK
Minister for Trade & Industry
Disarmarment
Committee
Organisation committee for

celebrations of historic war
events and veterans
Organisational Committee on the

structure of Russian Federation
Federal currency and export control

agency
Goskomstat
Committee on State
Reserves
National organisation committee

for international 10th anniversary
of native peoples of the world
State tax agency
Minister for Economics
Council on regional autonomy
Federal committee on Central Bank
Yuri Maslyukov
Minister for
Privatisation
Federal nuclear radiation safety agency
Justice Minister
Customs & excise committee
Transport Minister
Agriculture
Minister
Russian space agency
Energy Minister
Monetary policy committee
Committee on information and

technology
Minister for Railways
Minister for Natural Resources
Minister for Land Policy, Construction

and Municipal Services
U S S I A N
Budget revenue committee
Federal department of regulation of

transport monopolies
Committee supporting the

entrepreneurs
Committee on protecting the

environment
Antimonopoly Committee
Finance Minister
Organisational committee for

celebration of 300th anniversary
of the mining law
Federal department on regulation of

communications monopolies
Federal forestry department
Federal road department
Federal aviation department
Federal power committee
Minister for Atomic

Energy
Council for agro-industrial

strategy
socio-economic problems of
coal mining regions
Government committee on
operational Procedures
R
CLSA
September 1998
FIGURE 23B: GOVERNMENTAL BUREAUCRACY - NOW

Prime Minister Yevgeni Primakov
Interdepartmental
Committee on Social
Problems of the coalmining regions
Presidium
Interior Minister

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
LEGISLATURE
The constitution created a two-chamber legislature: the State Duma (lower chamber)
with 450 deputies elected for four years on a territorial basis; and the Federation
Council (upper chamber), with 178 deputies, two from each of Russias 89 republics
and regions, represented by heads of regional executive and legislative bodies. Half
of the State Duma members are elected from party lists (half the seats in the Duma
are reserved for parties gaining 5% or more of the votes), and half in a simple
majority contest.
TWO-HOUSE LEGISLATURE
The Duma has the power to impeach the President, although it is a cumbersome
procedure. It can oppose the nomination for Prime Minister, but by doing so faces
being dissolved by the President (as nearly happened this summer). The Duma
initiates legislation and votes on the governments fiscal and monetary policies, but
in case of a deadlock, the President has the upper hand.
AS THE PRESIDENT HAS
Centrist
Reformist
% of seats
30.7
11.3
8.7
7.8
14.4
10.0
10.0
7.1
Party
Communist
Liberal-Democratic
Peoples Power
Agrarians
Our Home is Russia
Yabloko
Russian Regions
Independent
DUMA, IT CAN DO
LITTLE
AGAINST HIM
THE RUSSIAN PARTY
FIGURE 24: THE DUMAs POWER EQUATIONS

Political camp
Communist/Nationalist
THE
POWER TO DISSOLVE THE
Leader
Gennady Zyuganov
Vladimir Zhirinovsky
Nicholai Ryzhkov
Nicholai Kharitonov
Alexander Shohin
Grigori Yavlinsky
Oleg Morozov
POLITICAL SCENE HAS A LARGE

NUMBER OF PARTIES AND
FACTIONS, BUT CAN BE
GROUPED ACCORDING TO
THREE MAIN POLITICAL CAMPS
THE JUDICIARY
The judicial branch has two levels - the federal and the local. At the federal level,
there is the Constitutional Court, the Supreme Court and the Supreme Arbitration
Court. The Constitutional Court implements the constitution in political, economic
and civil matters. It acts as the main arbiter between the Executive and the legislature.
The Supreme Court is the highest court in Russia and provides legal guarantees
and protects the legal rights of Russian citizens. The Supreme Arbitration Court
holds economic and business proceedings. The judges to the Federal Court are
nominated by the President and approved by the upper house of Parliament.
Constitutional Court judges serve for life, while Supreme Court and Supreme
Arbitration Court judges serve for ten years.
The state of current legal reform in Russia makes the activities of the Constitutional
and Supreme courts extremely complicated. Lack of clarity on the conflicting status
of presidential decrees and laws also leaves open the possibility of ongoing legislative
battles between the Executive and the legislative bodies.
FEDERAL COURT
JUDGES
APPOINTED BY THE
LEGAL REFORM
PRESIDENT
IS CONFUSING
THE COURTS ACTIVITIES
THE FOURTH BRANCH - FIG S

What are FIGs? Financial Industrial Groups (FIGs) are small groups of opportunistic
entrepreneurs who were exceptionally lucky and well connected, and who have built
up their businesses into massive empires. All FIGs started as trading groups that
quickly moved into banking. Having made their fortunes through currency and
inflation speculation, they then moved into industry.
OFTEN
BEHIND THE SCENES,
THE TYCOONS AND THEIR

POWERFUL HOLDINGS
DETERMINE THE COURSE OF
RUSSIAN POLITICS
AND
ECONOMICS
23

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
SHARES FOR LOANS WAS
GREAT DEAL
FIG S INFLUENCE IS STILL

GROWING
THE M AGNIFICENT SEVEN
24
The FIGs received a boost following the controversial share-for-loans scheme

developed in 1995. At that time, banks came to a deal with the then Deputy Prime
Minister Anatoly Chubais and the government to lend the cash-strapped government
money in the run-up to the 1995 presidential election in return for options on large
stakes in state-owned companies. The stakes were in energy and ore companies,
and the banks themselves. As the government never had the money to repay the
loans, the banks inherited these stakes. At the time of the 1996 presidential election,
Chubais was able to remind the firms that it was in their interest to support Yeltsin
and not Zyuganov. Those in government have accepted (or even encouraged) the
growth of FIGs as a price worth paying to dismantle the communist economic system,
while ensuring the economy remained in Russian hands. In return, the FIGs have
given financial, political and media support to those in power.
It might be difficult to determine just how large the Financial Industrial Groups
(FIGs) are because of their vague relationships with each other. It is easier to quantify
their holdings in the industrial and private sectors of the economy and see that their
influence is rapidly growing. Having accumulated large chunks of Russian GDP,
and maintaining a close relationship with the government, these influential industrial
groups are taking charge of Russias business and political world. The Association
of Financial Industrial Groups estimates that more than 53 FIGs have officially
registered since they were created in 1993.
The Big Seven - Alfa Group, LogoVAZ, Rosprom-Menatep Group, Most, SBCAfro, Inkombank and Unexim-Interros - are the jewels in the crown, controlling
some of the biggest asset-rich enterprises in the country. Boris Berezovsky was
responsible for the term The Seven Bankers (who are almost household names)
after an interview published in the Financial Times. In it, he claimed that together
they control over 50% of Russian GDP. This figure is quite plausible. Uneximbank,
which holds a prominent place among the largest FIGs, is one of the countrys
largest banks. It has over $4bn in assets, and MFK Renaissance (another of
Uneximbanks holdings) has assets of $1.3bn. According to a recent report from
Standard & Poors, Interross claims to control over 4% of Russia GDP and 7%
of its exports. With holdings in over 24 enterprises, it is highly possible.

CLSA
LogoVAZ
Boris Berezovsky
UneximbankInterross
Vladimir Potanin
Financial vehicles
Bank Imperial 20% (with Lukoil)
Gazprom Bank
National Reserve Bank
Inkombank - 25%
Promstroibank
Obyedinenny Bank
AvtoVAZ Bank
Uneximbank 100%
MFK Renaissance 100%
Sectors
Oil and gas
Banking
Media interest
Trud Newspaper
Rabochaya Tribuna
NTV - 30% (with MOST)
Komsomolskaya Pravda
Political allies
Victor Chernomyrdin
Sibneft
Aeroflot
AvtoVAZ
Oil and gas

Banking
Yeltsin family circle

Valentin Yumashev
Alexander Lebed
Sidanco - 86%
Norilsk Nickel 55.74%
Perm Motors 30%
Lomo 26.7%
North West Shipping 25.5%
Novolipetsk Metal Works 25%
Svyazinvest 25% plus 1 share (telecoms)
Rosexpertiza < 30%
Lukoil
Oil and gas

Metals
Engineering
ORT - 8%
Nezavisimya Gazeta
Ogonyok
TV6
Komsomolskaya Pravda 51%
Russky Telegraf 10%
Izvestia 51% (with Lukoil)
Expert Magazine 25%
Anatoly Chubais
Izvestia (with Uneximbank)
Victor Chernomyrdin
Banking
Alfa Capital
Mikhail Fridman
Alfa Bank 100%
Oil and gas

Banking
Inkombank
Vladimir Vinogradov
Inkombank
Tyumen Oil 51%

Alfa Cement Holding
(jointly owned by Alfa Bank and Holderbank (Swiss))
Alfa Real Estates 100%
Alfa Ecco 100%
Magnitogorsk Steel FIG 26%
owns 30.7% of Magnitogorsk Ferrous Metals Factory
Oskolsky Electrometallurgical Works 10%
Samara Metallurgical Complex (SAMECO) 14.2%
Energomash Co 15%
Sukhoi Aircraft Design 25.01%
Rot Front Chocolate Factory 51.59%
Babayevskoye Candy 65.7%
Krasnoyarsk Aluminium 28%
Lebedinsky Ore Enrichment Combine 46% (+10% to bid for)
Mikhailovsky, Stoilensky and Orlovsky enrichment Combines
Mikhail Khodorkovsky
Bank Menatep
Most
Vladimir Gusinsky
SBC-Agro
Rossisky Credit
Vitaly Malkin
Rossisky Credit
Steel
25
Metals
Metals
Machinery
Aerospace
Foods
Foods
Metals
Ores
Banking
Independent Media 10%

Literaturnaya Gazeta
Segodnya newspaper
Itogi magazine
NTV 47% (with Gazprom)
Ekho Moscow radio station
Smena newspaper
7 Dnei newspaper
Lisa Magazine
Kommersant Newspaper
ORT 5%
Dengi Magazine
Alfa TV 25%
Yuri Luzhkov
Grigory Yavlinsky
n.a.
Victor Chernomyrdin
n.a.
Alexander Lebed

Yuri Luzhkov
10
T L A S
NONE
RospromMenatep
SBC-Agro Bank
Bank Imperial 50% (with Gazprom)
N V E S T M E N T
Alexander Smolensky
Vagit Alekperov
Most Bank 96%
Yukos 89%
Eastern Oil 54%
Exohim 51%
NONE
Metals
Telecoms
Banking
Oil and gas
Oil and gas
Oil and gas
Oil and gas
Chemicals
Banking
Lukoil
League table
of power
1
Industrial interests
Gazprom
U S S I A N
Main man
Rem Vyakhirev
Group
Gazprom
September 1998
FIGURE 25: FINANCIAL INDUSTRIAL GROUPS - WHO REALLY RUNS RUSSIA?
U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
The economic consequences of the FIGs power have been mixed. Although it might
have been expected that the FIGs would invest heavily in the companies they own,
this does not appear to have been an early priority. Some of the companies, especially
those with goods that could easily be exported, like oil and metals, were simply
used as cash cows. The money gained then became part of the capital flight that
has seen at least some $50bn leave Russia in the last four-five years. The FIGs
have used their political influence to gain a financial advantage at the expense of
the state. Tax breaks and special privileges have meant that until recently the FIGs
were able to make profits which they could export, while the government has found
it increasingly difficult to raise revenues to fund public spending.
FIG S DONT NECESSARILY

MAXIMISE SHAREHOLDER
VALUE AT THEIR COMPANIES
FIGURE 26: THE MEDIA HAS BEEN USED TO ADVANCE OLIGARCHS POLITICAL AND
INDUSTRIAL INTERESTS
1
Group
Gazprom
LogoVAZ
Uneximbank- Interross
4
5
Lukoil
Rosprom-Menatep
Most
7
8
SBC-Agro
Alfa Capital
Newspaper
Trud newspaper
Rabochaya Tribuna
Komsomolskaya Pravda
Nezavisimaya Gazeta
Magazine
TV & radio
NTV - 30% (with MOST)
Ogonyok
ORT
TV6
Komsomolskaya Pravda 51%

Russky Telegraf 10%
Izvestia 51% (with Lukoil)
Izvestia (40% holding in its pension fund)
Literaturnaya Gazeta 70%
Expert magazine 25%

(in a trust as a collateral on a $20m loan)
Seven Dnei Publishing House

Segodnya newspaper
Smena newspaper (St Petersburg)
7 Dnei newspaper
Kommersant newspaper
Independent Media 10%

(includes the Moscow Times,
Russia Review,
Cosmopolitan & Playboy)
Itogi magazine
Lisa magazine
Dengi Magazine
NTV 47% (with Gazprom)

Ekho Moscow radio station
ORT 5%
Alfa TV 25%
FEW
HOLDINGS HAVE A CLEAR
STRATEGY
DEVALUATION IS DISASTROUS
FOR BANKING GROUPS
BEREZOVSKY OWNS
EVERYTHING
26
The question now is whether the oligarchs will prove that they can be a positive
force for the struggling Russian economy or whether they will continue to use their
holdings as a way of exploiting minority shareholders and enriching themselves.
Few of the holdings had a clear strategy and have overextended themselves. Most
of the banks (a core part of most FIGs) are now facing significant forward
dollar contract obligations and steep devaluation is turning out to be disastrous.
On the other hand, the large industrial holdings within FIGs are beneficiaries of
a falling rouble.
Berezovskys LogoVAZ is the most secretive of the FIGs. He is personally believed
to have significant stakes in both Aeroflot and Sibneft, although both firms deny
it. Another group with a less favourable reputation is Most group. It migrated towards
the media, reflecting the interest of its leader Vladimir Gusinsky. Though Alfa Group
claims to be transparent, the consensus is otherwise. The worst of the lot, however,
appears to be SBC-Agro. The Bankers Bank, as it has been nicknamed, claims
to have no industrial holdings and thus is the worst hit by the rouble devaluation.
The bank has been concentrating on developing retail banking.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
The Menatep-Rosprom and Uneximbank groups are most aggressive in restructuring.

Both Potanin and Khodorkovsky have moved to head the industrial part of the latter
groups holdings. However, as their giant industrial conglomerates are outweighing
the small banking institutions at the groups core, restructuring will require significant
foreign capital and expertise. The move to greater transparency has also been realised
at Inkombank, Rossisky Credit and Menatep. Inkombank has already produced
consolidated accounts, Menatep has done it on a partial basis and Uneximbank is
likely to follow suit soon.
Russian FIGs remain powerful elements in the economy, thus we do not see their
power being reduced much by the time of the next presidential elections. If the
tycoons are advancing their economical as well as political interests in an even more
frantic fashion as 2000 approaches, the real question is less who will succeed Mr
Yeltsin at the next presidential elections, but whose creature the successor will be.
Vladimir Potanin
Rem Vyakhirev
Vagit Alegperov
Mikhail Khodorkovsky
Boris Berezovsky
RESTRUCTURERS
FIGS ARE
LIKELY TO PLAY
MAJOR ROLE IN NEXT

PRESIDENTIAL ELECTIONS
THE
FIGURE 27: THE BILLIONAIRES CLUB

(estimated net worth in US$bn)
1997
0.7
1.1
1.4
2.4
3.0
MENATEP AND UNEXIMBANK

ARE THE MOST AGGRESSIVE
TOP FIVE OF
RUSSIAS
RICHEST MEN MADE IT INTO
FORBES MAGAZINES 100

1998
1.6
1.4
1.2
1.3
1.1
RICHEST FOR THE SECOND
. . . BUT
WHAT
DATES ONLY FROM
1989
YEAR RUNNING
ABOUT
1999?
Source: Forbes
CENTRAL BANK
Russias Central Bank (CBR) was established in 1989. On 20 December 1991, the
State Bank of the USSR was disbanded and all its assets and liabilities, hence its
property in Russia, were transferred to the CBR. The Bank of Russias main
objectives are:
CB
The protection of the rouble to ensure its stability.
F AILED ITS MOST

IMPORTANT OBJECTIVE
Money circulation and monetary regulation.
P RINTING MONEY
Legislate activity of private banks.
MONITORS BANKS
In December 1992, as a result of the establishment of a single centralised federal

treasury system accountable to the Ministry of Finance, the Bank of Russia was
no longer required to fulfil the functions of cash servicing of the federal budget.
The Central Bank began to set and publish the official exchange rates of foreign
currencies against the rouble.
In 1995, as an agent of the Ministry of Finance, it organised a government securities
market, known as the GKO market, and began to participate in its operations. On
26 April 1995, the Bank of Russia terminated direct lending to finance the federal
budget deficit and stopped extending centralised targeted credits to individual
industries and sectors of the economy.
Several amendments to the banks role in providing inflationary credit to finance
the government also took place that year. The new law declared the banks
independence as one of the key elements in its status and placed restrictions on its
issuing credit to the government. GKOs ceased to be issued in July this year and
the Central Bank reverted to short-term US$ borrowing to finance its liquidity needs.
CENTRAL BANK
NO
LONGER HAS TO ACT

AS
TREASURY,
TOO
CBR IS THEORETICALLY
INDEPENDENT
27

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
CBR MUST
NOW PROVIDE
MONTHLY DATA ON THE

FINANCIAL SITUATION OF
RUSSIAS TOP 30
BANKS
CBR ACCOUNTABLE TO THE

DUMA
28
Following the interbank crisis of August 1995, the banking system has undergone
a certain degree of consolidation. The CBR has substantially developed its regulatory
and supervisory capacities since. To facilitate short-term liquidity deposit auctions,
a Lombard facility and repurchase operations were introduced. Licensing policies
were tightened and a few large, troubled banks were placed under forced
administration. The CBR has also raised minimum capital adequacy requirements
for banks from ECU2m in 1997 to ECU5m by 1999. Minimum risk weighted CARs
are also to rise to 7-11% by 1999 from 6% in 1997 - still well below international
standards, but a step in the right direction. The CBR is conducting a monthly
assessment of the largest 200 banks. Following the agreement with the IMF on
a loan facility, the CBR will publish information on the financial situation of the
30 largest banks on a monthly basis. The CBR will increase transparency of its
own operations with weekly data on foreign reserves (started in June) and
announcements of base money. The CBR will accelerate the liquidation of small,
insolvent banks, revoking their licences by 1 January 2000 if their situation does
not improve. A major accounting reform is also on the horizon with the aim of
imposing international accounting standards. A special law on bankruptcies was also
recently adopted by the Duma, which should significantly facilitate the handling
of several hundred de-licensed banks. Obviously, the financial crisis and impending
bankruptcy of many Russian banks have eclipsed the implementation of many of
these measures. The Central Bank at present seems unable to formulate a policy
to deal with the banking crisis and it will be a long road back to gain the confidence
of individual depositors and build a functioning retail banking system.
The CBR is a legal entity and subject to public law. Nevertheless, it is not included
in the structure of any of the federal bodies and acts as a special institution
with the exclusive right to control money supply. The Central Banks financial
independence is also indicated by the fact that it takes its expenditure out of
its own revenues and it is not registered with the tax authorities. The Bank of
Russia is accountable to the Duma of the Federal Assembly. The governor of
the bank and members of the banks Board of Directors are nominated by the
President and confirmed by the State Duma. The appointment lasts four years
and the governor cannot be removed for reasons other than violating federal laws
of the banks charter. The most recent governor of the Central Bank was Sergei
Dubinin, elected for a four-year term on 22 November 1995. His first deputy
chairmen are Sergei Aleksashenko, Arnold Voilukov and Andrei Kozlov. All began
performing their functions in March 1996. Dubinin and Kozlov resigned in early
September, well before their terms run out in winter next year. The new CBR
chairman was approved by the Duma. Gerashenko, who was fired as the Central
Banks chief in 1994 after a tenure market by easy money and a currency crisis,
is popular with the Communists and reviled by free market liberals.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
THE ECONOMY - THE ONCE AND FUTURE

PROBLEM
Russias economy was severely disrupted by the break-up of the USSR in 1991.
Once overly dependent on military and heavy industry (the military alone represented
80% of GDP in 1987), Russia was forced to recast itself with an emphasis on
consumer needs. The new government initiated privatisation, but market reforms
were met with widespread resistance and many industries experienced a sharp decline
in output. The strong desire to turn Russia into a modern industrial economy has
not yet been fulfilled. Russia remains a largely raw-material outpost for thriving
EU and Asian economies, as 70% of hard currency revenues come from commodity
(primarily oil, gas and metals) exports.
ECONOMY
CHANGES
SU.
INITIATED, BUT MET
WITH RESISTANCE
AT
FIGURE 28: GDP BREAKDOWN, 1997
IN DECLINE POST
THE BREAK- UP OF THE
THE END OF
1997, THE
PRIVATE SECTOR ACCOUNTED
70% OF GDP,
60% OF EMPLOYMENT
AND 74% OF ALL
FOR ABOUT
Other
11%
Food processing &

agriculture
15%
Oil and gas

26%
OVER
Construction
materials
2%
Pulp and paper
3%
INVESTMENTS
Chemicals
5%
Engineering
11%
Power
11%
Telecoms
3%
Metals
13%
RUSSIAS MAJOR ECONOMIC PROBLEMS

Russias biggest economic problems are: outdated industries, a demand/supply
imbalance after the break-up of the Warsaw Pact, the cash crunch and punishing
tax and tariff systems
Outdated industries: Russia has a very distinct industry structure. It differs from
the European industrial economies, which tend to be much more diverse. The legacy
of central planning meant production of materials and commodities in Russia has
been allocated to large plants, often incurring huge transport costs. This has inevitably
led to the inefficiencies and market distortions associated with monopolies. The
vertical integration model of Russian industry has also taken its toll. It was typical
for a factory to operate its own foundry, rather than allowing a separate foundry
industry to develop - to specialise and deploy more advanced casting technologies
supplied down the value chain. Vertical integration also meant that valuable
technologies were often developed for singular applications without exploiting their
wider market potential, leaving Russian industry increasingly lagging in terms of
price/performance output measures.
Demand/supply imbalance: Economies and manufacturing plants within the former
Soviet Union and Communist bloc states were geared to produce a huge output
to supply the entire Soviet bloc market. With the virtual breakdown of inter-republic
trade with the collapse of communism, companies were left without markets to sell
to. One example of this can be found in the steel industry, where Russia and Ukraine
shared production of 150m tonnes of steel annually, but where each country
INDUSTRIES DEVELOPED
BECAUSE OF CENTRAL
PLANNING, NOT ECONOMIC
VIABILITY
CANT SELL GOODS TO

WARSAW PACT SATELLITES
ANY MORE
29

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
SEVERE IMBALANCES IN
SUCH
INDUSTRIES AS STEEL
specialised in specific steel types. Now each national economy faces a severe
imbalance in steel demand and supply by steel type. Similarly in the coal and energy
industries, Russia supplied gas and oil whilst Ukraine manufactured the bulk of
Russias coal mining equipment, again from huge concentrated plants - a pattern
which that also collapsed, leaving huge capacity lying idle. Large enterprises used
to focus on military-industrial output, keeping consumer production at a minimum.
Russian industry has also long focused on exporting primary commodities rather
than manufactured goods - Norilsks nickel and other metals, Krasnoyarsks
aluminium, Gazprom and Lukoils gas and oil are typical. The production of valueadded manufactured products were, therefore, left to Russias Eastern European
partners. Latvias Ruff buses, Czechoslovakias Skoda electric trams and Hungarian
Ikarus Buses supplied the whole of the FSU.
ONE-QUARTER OF PEOPLE
WORK IN INDUSTRY
FIGURE 29: EMPLOYMENT BY SECTOR (%)

Year to 31 Dec
Industry
Agriculture and forestry
Construction
Transport and communication
Trade and public supply
Housing
Public health/social security
Education, culture and art
Science
Finance and assurance
Civil service
Other
1992
29.6
14.3
11.0
7.8
7.9
4.1
5.9
10.4
3.2
0.7
2.1
3.0
1993
29.4
14.6
10.1
7.6
9.0
4.2
6.0
10.2
3.2
0.8
2.3
2.6
1994
27.1
15.4
9.9
7.8
9.5
4.4
6.4
10.8
2.7
1.1
2.4
2.5
1995
25.9
15.1
9.3
7.9
10.1
4.5
6.7
11.0
2.5
1.2
3.0
2.8
1996
24.7
14.8
9.7
8.0
10.0
5.0
7.0
11.7
2.4
1.3
2.6
2.8
7M
PEOPLE ARE UNEMPLOYED
FIGURE 30: UNEMPLOYMENT

(m)
10
(m)
78
76
74
72
70
68
66
64
62
60
58
56
9
8
7
6
5
4
3
2
1
0
92
93
94
Labour
LabourFource
force (m)
(m)
95
96
Employment (m)
97
98CL
99CL
00CL
(LHS)
Unemployment (m) (RHS)
HIGH
PERSONNEL COSTS
REDUCE INTERNATIONAL
COMPETITIVENESS
30
High personnel costs are one reason Russia is unlikely to become an attractive
exporter to its ex-trading partners without a devaluation (very high tariffs is another,
but more on that later). Average salaries are on a par with the US or the UK.
Wage payments have been liberalised, and are determined without government
intervention. Although public sector wages are set as multiples of the nominal
minimum wage. The minimum monthly wage was set at Rbl83.49 ($13.7) in June
1998. At that time, the average monthly wage was about Rbl850 ($139). Wage
arrears continue to be widespread and amounted to Rbl56bn (US$9bn) in June 1998.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 31: AVERAGE SALARIES PAID BY FOREIGN COMPANIES

IN RUSSIA vs LOCAL RUSSIAN COMPANIES (US$ per month)
Foreign
1,500
2,450
750
1,625
1,714
2,000
800
988
2,087
Advertising manager
HR Manager
Receptionist
Programmer
Chief accountant
Lawyer
Client services manager
Personal assistant
Financial director
ITS BETTER TO WORK
FOR A
FOREIGNER
Russian
450
800
250
597
700
1,000
400
850
2,750
Source: Aon Consulting
STAFF
FIGURE 32: EMPLOYMENT RISKS: WHAT ARE

THE GREATEST PROBLEMS CONCERNING EMPLOYEES?
Russia
71
47
35
28
24
16
2
Staff turnover
Employee compensation
Negative PR
Workplace safety
Litigation exposure
Employee theft
Workplace violence
US
72
36
44
35
69
10
10
TURNOVER
- THE
BIGGEST PROBLEM
UK
59
67
51
45
36
9
7
Source: Aon Consulting
THE
FIGURE 33: REAL GDP (BARS) AND

INDUSTRIAL OUTPUT (LINE) (% change)
FINANCIAL CRISIS HAS
DESTROYED
GDP GROWTH
5
0.8%
0
(5)
(4.1%)
(4.9%)
(6.0%)
(10)
(8.7%)
(15)
(14.5%)
(12.7%)
(20)
92
93
94
YoY%%real
real
yoy
95
96
97
98CL
YoY%%
yoy
The cash crunch: Over 50% of the Russian companies operating today will fail
once faced with the competitive pressures of a true market economy. Why? The
main reason is substantial non-payment and the barter system, where companies
unable to pay cash for their products use their output to pay for raw materials,
labour and other expenses. Trading tractors for pipes and tights may not be the
best way to do business elsewhere, but it is a reality for Russia and will be further
intensified by the repercussions of the current financial crisis. Since the collapse
of the Soviet Union, Russian companies continued to exist, many in a limbo of
functional (if undeclared) bankruptcy. A large and modern combine harvester plant
CASH IS HARD
RUSSIA
TO COME BY IN
31

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
near Tula is largely idle; the Nizhny Novgorod tractor plant still struggles to reach
viability; the Kamaz lorry company is in difficulty; and the Mitishi underground
metro train plant has a dearth of orders.
FIGURE 34: TOTAL OVERDUE ACCOUNTS PAYABLE AND

ACCOUNTS RECEIVABLE AS A % OF RUSSIAN GDP
(Rbl bn)
1,000
900
800
700
600
500
400
300
200
100
0
0.4
939.2
0.35
756.1
0.3
570.3
514.4
458.4
0.2
335.5
0.15
238.9
0.1
165.5
90.4 80.4
0.25
0.05
0
1994
1995
1996
Total overdue payables

Accounts
Accounts receivable
Recievableasas%%ofofGDP
GDP
1997
1998 YTD/CL
Total overdue receivables

Accounts Payable
payable as % of GDP
Accounts
FOR
EVERY DOLLAR AN
INDUSTRIAL COMPANY
RECEIVES IN CASH, IT
RECEIVES ANOTHER IN THE
FORM OF A WIDGET
THE SHARE OF BARTER AS A

% OF TOTAL TRANSACTIONS IS
Firms on every point of the production chain, from manufacturers of finished goods
to their suppliers, conduct barter. This has been particularly severe in the energy sector
(over 85% in some instances). It remains acute, with wages remaining unpaid for
several months. The fact that employees remain loyal and report for work despite
this nonpayment demonstrates the comparative lack of normal market economy
income and consumption relationships! Inter-enterprise debt also has a disabling effect
on competition - competitive pricing becomes redundant if no price has effectively
been paid for at least several months. The recipient of the barter prices in the
inconvenience of doing someone elses business and demands a discount, typically
around 30%. The discount cuts heavily into the producers profits. On the other hand,
for the large conglomerates like Gazprom, Lukoil and the like, the barter payment
that is coming in cement, pipes and car parts is effectively the companys capex.
Introduction of a new VAT scheme as of 1 August, when VAT is to be paid on delivery
of goods rather than on cash receipts should improve the non-payments situation.
FIGURE 35: BARTERING AS A PROPORTION OF TOTAL SALES
CLIMBING SHARPLY
Power generation
Oil and gas
Metallurgy
Heavy engineering and machining
Chemical and petrochemical industry
Forestry, pulp and paper
Building materials, cement industry
Light industry
Food industry
Others
Processing industry
Consumer products
Investment goods
Intermediate goods
Agriculture
Avg Russia
1993
4
10
14
12
21
12
11
8
6
8
1994
13
17
32
18
25
21
24
20
9
11
1995
19
20
37
23
23
18
35
22
11
16
1996
35
32
47
35
43
35
48
40
17
24
1997
46
33
56
41
52
46
59
42
25
27
7
12
11
10
10
12
17
25
15
19
14
20
30
14
22
26
37
44
22
35
32
42
55
31
42
Source: EBRD
32

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 36: GROWTH OF BARTER TRANSACTIONS

IN INDUSTRIAL COMPANY SALES
(%)
45
(%)
0.9
40
0.8
35
0.7
30
0.6
25
0.5
20
0.4
15
0.3
10
0.2
0.1
0.0
1992
1993
1994
Barter as aa %
% ofofSales
sales (LHS)
(LHS)
1995
1996
1997
Annual %
%Growth
growthininBarter
barter(RHS)
(RHS)
Punishing tax and tariffs: Despite all the problems, companies prefer to barter
than collect cash from their customers. The simple explanation is taxes. According
to the Russian legislation, companies can pay wages before they have to pay taxes.
As wages make up about 15% on average of the total costs, industrialists prefer
to report that they are doing 85% of the business in barter. Once wages are paid,
the tax authorities have the power to seize whatever cash is left to cover the tax
bill. Obviously, the mounting tax bill means that as soon as the company decides
to do business on a cash basis, it will go bankrupt. One could be forgiven for thinking
Russians have a natural propensity for tricking the tax police and avoiding the
payment of taxes. Hence, although there are some incentives to stop bartering, many
companies feel these are minor compared with the satisfaction of not paying their
tax bills. Tax evasion is rampant in Russia on both a personal and corporate level
Approximately 60m Russians work illegally in one way or another - as either
employers or employees - and are connected with the shadow economy, which
is estimated at 65% of GDP vs 5-15% in the West.
It is notable that very few Russian-labelled products reach Western markets,
compared with the rush within Russia for Western or Asian items. In the meantime,
hidden technology and capability can always be found within Russias manufacturing
industry - one example is the potential production of infra-red night glasses capable
of being produced by a former military plant in Novosibirsk for $400 yet selling
in the US market for $5,000! Also, the Bor plant for car glass manufacturing
near Nizhny Novgorod is one of the largest in the world, and has the potential
to benefit from moderate technology transfer to regain a stronger market position.
However, before this can be done, the punishing levels of import, export and
transportation tariffs must be addressed.
The tax regime has been one of the weakest elements of Russias macro-economic
planning. Tax avoidance and the complexity of the structure are the most important
flaws in the entire Russian business climate. Tax revenues declined sharply
throughout the transition period in mid-90s. According to Goskomstat, the actual
tax revenues of Russias enlarged budget (including the consolidated revenues
of the federal and regional budgets and those of the extra-budgetary funds) fell
from over 44% of GDP in 1993 to less than 25% in 1996, with the trend
continuing in 1997.
BARTER CONTINUES TO
BE
PREFERRED, BECAUSE YOU

CANT TAX IT
65% OF RUSSIAS GDP IS

SHADOW ECONOMY
THE
T ARIFFS REDUCE EXPORT

COMPETITIVENESS
T HE RUSSIAN GOVERNMENT
HAS FACED CONTINUAL
SETBACKS WITH TAX REFORM
33

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
FIGURE 37: FEDERAL TAX COLLECTION (US$bn)

45
42.7
42.1
96
97
38.3
40
32.6
35
30
25
20
18.3
15
10
5
0
93
94
95
THE IMF HAS DEMANDED

TAX REFORM
A TYPICAL SERVICES
9
COMPANY RETAINS
The fiscal reforms are expected to accelerate, following the implementation of

the governments fiscal austerity plan agreed with the IMF and the World Bank.
Key measures of the action plan include the elimination of tax offsets, restructuring
tax debts of enterprises, strong measures against the largest tax debtors, and
improving expenditure control by moving all federal government accounts to the
Treasury. A new compromise version of the tax code is finally expected to be
adopted by the Duma this autumn. As the new code aims to modernise the system,
cutting down on the number of taxes and slimming the corporate tax burden
are envisaged. Profit tax, levied by both the federal and local governments, is
currently subject to a ceiling of 35%. Under the new code, VAT would be
standardised at 20%, with the separate 10% and 20% VAT categories abolished.
FIGURE 38: AVERAGE EFFECTIVE TAX BY SECTOR (%)

MORE
ON A DOLLAR OF GROSS
EARNINGS THAN A TYPICAL
MANUFACTURER
Diversified
Services
Distribution
Manufacturing
48
50
52
54
56
58
60
62
64
(%)
34

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 39: TAXES FACED BY A RUSSIAN MANUFACTURER

Corporate taxation. The corporate profit tax rate varies between 35% and 43%, depending on the type of
company. This rate is made up of a 13% tax levied by the federal government, and regional tax averaging 22%.
NO WONDER RUSSIAN GOODS

AREN T INTERNATIONALLY
COMPETITIVE
Capital Gains Tax. There is no capital gains tax, and capital gains are taxed as ordinary income.
Branch Profits Tax. Branches of foreign companies carrying on business in the Russian Federation are taxed
on their Russian-source income, at the corporate tax rate. Branch income may be exempt from Russian Federation
tax in terms of a double taxation agreement between the Russian Federation and the companys country of
residence.
Depreciation. Depreciation of business assets is effected in the same way for tax purposes as it is for accounting
purposes. The straight line method may be used, over the expected useful life of the asset, or if the useful life cannot
be ascertained, then over 10 years. Depletion allowances are granted against income from wasting assets, such
as land, minerals and other natural resources.
Losses. Net operating losses may be carried forward for five years. Branches of foreign companies may not carry
losses forward at all.
Withholding taxes. The following withholding taxes are imposed by the Russian Federation:
Interest 15%
Dividends 15%
Royalties 20%
Rental income 20%
Carriage of goods 6%
Payroll taxes. Every Russian Federation employer is required to make a contribution for social security equal
to 39% of employee remuneration. Each employee contributes a further 1%.
Property tax. Local authorities impose a property tax on the value of fixed assets, incorporeal property and
trading stock. The maximum tax rate is 2% of the value of the property.
Tax on exports. A tax is imposed on the exportation of goods, including raw materials, from Russia. The rate
of the tax is fixed as a percentage of the customs value of the goods.
Tax on Imports. A uniform, temporary 3% import duty tax has been imposed from 1 August 1998 until the end
of 1999
Sales Tax. A 5% sales tax is introduced at the regional level.
VAT. Any purchase is subject to a 10% or 20% VAT, depending on the item. The current plan is to standardise
this VAT to 20%. In a bizarre twist, imports from other CIS countries are VAT exempt, but exports from Russia
to CIS countries are subject to VAT.
Transport tax. Oil companies must pay a tax to the government for use of its pipelines to transport the companys
products.
Not exactly a tax but also falling into a major cost for businesses are governmentmandated cross subsidies. It will take a while for Russia to leave behind its
communist past, although just basic utilities and a restricted list of producer goods
and services remain subject to price controls at the federal level. Prices in sectors
or organisations deemed natural monopolies, including gas, electricity, railways and
telecommunications are administered by the government both for households and
industrial users. As a rule there is major cross-subsidisation, with household prices
and tariffs amounting to just half of the levels charged to industrial consumers.
Housing rents and prices for related communal services remain at an artificially
low level, sometimes as low as 30% of costs (see Sector report on Power). Cross
subsidies will be forced to unwind simply because industrial users are refusing
to pay them. According to the presidential decree, up to 50% discounts are to
be offered this year to industrial users for prompt cash payments for gas, electricity
and railway tariffs.
CROSS
SUBSIDISATION LIMITS
INTERNATIONAL
COMPETITIVENESS
35

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
MONETARY AND FISCAL POLICIES

MONETARY STABILITY:
ITS
FAILURE RUINED THE

REPUTATION OF THE CURRENT
GOVERNMENT
Since 1992, the monetary policy of the government has aimed at bringing financial
stabilisation, especially lowering the inflation rate. After the collapse of the Soviet
Union in 1991, the country continued to supply cheap credit to other former Soviet
republics and to state enterprises that kept producing unsellable products even while
inventories were accumulating. The rouble was floated in 1992. The budget deficit
of 10% in that year, mainly caused by the price liberalisation at the start of the
year, together with an increase in the broad money supply of around 560% produced
huge inflation of over 2,500% that year. Russia reduced the fiscal deficit to 4.6%
of GDP (via the printing presses), but as a result money supply increased by over
400%. When the 1994 budget deficit again reached over 10% of GDP, the run
on the rouble in Russias nascent financial markets later that year convinced the
government to return to a restrictive fiscal policy, and 1995 ended with a federal
deficit of just 5% of GDP. Following the introduction of a more restrictive monetary
policy, a band of 4,300-4,800 roubles per US dollar was introduced in July 1995.
From January 1996 to July 1996, the band was set at 4,550-5,150 roubles per dollar.
In July 1996, the government abandoned the rouble band in favour of a crawling
peg. The sliding currency corridor exchange rate regime applied from July 1996
and was extended through 1997. The currency band was set to depreciate from
its initial level of 5,500-6,100 roubles to 5,750-6,350 roubles/US$ by the end of
1996. That year the exchange rate of the US$ to the rouble rose by 19.8%, which
represented a monthly average of 1.5%. Since inflation in Russia ran at 21.8% and
was about 3% in the US, over the year the real exchange rate of the rouble declined
by 1.3%. In 1997, adjusted to inflation, the grew by 1.6%.
EXPECT A SHARP UPSWING AS
FIGURE 40: MONETARY BASE (Rbl bn)
THE GOVERNMENT HEATS UP

THE PRINTING PRESSES
180
160
140
120
100
80
60
40
0
Jan-96
Feb-96
Mar-96
Apr-96
May-96
Jun-96
Jul-96
Aug-96
Sep-96
Oct-96
Nov-96
Dec-96
Jan-97
Feb-97
Mar-97
Apr-97
May-97
Jun-97
Jul-97
Aug-97
Sep-97
Oct-97
Nov-97
Dec-97
Jan-98
Feb-98
Mar-98
Apr-98
May-98
Jun-98
20
Net International
international Reserves
reserves (NIR)
Net
(NIR) ($bn)
($ bn)
1
Net Domestic
domestic Assets
assets (NDA)
(Rbl
bn)
Net
(NDA)*
(R bn)
NDA is calculated using the exchange rates of R5.560 for 1997 data, R4.640 for 1996, R3.550 for 1995 and R1.247 for 1994
NDA equals monetary base minus net international reserves
36

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 41: MONETARY BASE AND GROSS

INTERNATIONAL RESERVES (US$bn)
35
30
25
20
15
10
Jan-96
Feb-96
Mar-96
Apr-96
May-96
Jun-96
Jul-96
Aug-96
Sep-96
Oct-96
Nov-96
Dec-96
Jan-97
Feb-97
Mar-97
Apr-97
May-97
Jun-97
Jul-97
Aug-97
Sep-97
Oct-97
Nov-97
Dec-97
Jan-98
Feb-98
Mar-98
Apr-98
May-98
Jun-98
Jul-98
($bn)
Monetary base ($
bn)
Gross international reserves (including gold) ($bn)

$ bn
It should be noted that the currency became current account convertible on 1 June
1996. The rouble was redenominated at the beginning of 1998, with Rbl rate of
6,000 for 1 US$ becoming 6 Rbl/US$. There is a 0.5% tax on hard currency
purchases by individuals. The initial rate for this year was set at 5.27/US$ to 7.13/
US$, allowing the rouble to fluctuate within that band (15% on either side of the
central rate of 6 Rbl for US$. After the peg was widened due to significant external
pressure on reserves on 17 August, the Central Bank has made several efforts to
fix the rouble at specific US$ exchange rates. However, momentum has proved
superior and the Central Bank in its weakened forex reserve position has been unable
to hold the rouble at any level. As of September 14, the rouble had topped to over
Rbl20/US$. The government and Central Bank are said to be thinking of several
alternatives, including a currency board, to stem the roubles slide.
CRAWLING PEG
1996
INTRODUCED
IN
FIGURE 42: THE ROUBLE EXCHANGE RATE AND THE

CORRIDOR (US$/Rbl)
12
11
10
9
8
7
6
5
4
2-Jan
9-Feb
12-Mar
RussianRouble
rouble
Russian
15-Apr
20-May
Corridor top
24-Jun
28-Jul
27-Aug
Corridor bottom
37

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
INTEREST RATES MATTER TO

BANKS, NOT PEOPLE
Banks in Russia are free to set deposit and lending rates without government
intervention. Government bond yields have generally driven the interest rate
structure. Their annualised rate on all maturities has steadily fallen from at least
200% in May 1996 to below 20% in June 1997, despite the introduction of a 15%
tax on all GKOs in early 1997. The CBR can influence government bond yields
by altering supply and demand conditions in these markets. The CBR refinancing
rate, another benchmark interest rate, sets the floor on the credit auctions but has
not been actively used. Following the crash in Asian markets, interest rates jumped
to over 40% at the beginning of December 1997. As Russia slipped closer to crisis,
interest rates rose steadily, at one point topping 200%. Interest rates have been
volatile since reaching highs of 150%, and have fallen to 80-100% recently. As
barely 25% of Russian savings are placed in banks (the underside of the family
mattress is seen as a far safer alternative) and personal borrowing is in its infancy,
these interest rates have had little effect on the average citizen. One must remember
that Russian banks (except Sberbank) are not actually banks but forex and interest
rate speculators. Russian banks high GKO/OFZ exposure (40% of the total market)
has already undermined their asset quality and their significant forward rouble
contract obligations to foreign investors means in many cases that they are already
technically bankrupt. The rush to withdraw deposits is already well under way,
although to what extent the government will come to the aid of depositors remains
unclear. Only deposits at Sberbank were insured by the government.
FIGURE 43: RUSSIAN CENTRAL BANK BORROWING RATE

vs RUSSIAN GKO (Rbl) YIELDS (%)
200
180
160
140
120
100
80
60
40
20
0
Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98
refinancerate*
rate (%)
CBR refinance
GKO average yield all maturities (%)
CB LEARNS NOT
TO RELY ON
THE PRINTING PRESSES
38
Central Bank policy remains uncertain in the wake of devaluation. Previously, policy
has been extremely hit and miss. After the first rouble crisis in 1994, the Central
Bank followed a strict monetary policy and slowed the expansion of the money
supply from over 200% in 1994 to 126% in 1995 (10% real) and just 26% in 1997
(17.6% real). This year, the government was aiming for a pre-devaluation M2 growth
of 22-30% with inflation contained below 8%. However, it is likely the government
will resort to the printing presses to meet its obligations after the financial crisis.
Anything other than rampant money supply growth would probably be taken as
a major positive for the economy.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 44: INFLATION AND ROUBLE DEPRECIATION PRE-CRISIS

(%)
900
80
840
70
800
700
60
600
50
500
40
400
30
300
20
215
200
131
10
100
22
0
93
94
95
11
96
Nominal Rouble
rouble depreciation
Nominal
depreciation
97
CPI (%) yr end (RHS)
THE
FIGURE 45: SOUTH AFRICAN RAND vs

AUSTRALIAN DOLLAR vs RUSSIAN ROUBLE
ROUBLE HAS NOW FALLEN
AS MUCH AS THE CURRENCIES

OF OTHER COMMODITY
ECONOMIES
...
105
100
95
90
85
80
75
70
65
60
May-97
Jul-97
Oct-97
South African rand

Rand
Jan-98
Mar-98
Russian
Russian Rouble
rouble
Jun-98
Aug-98
Australian
Australiandollar
Dollar
The recent (and ongoing) currency crisis has exposed a fundamental weakness in
Russia - a highly commodity based economy relying on a highly unresponsive
exchange rate mechanism. To avoid this in the future, Russia probably ought to
peg its currency against a basket of commodity prices, given its sensitivity to them.
The three energy sectors combined accounted for US$39.4bn or 44.7% of total
exports. Reflecting tumbling commodity prices, the value of Russian exports has
shrunk, and so should have the value of the rouble. Had the rouble adjusted in
accordance, Russia would have been in much better shape today - were it not for
the fact that the banking system is so exposed to devaluation. As long as the Russian
economy remains driven by natural resource exports, its currency must be
flexibleenough to adjust to movements in commodity prices.
AS LONG AS
THE
RUSSIAN
ECONOMY REMAINS DRIVEN BY

NATURAL RESOURCE EXPORTS,
ITS CURRENCY MUST BE
FLEXIBLE ENOUGH TO ADJUST
TO MOVEMENTS IN COMMODITY
PRICES
...
39

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
FIGURE 46: URALS AND BRENT OIL

PRICES vs RUSSIAN ROUBLE REBASED
. . . AND AS MUCH AS
RUSSIAS EXPORT OIL PRICE
140
130
120
110
100
90
80
70
60
50
40
Jun-97 Aug-97 Sep-97
Oct-97
Dec-97
Jan-98
Mar-98
Apr-98
Jun-98
Jul-98
Sep-98
Russian Rouble
rouble
Russian
Urals
DEBT FINANCING COSTS
FIGURE 47: OUTSTANDING GKOS, ROUBLE HOUSEHOLD

DEPOSITS AND M0 ( as at June 1998) (Rbl bn)
ARE
SHOOTING UP
500
400
300
200
100
0
Jan-96
Apr-96
Jul-96
Bank deposits
Oct-96
Jan-97
1
M0**
MO
May-97
Aug-97
Nov-97
Feb-98
Jun-98
Oustanding stock of GKOs/OFZs (nominal)
M0 is currency in circulation
HOT MONEY
FINANCING
CAUSED THE ROUBLE CRISIS;

ONLY WAY TO FIX FISCAL
DEFICIT IS VIA IMPROVED TAX
COLLECTION
40
Russias reliance on foreign borrowings was one of the main factors undermining the
stability of the rouble. As the country has long relied on foreign hot money for
financing its deficit, its sudden outflow - taking the rouble peg with it - has jeopardised
the economy. Interest rates have soared and, as a result, so has government expenditure
on debt financing. The instability has also jeopardised privatisation, thus hitting
government revenue. This has put the budget deficit under tremendous pressure. In
1997, the fiscal deficit crept up to 7.5% of GDP, due to the declining tax base in the
official economy. Thus, the most urgent structural problem in 1998 remains
insufficient tax collection. At the same time pressures for higher expenditures
increased, in part related to the elections and governmental reshuffle. Substantial
arrears to pensioners, state employees and others aggravated social problems.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 48: RUSSIAN FX RESERVES vs URALS OIL PRICE vs

THE ROUBLE (% YoY)
F OREX
RESERVES ARE
PERILOUSLY LOW, ALTHOUGH

RECOVERED FROM A NEAR
ZERO AT THE END OF
80
1991
60
40
20
0
(20)
(40)
(60)
Jun-97
Aug-97
Oct-97
Dec-97
Feb-98
Apr-98
Exchange Rate
rate (Rouble/US$)
(rouble/US$) m/e
Gross incl gold ($ m) y/e
Jun-98
Aug-98
oil Price
price($($bbl)
Urals Oil
bbl)
DOLLAR DEBT IS HUGE AND GROWING

Russias convertible currency external debt was estimated at $125bn at the end of
1997, equivalent to about one-third of nominal GDP. German banks have exposure
of $30bn to Russia (half of the total foreign commercial bank lending to Russia).
Another interesting note is that as at end-1997, 45% of total foreign lending to
Russia was of maturities of two years or more. 56% of lending was to the banking
sector, 12% to the public sector and 32% to private companies. Thus, the common
perception that the Russian government is the main debtor appears inaccurate.
FOREX
DEBT OF
$125BN AT
$140BN
END-1997 AND OVER

AT PRESENT
MANY BANKS ARE BANKRUPT SO, FAT CHANCE OF GETTING
FIGURE 49: FOREIGN BANK LENDING TO RUSSIA

- SECTORAL DISTRIBUTION (%)
THIS MONEY BACK
90
80
70
60
50
40
30
20
10
0
1985
1986
1987
1988
1989
1990
1991
Private sector
1992
1993
1994
1995
1996
1997
Banks
Official bilateral lenders held around 55% of this debt, commercial banks and other
private creditors around 30%, and the IMF and World Bank around 15%. The
external debt has been rising steadily, partly because of new borrowings (mostly
from the IMF and the World Bank), and partly because of debt restructuring. In
April 1996, the Paris Club rescheduled US$37.6bn of official debt mostly over 25
years, with six years of grace. The London Club of creditors provided a similar
arrangement for the stock of outstanding principal.
BORROW MORE TO PAY

ACCRUED INTEREST ON
OLD DEBT
41

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
FULL DEFAULT IS EXPECTED

$18BN IN
INTEREST DUE THIS
YEAR
The debt rescheduling has eased Russias debt servicing burden by some US$6bn
a year in principal repayments, from nearly US$10bn in 1991, to about US$4bn
in 1996. Russia was also to pay about US$5bn a year in interest, but has made
only partial payments, accumulating arrears that grew to over US$8bn by 1995.
On the basis of interest payments due and principal repaid, the overall debt service
burden dropped from US$14bn in 1991 to US$6.4bn in 1992, falling to US$3.7bn
in 1994. Nevertheless, it jumped to nearly $10bn in 1997, and an estimated $18bn
in 1998 - equal to 4% of GDP and well above Russias current forex reserves.
At present, the Eurobond market is pricing in default on most of this debt.
TRADE: DOWN BUT NOT OUT

TRADE
LIBERALISATION
The feature of communist economies was self-sufficiency, combined with a

reliance on its closest backers. It is hardly surprising that until very recently, the
Russian economy was effectively closed for trade with the outside world apart from
the former Communist Block countries. With the collapse of communism,
liberalisation of the trade system has also appeared on the radar screen. Import duties
have been brought down, and with many industries being deregulated and demonopolised, efforts were made to comply with the international norms such as
those of the WTO (World Trade Organisation), which Russia is planning to become
a member of from the year 2000.
FIGURE 50: BALANCE OF PAYMENTS

Current account ($bn)
Current account (% GDP)
Capital account ($bn)
Capital account (% GDP)
94A
9.3
3.4
(32.4)
(11.7)
95A
7.9
2.2
(20.1)
(5.6)
96A
12.1
2.7
(4.6)
(1.0)
97A
3.3
0.7
7.5
1.7
98CL
(5.5)
(1.3)
14
3.2
TARIFFS AND VAT STILL

UNDERMINE EXPORT EFFORTS
TRADE
IS STILL HARDLY FREE
WITH AVG IMPORT TARIFFS AT
14%
FROM
A HISTORIC TRADE
SURPLUS,
RUSSIAS TRADE
BALANCE IS HEADING SOUTH

RAPIDLY
42
However, several social and political constraints, such as the need to support growing
domestic industries and avoid inflating unemployment, still undermine steps forward.
Contrary to the regulations on Russias trade and international practices, exports
to the CIS countries continue to be subject to VAT, while imports form these
countries are free from VAT. The draft code envisages the adoption of international
standards in the trade with CIS countries form the beginning of the century.
The average trade weighted import tariff in 1996 was around 13-14%. The maximum
tariff level (except for Alcohol) was reduced by 30% in the 4Q96. As a further
measure to contain capital flight, a new excise law came into effect from early 1997,
providing for similar treatment of domestic and imported goods and services. A new
law requires all retail goods imports to display a label in Russian. Restrictions on
alcohol imports have been tightened, including an increase in the minimum price
of imported spirits and the introduction of a special licensing system. Driven also
by budgetary considerations, new tariff rules have been applied to shuttle trade
- independent imports by individuals. One of the measurements of the openness of
trade is the ratio of total trade (imports and exports) to the countrys GDP. In Russia
this ratio has been steadily growing from just 21% in 1992 to over 34% this year.
Russias exports have expanded substantially since 1992, from US$53.6bn to
US$89bn in 1997, but so have imports which rose from US$43bn to US$67bn in
the same period. Russia has therefore recorded substantial and trade surpluses,
increasing from US$10bn in 1992 to US$19bn in 1997.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 51: RUSSIAs MONTHLY EXPORTS,

IMPORTS & TRADE BALANCE (US$m)
10,000
4,150
9,000
3,650
8,000
3,150
2,650
7,000
2,150
6,000
1,650
5,000
1,150
4,000
650
3,000
150
(350)
2,000
Jan 31, 1994
Nov 30, 1994
Sep 30, 1995
Imports
Jul 31, 1996

Exports
May 31, 1997
Mar 31, 1998
Balance
The 1H98 trade numbers highlighted the deterioration in Russias trade account.
In fact 1Q98 was the fifth successive quarter in which the trade surplus shrank.
The lacklustre oil price over the past three months suggests that when 2Q98 figures
are released they will be very disappointing, too. What is even more alarming is
that 3Q97 saw a strong rally in the oil price from a low of US$17.5/bbl to US$24.9/
bbl, and if that is not repeated this year then the YoY comparisons will look
extremely worrying. CLSA forecasts that Russia will run a small trade deficit in
1998 of US$1.4bn vs a trade surplus of US$19.8bn in 1997 - a massive swing
of US$21bn.
FOR
FIGURE 52: RUSSIAN TRADE NUMBERS (US$bn)

Quarterly trade data
Exports
Imports
Trade position
1Q97
20.9
14.2
6.7
1Q98
17.7
16.0
1.7
Diff % change
(3.2)
(15)
1.8
13
(5.0)
(75)
2Q97 2Q98
19.9 18.0
16.0 17.5
3.9
0.5
T HE TRADE SURPLUS FELL

87% IN 1H98
Diff % change
(1.9)
(10)
1.5
9
(3.4)
(87)
THE FULL YEAR, THE
SWING IN THE TRADE ACCOUNT

COULD REACH
US$21BN
A large contributor to the deficit is the oil price decline. The Russian Urals crude
oil price YTD is down 42% YoY, and gas prices have followed suit, having declined
14% YTD. Over the first six months this year, crude oil revenues fell by 25%.
Natural gas export proceeds also declined by over 17%. As Russia remains heavily
dependent on raw material exports, an estimated 25% fall in export revenue wipes
US$13.8bn, or a staggering 70%, off the trade surplus - using 1997 as a base. A
10% rise in imports sweeps another US$3.4bn, or 17%, off the Russian trade surplus.
THE
SLUMP IN COMMODITY
PRICES IS HITTING
RUSSIA
HARD
43

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
CLSA ESTIMATES RUSSIAN

16% IN
1998
FIGURE 53: RUSSIAN TRADE ACCOUNT - SENSITIVITY ANALYSIS
EXPORTS WILL FALL
1997A
Avg price ($) Revenue ($bn)
15.8
14.7
16.1
7.2
82.0
16.4
2,103.0
1.1
6,744.0
1.5
1,402.0
3.8
42.7
87.4
Crude oil (bbl)

Oil products (bbl)
Natural gas (bcm)
Copper (000t)
Nickel (000t)
Aluminium (000t)
Other exports
Total exports
1998CL
Avg price ($) Revenue ($bn)
11.9
11.0
12.1
5.4
61.5
12.3
1,577.3
0.8
5,058.0
1.1
1,051.5
2.8
40.1
73.6
THE
ENERGY PRICE DECLINE IS
FIGURE 54: RUSSIAN TRADE ACCOUNT (YoY % change)
DEVASTATING FOR THE
RUSSIAN TRADE ACCOUNT
Trade balance
Exports total ($bn)
YoY %
Imports total ($bn)
YoY %
Trade balance ($bn)
% of GDP
Total trade (% of GDP)
92A
93A
94A
95A
96A
97A
98CL
99CL
53.6
n.a.
43.0
n.a.
10.6
12.7
21
59.7
11
44.3
3
15.4
8.4
23
67.8
14
50.6
14
17.2
6.2
26
81.1
20
60.9
20
20.2
5.7
31
89.2
10
67.8
11
21.4
4.9
35
87.4
(2)
67.6
(0.3)
19.8
4.4
34
73.6
(16)
75.0
11
(1.4)
(0.3)
33
78.0
6
74.5
(1)
3.5
0.8
34
OTHER CIS
COUNTRIES STILL
ACCOUNT FOR
38% OF
FIGURE 55: EXPORTS - BY COUNTRY
EXPORTS
China
13%
Germany
21%
Netherlands
13%
US
15%
Belarus
13%
Ukraine
25%
44

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 56: IMPORTS - BY COUNTRY
GERMANY -
A MASSIVE
TRADING PARTNER
Netherlands
13%
Germany
28%
US
17%
Ukraine
22%
Belarus
20%
FIGURE 57: EXPORTS VOLUME BY PRODUCT

Timber products
3%
Other
3%
Chemical products
9%
Natural gas
25%
Machinery &
equipment
11%
Metals
22%
HEAVILY COMMODITY BASED:

86% OF EXPORTS
Crude oil
18%
Coal
9%
FIGURE 58: IMPORTS VOLUME BY PRODUCT
IMPORTS ARE
NEARLY ALL
MANUFACTURED/ PROCESSED
GOODS
Chemicals
15%
Machinery and
equipment
35%
Food
26%
Metals
9%
Clothing &
household goods
15%
45

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
INVESTMENT - FINDING VALUE IN RUSSIA

There are four ways to invest in Russia - debt, secondary equity market, privatisations
and FDI.
DEBT: FIRST TO DEVELOP

GOVERNMENT
BONDS WERE
SUPPOSEDLY SAFE THANKS TO

FORWARD CURRENCY
CONTRACTS WITH BANKS
Within the Russian securities market, government bond instruments were the fastest
to develop. GKO (Russian Treasury bills), OFZ (federal loan bonds) and MinFINs
($-denominated bonds) were the key instruments. In mid 1997, the nominal value
of GKOs/OFZ outstanding amounted to at least $51.3bn or close to 12% of GDP
- a sharp rise on 7.1% just a year ago. The average maturity on all outstanding
bonds continued to increase and in mid-1997 stood at above six months. Access
by foreigners to the GKO/OFZ market was permitted since early 1996 and was
further eased in July 1996 and early 1997. The government has announced a
restructuring of the GKO market and put a stop on any further issuance of the
rouble-denominated short-term debt as of July this year. Currently, foreigners account
for about 20% of the Russia government bond market.
FIGURE 59: RUSSIAN DEBT INSTRUMENTS

(US$bn)
Total debt
External (dollar) debt
28.4
Restructured in 1997 into PRINS (Principals) & IANs (interest arrears notes)
37.6
External SU debt restructured in 1996 to the Paris Club (principal payments begin in 2002)
4
Still to be restructured
10.3
MinFins
Long-term dollar domestic debt
15.9
Eurobonds
Domestic (rouble) debt
44
GKO (Short term T-bills) and OFZ (long-term bonds)
At least $11bn is owned by non-residents
141
Total (of which US$90bn is old Soviet Union debt)
200% YIELDS SHOULD HAVE
FIGURE 60: GKO YIELDS PRE AND AFTER THE IMF PACKAGE (%)
BEEN TELLING THE PEOPLE

SOMETHING
(%)
200
180
160
140
120
100
80
60
40
20
0
17-Mar-98
16-Apr-98
21-May-98
18-Jun-98
20-Jul-98
12-Aug-98
Moodys, Standard & Poors and Fitch IBCA awarded Russia its first credit ratings
in October 1996, preceding Russias first Eurobond issue. Moodys awarded Ba2,
while S&P gave a rating one below at BB-, and Fitch awarded a rating one higher
at BB+.
46

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
It was clearly expected that if the rouble were to collapse, further debt downgrades
would be on the cards. Moodys, which had already downgraded Russia twice this
year, lowered Russias US dollar debt from B2 to B3, and its local currency debt
rating in roubles from Caa1 to Ca. The ceiling for Russias banking deposits rating
was lowered from Caa1 to Ca3. S&P has decided to downgrade Russias long-term
foreign currency credit rating to CCC from B-. Short-term foreign currency ratings
remain unchanged at C. Fitch IBCA downgraded both Russias long and short-term
foreign currency ratings from B- to CCC and from B to C, respectively. These
significant downgrades surprised no one after Russias debt default.
Present
B+
BBB1
Previous
BBBB
Ba3
DOWNGRADES LIKELY
CANT PAY, WONT PAY
FIGURE 61: HOW THE RATINGS HAVE CHANGED

Standard & Poors
Fitch-IBCA
Moodys
RUSSIAN DEBT RATINGS STILL

NOT SETTLED, WITH FURTHER
Date changed
9 Jun
30 July
29 May
On 17 August, when Russia announced the widening of the rouble peg, it also
announced a 90-day moratorium on all non-governmental foreign debt, and a
restructuring of (eg default) its $30bn+ of GKO liabilities. About a week later, the
terms of the restructuring were announced. According to the Presidents decree, the
new order covers the GKOs and OFZs maturing up to 31 December 1999 and issued
up to 17 August 1998. Principally, investors holding these types of securities can wait
to the maturity of bonds, and receive their nominal value to special transit accounts.
The funds from these accounts can be used only for re-investment in three new types
of rouble-denominated bonds, to be issued by the authorities. The options are:
FIGURE 62: GKO RESTRUCTURING - OPTIONS FOR HOLDERS

Rouble-denominated securities
5% cash upfront
The same face value
3-year duration @30% interest
4-year duration @30% annual interest in the first 3 years, and 25% in the last year
5-year duration @ 30% in the first 3 years, 25% in the 4th, and 20% in the last year
Dollar-denominated securities
20% of the remainder @14 Aug value for US$-denominated debt [6m GKO weighted avg price 54.34]
Face value to be calculated at the avg foreign exchange rate from 17 Aug-26 Aug
Maturity 2006 (8 years)
Annual interest of 5%
Russia has so far managed to tiptoe around the cross-default provisions in its
Eurobond liabilities, although the bonds are pricing in default, yielding over 50%
in the case of the 07 US$ bond. Eurobonds were a brave new world for Russia
and it was symptomatic of the easy credit of 1996-97 that Russia was able to have
their maiden issues. Russia issued its first Eurobond, a five-year $1bn issue, on
21 November 1996. The most well-known of Russias bonds is its 10-year US$
issue of June 1997. Russia had great plans for exploiting the euro-market, with
its internal limit on Eurobond issuing being raised from Rbl137bn to Rbl190bn.
However thanks to the investor flight due to the botched rouble devaluation, further
tapping of the Eurobond market seems unlikely at the present time.
E UROBONDS: NOW TRADING

17 ON THE DOLLAR
AT
47

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
T RADING AT
FIGURE 63: RUSSIAN 07 US$ EUROBOND

PREMIUM OVER US TREASURIES
DEFAULT LEVELS
(%)
45
40
35
30
25
20
15
10
5
0
Jun-97
Aug-97
Oct-97
Dec-97
Feb-98
Apr-98
Jun-98
Aug-98
40M
SHAREHOLDERS WERE
CREATED IN
1992
SECONDARY STOCK MARKET

BEGAN IN 1994
E MPLOYEE OWNERSHIP
IS HIGH
48
Privatisation of Russian companies began in 1992. One of the positive results of the
process was the creation of some 40m shareholders, thereby providing favourable
conditions for the emergence of a stock market. As Russian officials liked to note,
Russia now has more private shareholders than the whole of Western Europe. The
first one opened in 1991 in Moscow and by 1995 some one hundred trading places
were in operation , when 72 companies were listed. The market got off to a fast start,
rapidly increasing volumes and a limited selection of stocks to invest in, although
inadequate regulation and custody registration systems constrained faster growth. A
commission for the Securities and Stock Market was established in 1994. While the
very concept of a stock market was alien to Marxist culture, this very fact made it
especially attractive to the younger generation, which, although their knowledge was
initially confined to textbooks, rapidly developed a whole investing culture. Just as
in many other emerging markets, foreign investors play a dominant role in the Russian
stock market, accounting for approximately 25% of both capitalisation and turnover.
The market gathered momentum and in 1996 rose an incredible 170% in US$ terms,
making Russia the best performing emerging market that year. It continued to rise
strongly before a crash in October 1997, and has not recovered since. At the end of
2Q98, the total markets capitalisation was back to US$45bn
In over 65% of Russias 18,000 privatised medium-sized and large firms,
management and employees have majority ownership, whereas non-state outsiders
control only 20% of these companies. While in the top 100 companies, outsiders
have an ownership stake well above the average, the wide dispersion of these
shareholdings often ensures a controlling position for management. Although there
are plenty of examples of manipulation of voting procedures and obstacles to outside
shareholders gaining board representation, they have not deterred foreign investors.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
EQUITIES: HIGH RISK, SOMETIMES HIGH RETURN

RUSSIAS STOCK MARKET
FIGURE 64: RUSSIA PE BAND CHART
CAPITALISATION IS NOW
SMALLER THAN THE
UK
WATER INDUSTRYS
600,000
500,000
400,000
300,000
12x
10x
200,000
8x
6x
100,000
4x
0
Mar-95
Sep-95
Mar-96
Sep-96
Mar-97
Sep-97
Mar-98
Sep-98
FIGURE 65: RUSSIA MARKET STATISTICS AND FORECASTS

Year to 31 Decemberr
Earnings (Rbl m)
Total equity (Rbl m)
Mkt cap (Rbl m)
Mkt earnings growth (%)
PE (x)
ROE (%)
P/Book (x)
1994A
15,035
362,918
22,040
12.20
4.10
0.51
1995A
41,882
679,358
46,317
178.60
4.38
6.20
0.27
1996A
46,008
831,531
164,584
9.90
3.99
5.50
0.22
1997A
32,066
859,856
503,425
35.00
5.72
3.70
0.21
1998CL
24,457
n.a.
183,497
(23.7)
7.5
n.a.
n.a.
1999CL
44,171
n.a.
183,497
(6.0)
4.2
n.a.
n.a.
Currently the Rbl40bn that Russians have invested in the Russian stock market
represents only 1.6% of GDP. Although the percentage of total savings investments
in securities has increased from 2.7% to over 4%, the comparable percentage of
GDP invested in securities in Britain is 17% and in the US more than 39%. There
is clearly a huge window for growth.
Under the 1996 Securities Law, the Federal Commission for the Securities Market
stated that all stock exchanges and professional market participants (including
brokers, dealers, trust managers, depositories, etc) were to be re-licensed by October
1997, replacing previous licences granted by the Finance Ministry of the Central
Bank of Russia. With the adoption of more rigorous licensing and minimum capital
requirements, the number of stock exchanges and trade organisers in Russia
decreased substantially from around 60 in 1995 to 11 by year-end 1997. Prior to
that, a wide range of instruments were traded on the Russian capital markets, ranging
from common shares with different voting rights, preference shares, debt securities,
depository receipts, futures contracts on commodities, shares, currencies, gold
certificates and veksels, or promissory notes. Since 1997, securities trading in Russia
has evolved from a low volume on a large number of exchanges to a substantially
higher volume dominated by two trading platforms - the Russian Trading System
(RTS) for equity trading and the Moscow Interbank Currency Exchange (MICEX)
for government debt and currency trading.
E QUITY MARKET IS NOT
WELL
REGULATED
49

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
FIGURE 66: ANATOMY OF A CRISIS - AS REFLECTED IN THE RTS INDEX

RECENT
KEY EVENTS THAT DRAGGED DOWN THE
RUSSIAN STOCK MARKET
600
January 1998
Yeltsin reshuffles
the cabinet.
30 November 1997
IMF delays quarterly
loan.
500
4 March 1998
Duma passes
Federal Budget - 3
months late.
20-27 May 1998

Russias stock market
crashes, interest rates sky
rocket to 150%.
22 June 1998
The IMF and the
Russian government
start negotiating a
bail-out plan.
400
300
13 July
International multilateral lenders
(the World Bank and the IMF)
pledge an unexpectedly large
sum of $22.6bn in extra credits
for 1998 and 1999.
29 April - 5 May
1998
26 May 1998
Kirienko names a pro- Yeltsin signs austerity
reform, young cabinet. budget package.
27-28 October 1997

World stock markets
crash, led by declines
in Asia.
23 March
President Boris Yeltsin
saying reforms are too
slow, fires Prime Minister
Victor Chernomyrdin and
the entire cabinet.
February 1998
Investors retreat. Sergei
Oil companies issue
Kirienko named acting
18 June
profit warnings.
Prime Minister.
The IMF delays $670m
tranche of a loan citing
fiscal problems.
14 May 1998
Coal miners protesting unpaid
13 August
wages, block Siberian railway line.
George Soros advises rouble
Stocks fall on Duma passing the
devaluation. Shares plunge to
law restricting foreign ownership of
their lowest level in more than
shares in electricity giant UES.
two years.
17 August
Government widens the
rouble corridor to 9.5
roubles in trading against
the dollar, allowing it to
devalue. Announced
restructuring and debt
moratorium of rouble
denominated debt (GKOs).
10
10 December
December - January
January 1997
1998
Yeltsin sick, bedridden until

January.
200
100
0
28-Aug-97
28-Oct-97
28-Dec-97
28-Feb-98
28-Apr-98
28-Jun-98
23 August
Yeltsin sacks the entire
government, including
the PM Kirienko,
names Chernomyrdin
acting Prime Minister.
27 August
The CBR suspends rouble
trading for the third
consecutive day. Street level
reaches 15 roubles to the
dollar.
28-Aug-98
RTS SYSTEM IS AN
ELECTRONIC MARKET SIMILAR
TO
NASDAQ
The Russian equity market has historically developed as an over-the-counter market,

which accounts for about 90% of all equity trades. The RTS, established in 1995
and re-licensed in March 1997, is similar to the NASDAQ trading system in the
US. It has more than 400 members in 30 locations and operates a computer network
offering electronic links between its member for price quotes and executing
transactions. In 1997, the RTS established two tiers of listings - the RTS-1, which
includes larger companies, and RTS-2, which includes smaller companies with less
liquid shares. As at 31 December 1997, 64 companies with 107 securities, including
64 common shares and 43 preferred shares, were listed on RTS, and 165 companies
with 244 securities were listed on RTS-2.
FIGURE 67: TOTAL NUMBER OF ISSUES TRADED

ON BOTH RTS-1 AND RTS-2
No. of new issues
Cumul no. of issues
1995
8
72
1996
26
83
1997
218
310
1998 (May end)

41
351
50

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
This page is intentionally left blank
51

U S S I A N
N V E S T M E N T
CLSA
T L A S
CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
September 1998
FIGURE 68: RUSSIAN EQUITY

Bloomberg
Company name
code
Price change absolute, %
MARKET MATRIX
Price
Mkt cap
Index
Price change rel to local index (%)
Equity PEx
Dividend
High
Low
Volatility
(Rbl)
(Rbl m)
weighting (%)
-1mth
-3mths
-6mths
YTD
-1mth
-3mths
-6mths
174.9
789
0.5
(58.7)
(71.6)
(76.0)
(72.3)
(41.4)
(46.7)
2.2
274
0.2
n.a.
n.a.
n.a.
n.a.
n.a.
Beta
YTD
Rel
yield (%)
52 week
52 week
90 day
(33.9)
1.7
0.8
1.7
904.3
175.0
n.a.
0.8
n.a.
n.a.
n.a.
n.a.
n.a.
25.1
0.007
n.a.
n.a.
AUTO
GAZA RU Equity
GAZ AUTO PLANT
KMAZ RU Equity
KamAZ
BANKS
SBER RU Equity
SBERBANK OF RUSSIA
314.4
4,176
2.6
(46.9)
(59.5)
(70.9)
(80.3)
(24.6)
(23.9)
(19.8)
(27.7)
0.1
3.2
1,948.4
209.7
187.8
1.0
AVTB RU Equity
AVTOBANK
207.2
26
0.0
(29.1)
(64.2)
(72.1)
(66.4)
0.6
(32.8)
(23.2)
23.3
0.0
4.8
n.a.
0.7
129.6
0.3
INBK RU Equity
INKOMBANK
0.4
394
0.3
(48.6)
(75.8)
(79.7)
(84.1)
(27.1)
(54.6)
(44.0)
(41.5)
0.0
13.9
n.a.
0.002
83.8
0.4
MBUB RU Equity
MOSBUSINESSBANK
2.4
170
0.1
(15.9)
(8.9)
(30.0)
(51.8)
19.4
71.2
92.8
77.2
0.9
n.a.
n.a.
0.003
74.2
0.4
NORILSK NICKEL
6.3
1,040
0.6
(40.6)
(70.8)
(80.1)
(83.4)
(15.7)
(45.2)
(45.1)
(39.0)
0.4
n.a.
75.5
6.0
136.4
0.9
GAZP RU Equity
GAZPROM
1.2
27,485
17.7
(50.7)
(65.0)
(77.9)
(83.9)
(30.1)
(34.3)
(39.1)
(40.8)
n.a.
2.6
10.2
0.8
167.5
0.9
LKOH RU Equity
LUKOIL-HOLDING
24.1
20,093
10.4
(53.7)
(63.1)
(77.7)
(82.5)
(34.3)
(30.6)
(38.7)
(35.6)
4.3
0.9
169.5
24.1
129.4
1.0
SNGS RU Equity
SURGUTNEFTEGAZ
0.4
12,693
6.5
(33.3)
(36.1)
(49.6)
(63.0)
(5.4)
20.1
38.8
36.0
2.9
1.6
1.7
0.4
131.5
1.0
TATN RU Equity
TATNEFT
0.9
1,908
0.0
(55.9)
(75.8)
(87.2)
(90.0)
(37.4)
(54.5)
(64.6)
(63.2)
0.5
6.9
11.9
0.9
152.0
1.0
YUKO RU Equity
YUKOS HOLDING
5.3
11,753
6.5
(8.3)
(33.4)
(55.6)
(70.8)
30.1
25.2
22.4
7.3
4.9
n.a.
27.1
4.5
n.a.
0.8
BEGY RU Equity
BASHKIRENERGO
0.3
318
0.2
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
0.2
6.4
5.0
0.5
n.a.
n.a.
IRGZ RU Equity
IRKUTSKENERGO
0.2
1,125
0.7
(62.1)
(71.9)
(74.3)
(79.9)
(46.2)
(47.3)
(29.3)
(26.4)
0.4
4.5
2.1
0.2
143.6
1.1
KRNG RU Equity
KRASNOYARSKENERGO
0.1
57
0.0
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
0.2
n.a.
3.6
0.4
n.a.
n.a.
LSNG RU Equity
LENENERGO
1.5
1,196
0.7
(32.3)
(35.6)
(40.7)
(71.2)
(3.9)
21.0
63.5
5.8
n.a.
n.a.
6.4
1.0
n.a.
0.9
MSNG RU Equity
MOSENERGO
0.1
3,277
1.9
(63.6)
(73.1)
(85.1)
(84.4)
(48.3)
(49.4)
(59.0)
(42.7)
0.5
4.2
1.1
0.1
139.7
1.1
SAGO RU Equity
SAMARAENERGO
n.a.
328
0.2
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
4.6
5.6
0.7
n.a.
n.a.
SVER RU Equity
SVERDLOVENERGO
0.1
96
0.0
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
0.1
3.6
6.8
0.5
n.a.
n.a.
EESR RU Equity
UNIFIED ENERGY SYSTEMS
0.2
7,623
5.1
(76.8)
(82.6)
(88.5)
(89.2)
(67.1)
(67.3)
(68.2)
(60.4)
0.6
2.6
2.7
0.2
160.3
1.2
TRADE HOUSE GUM
5.2
315
0.2
(39.9)
(49.9)
(65.6)
(65.0)
(14.7)
(5.9)
(5.2)
28.5
0.8
2.9
30.9
5.0
n.a.
0.9
232.1
734
(44.8)
(62.3)
(67.0)
(69.6)
(21.7)
(29.3)
(9.2)
11.7
2.0
1.2
1,187.4
171.4
n.a.
n.a.
76.4
897
0.5
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
1.9
1.2
246.4
76.0
n.a.
n.a.
1,121.0
1,314
0.7
(30.7)
(50.8)
(76.9)
(86.1)
(1.7)
(7.6)
(36.4)
(48.8)
1.8
2.6
n.a.
1,048.5
n.a.
0.8
METALS
NKEL RU Equity
OIL & GAS
POWER
RETAIL
GUMM RU Equity
TRANSPORT
AFLT RU Equity
AEROFLOT
TELECOMS
KUBN RU Equity
KUBANELECTROSVYAZ
MGTS RU Equity
MOSCOW CITY TELEPHONE NETWRK
NNSI RU Equity
NIZHEGORODSVYAZINFORM
n.a.
n.a.
0.2
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
40.8
6.8
n.a.
n.a.
RTKM RU Equity
ROSTELECOM
3.5
3,941
1.6
(75.4)
(78.7)
(83.4)
(83.3)
(65.1)
(59.9)
(54.3)
(38.6)
3.7
2.3
28.0
3.5
138.0
0.9
ASPMT Index
ASP MT INDEX, Rb
175.1
104
100.0
(41.6)
(56.5)
(72.8)
(78.5)
1,136.5
175.1
96.1
ASPMT$ Index
ASP MT INDEX, $
58.1
12
100.0
(49.0)
(63.7)
(75.0)
(80.8)
429.1
55.9
98.9
Source: Bloomberg and CLSA Global Emerging Markets
52

53
U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
AVG DAILY
MARKET TURNOVER
USED TO REACH
REGULATION
US$95M
The RTS system transacts a significant amount of trading on the OTC market. Deals
are made by telephone. Continuous trading is based on a bid/offer system. The
average daily turnover per trading day on the RTS was approximately US$64m
in 1997 and US$95m in 1Q98. The average daily turnover per trading day on the
RTS-2 was approximately US$3.8m and US$1.4m, respectively, for FY97 and 1Q98.
The total number of equities listed on RTS-1 and RTS-2 during FY97 and the 1Q98
was 169 and 19, respectively. The Russian Trading System index (RTS) is the most
commonly used index for measuring the performance of the Russian equity market.
It is a capitalisation-weighted index on the basis of all stocks listed on the RTS.
Trading takes place between 11.00am and 6.00pm every working day. Although
regulation has improved, there are still risks for the foreign investor. Russia lacks
a centralised formal security register. Based on a sample of 24 of Russias biggest
100 companies, a study by Harvard University noted that 17% illegally maintained
their own shareholders register, while 44% had bought back and resold their own
shares to insiders rather than retiring them.
ISSUES
Greater progress has been made over the past year as it is becoming easier to invest
in Russia via American Depository Receipts (ADRs), which currently account for
8-10% of the total capitalisation of the Russian equities market. It should rise to
around 15% when all currently planned ADRs are issued.
MINORITY RIGHTS ARE
NOT
WELL RESPECTED
One of the main problems of the equity market is that Russia does not have a
history of share ownership. The companies are still learning that privatisation means
they are answerable not just to the state, but to a whole range of shareholders.
As the recent examples of MGTS and Norilsk Nickel have shown, shareholder rights
can be as easily violated as revoked in poorly-regulated Russia. Nevertheless the
recent high profile cases of enforcing improved corporate governance and preserving
shareholder rights (UES, Gazprom) are encouraging signs. Investors, particularly
foreign investors, want detailed, accurate information about corporate assets. This
is infrequently provided
FOREIGN DIRECT INVESTMENT - BADLY NEEDED

NET
FOREIGN CAPITAL INFLOW
TO END-1997 WAS ONLY
$22BN
54
Quantifying the amount of FDI in Russia is extremely difficult. The latest available
data from Goskomstat showed that the accumulated inflow of foreign capital to 1
January 1998 was US$21.8bn. US$10.5bn of that came in during 1997, after
US$6.5bn in 1996 and $2.8bn in 1995. Nevertheless, the numbers show that FDI
has remained low, with its doubling between 1995 and 1997 much smaller than
the quadrupling of total foreign investment (including portfolio investment, bank
deposits and credits). As Figure 69 shows, FDI was $2.021bn in 1995, $2.040bn
in 1996 and $3.897bn in 1997. This compares with a jump in portfolio investment
from US$30m in 1995 to US$343m in 1997. The overall increase in foreign
investment has been driven by trade credits, bank deposits and others. These
amounted to $890m in 1995 and nearly $6.3bn in 1997.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FDI IS MINUTE COMPARED

EAST EUROPEAN
FIGURE 69: FDI INFLOW vs GDP PER CAPITA (US$)
WITH OTHER
COUNTRIES
6,000
250
5,000
200
4,000
150
3,000
100
2,000
50
1,000
0
0
Czech Rep
Hungary
Poland
GDP per head

Head(LHS)
($)
Russia
Inflows per
per capita
capita(RHS)
(US$)
FIGURE 70: FDI COMPARISON:

RUSSIA AND EASTERN EUROPEAN STATES (US$m)
Czech Rep
Hungary
Poland
Russia
1995
2,526
4,453
1,134
2,021
1996
1,388
1,986
2,741
2,040
1997
1,275
2,100
3,044
3,897
FDI cumul 89-97FDI

7,473
15,403
8,442
9,743
% of GDP97
2.4
4.7
2.3
0.8
Source: IMF/EBRD
In Russia, policies and system improvements designed to attract foreign investment,

as well as the domestic political and economic stability achieved in 1996 and 1997,
have been welcomed by foreign and domestic investors alike and have contributed
to the recent launch of full-scale foreign investment in the country. Moreover, the
designation of areas covered by the law for production-sharing agreements and the
conclusion of a basic agreement to deal with private debts from the Soviet era are
expected to positively influence the investment environment.
The US accounts for at least 26% of foreign investment in Russia, closely followed
by Switzerland. In the manufacturing sector, knockdown production has been
expanding in industries such as automobiles and electric appliances. In addition,
foreign investment in newly privatised firms is rising and a number of major US
and European oil companies are participating in energy development projects.
CHANGES IN
INVESTMENT
ENVIRONMENT
US IS THE BIGGEST
IN R USSIA
INVESTOR
FIGURE 71: FOREIGN INVESTMENT BY COUNTRY OF ORIGIN, 1997

US
Switzerland
Netherlands
UK
Germany
Austria
Sweden
Japan
Belgium
France
Others
(US$m)
1,695
1,323
980
486
289
164
155
75
65
42
1,232
(%)
26
20
15
7
4
3
2
1
1
1
19
55

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
TRADE
AND FINANCE
- THE
TWO BIGGEST AREAS
FIGURE 72: FOREIGN INVESTMENT

BY BRANCHES OF THE ECONOMY
Industrial machinery
3%
Transport
4%
Pulp and paper
4%
Non-ferrous
metallurgy
3%
Finance, credit and
insurance
29%
Trade and
catering
5%
Fuel
8%
Other
9%
TINY SIZE OF
INVESTMENT IN
FUEL SECTOR VS POTENTIAL

SHOWS HOW MINOR
FDI
IS IN
RUSSIA
INCENTIVES ARE
GRADUALLY
IMPROVING
SOME
DEALS ALREADY
ANNOUNCED
. . . SOME
...
INVESTORS
ALREADY GIVING UP
56
Food
11%
General
commercial activity
24%
One of the largest sums within the industry was invested in the fuel sector. As
Russia is estimated to be the worlds third largest oil producer by the turn of the
century, it is no surprise. However, it is notable, that total investment in fuel in
1997 amounted to $1.657bn, which might represent investment in the energy sector
last year by Royal/Dutch Shell and BP. But the sum is still extremely low given
the potential and the levels of investment required to lift production and exports.
In addition, better legislation is being put forward, eg bankruptcy legislation is now
in operation and internationally recognised accounting methods are becoming
increasingly more common. Furthermore, Yeltsin has signed a decree creating special
free economic zones for companies and foreign investors that invest more than
$250m in Russia. These zones will carry the additional provision that within five
years all manufactured goods produced in them must consist of at least 50% of
domestic parts.
In the auto sector, the following deals have already been announced - Fiat and GAZ
have signed a $850m JV to produce vehicles in Nizhny Novgorod, and Kia cars
are being assembled in Kaliningrad (further, the company said back in 1996 that
it would invest $1bn over the next five-six years). Renault has agreed a $350m
deal in Moscow with Moskvitch; Daewoo may set up plant in Rostov; Ford is
deciding on a $150m plant in St Petersburg; and General Motors and AvtoVAZ
have been in talks on building a plant in the St Petersburg or Central Russia region.
Continental is considering buying or setting up a tyre factory in Russia to produce
some 5m units a year. March saw a spate of announcements by tobacco companies
intent on building plants in Russia. Phillip Morris intends to spend $250-300m on
a factory in the St Petersburg region and RJ Reynolds also plans to invest $120m
over 1998-99 (having already put in $400m since 1992 and has 20% of the market).
BAT Industries plans to invest another $60m (on top of $150m spent upgrading
two plants it owns in Moscow and Saratov).
Yet, foreign companies are also leaving Russia. Having set up a television factory,
Philips is pulling out. A prominent Scandinavian paper firm has pulled out of Russia
having failed to see scope in the short-term profit.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 73: MAJOR FDI PLAYERS IN RUSSIA AND THE FSU

US
Germany
China
Finland
UK
Italy
Poland
Austria
Cyprus
Switzerland
Turkey
France
Netherlands
Japan
Hungary
Czech Republic
Total
1996
2,166
1,971
1,376
1,061
947
708
596
541
398
487
379
395
292
338
261
240
12,156
1997
3,079
2,147
1,475
1,188
1,201
768
622
579
637
562
488
440
354
339
277
263
14,419
% in 1997
21
15
10
8
8
5
4
4
4
4
3
3
2
2
2
2
NUMBER OF ESTABLISHED
JVS BETWEEN FOREIGN AND
RUSSIAN COMPANIES
PRIVATISATION
Privatisation was initially one of Russias success stories. The effort to privatise
state enterprises was launched in the autumn of 1992, via voucher distribution to
all citizens. Vouchers could be exchanged for shares in enterprises, transferred to
an investment fund or sold for cash. Bidding for shares began in December 1992
and ended in June 1994. By mid-1995, more than 15,000 medium-sized and large
enterprises (about 70% of the total number of firms, employing over 80% of the
industrial workforce) were formally transferred to private ownership. The largest
portion of equity was generally offered to company employees and management.
However, in many cases, this still meant the state continued to hold large or
controlling interests in these companies. In the aggregate, the state still owned about
one-third of the industrial sector.
The second stage of the privatisation process - selling stakes of some 4,600 small
firms for cash - has been much more problematic. Privatisation revenues to the
federal budget came in at less than 10% of the Rbl12,400bn target in 1996. However,
privatisation revenues increased sharply in 1Q97, due primarily to the auctioning
off of 8.5% in Unified Energy Systems (UES). Since September 1996, the
beneficiaries of the shares-for-loans schemes of 1995 have received the right to
sell the shares of their holdings. By mid-1997, in five of the original 11 sharefor-loans transactions the auctions had taken place and in each case, the original
loan provider won it. Privatisation targets for 1998-2000 include several blue chips
like Svyazinvest (the major telephony holding company), Rosneft (the last solely
state-owned oil holding company) and Lukoil, as well as nearly 70 other fully stateowned companies or further blocks of shares in partially privatised enterprises.
THE
OBJECTIVES OF
RUSSIAN
PRIVATISATION WERE NOT

CLEAR-CUT
AGGRESSIVE PRIVATISATION
TARGETS FOR NEXT TWO
YEARS LOOK INCREASINGLY
REMOTE
The objectives of removing state ownership in the Russian economy are not the
same as the aims of privatisation in Western economies:
57

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
FIGURE 74: DIFFERENT GOALS

Western privatisation goals:
wider share ownership
raising revenue for government
de-politicisation of decision making
liberalisation of competitive product markets
strategic collaborative benefits for the industry via introduction of foreign expertise
the injection of fresh management expertise
the raising of further equity capital investment
Russian privatisation methods:
the sale of shares in open-type JSCs (joint stock companies) created during the privatisation process
no new equity sold
auctions - the sale of enterprises, which are not JSCs
commercial tenders - the sale of enterprises that are not JSCs
commercial tenders - the sale of blocks of shares in JSCs
the sale of shareholdings in state or municipal property by auction and commercial tender
political rather than economic process, designed to remove the State from the economy
RUSSIAN PRIVATISATION
PROCESS RESEMBLED MORE
COLLECTIVISATION THAN
PRIVATISATION
PRIVATISATION MORE A
POLITICAL THAN ECONOMIC
PROCESS
NO NEW
EQUITY RAISED;
INCUMBENT MANAGEMENTS
POSITION STRENGTHENED
58
Until now, one of the most striking features of Russias privatisation programme
has been how little revenue the government has received. In spite of privatising
about 123,000 enterprises by the end of 1996, the governments privatisation receipts
have never amounted to more than 0.28 % of GDP in any one year. In contrast,
the privatisation programmes in Poland, Hungary and the Czech Republic have raised
much more revenue. In 1994, for example, the Czech government received an
equivalent of 3.2% of GDP from privatisation sales. It is quite obvious that several
fundamental principles of privatisation were lacking in Russia. Essentially the process
resembled more collectivisation than privatisation, and achieved nothing, but a
gridlock in industrial performance. Shares were distributed to employees and to the
general population, then debt was swapped for equity, as many banks acquired large
share-holdings for a relatively low price.
There are perhaps two main reasons for the difference. It seems that privatisation
in Russia was initially more of a political than economic process, designed to remove
the state from the economy and create a new class of private owners. Control was
freely given to outsiders in the belief that in a competitive market they would either
use or lose their assets. Second, foreign investors have largely been excluded from
Russian privatisation deals limiting the degree of competition. In most strategically
important sectors (energy, utilities) foreigners were not allowed to own stakes larger
than 15% of the total equity. At the end of 1997, foreigners owned less than 2%
of Russias medium-sized and large enterprises. However, in the largest 100
companies, foreign participation amounted to a chunkier 15%. So, has the business
environment changed? The Duma has approved the new Privatisation Law, which
eliminates most insider privileges during privatisation and sets out procedures for
determining a more realistic market valuation of assets on sale. After the bad
publicity surrounding auctions such as Svyazinvests sell-off, there does appear to
be genuine competition between the groups for the highest bid.
One of the primary goals of the traditional joint stock listing is to raise capital
for its further development, or to realise its corporate worth by selling its equity.
This fundamental has been lacking in Russian privatisation - no equity was raised
and the stock was simply transferred to employees usually lacking any financial
resources or knowledge to target further rights issues. Corporate managements
position was strengthened rather than weakened, since it was offered major stakes
and other shareholdings were extremely fragmented. No strategic foreign investors
were initially introduced, so the opportunity to exploit outside experience was also
missed. The consolidation of the majority shareholding in banks hands represented
a more realistic opportunity, as they had the capital to build up competitiveness.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 75: IN THE PIPELINE - UPCOMING STATE-OWNED HOLDINGS TO BE PRIVATISED

Company
Year 1
Eastern Oil
1998
Oil
384
34.0
Gazprom
1998
Gas
1,500
5.87
35
Sector
Proposed
Stake
State
MV stake ($m) to be sold (% remaining)
(%)
Current
Status
Shareholding
Yukos 54%, state 34%, employees 12%
Postponed
Domestic institutions 29%, employees
End
15%,foreign investors 1.98%, Gazprom
September
group 13%
Lukoil
1998
Oil
689
5.4
21.6
30% state, 25% ADRs, Lukoil 11%,
TBC
Nikoil 18%, other 13%, individuals 3%

Lukoil
1998
Oil
82
10.6
11
Moscow Electrosvyaz
1998
Engineering
49
22.0
as above
Postponed
Property Fund of Moscow 22%,

Svyazinvest 38%, others 40%
No bidders,
Postponed until
late September
Norsi Oil
1998
Oil
34
14.9
71
85.5% state, plans to sell a total of

51%, 14.5% others
Novosibirsk Electrode Plant 1998

Rosneft
1998
Engineering
5.4
21.5
Oil
1,600
75
Was due to
open August 25
control under dispute

21
96% state, rest by employees
TBC
Results due
end October
Sibur
1998
Oil
73
Sibur
1998
Oil
180
20.2
60
50% less as above
85% state
as above
Happened
Still on
1 share
Slavneft
1998
Oil
234
19.7
Russian and Belorussian JV 100%

(Russia 75%, Belorussia 11%, rest by
Western investors)
Svyazinvest
1998
Telecoms
1,700
25% less
75%
Delayed due
to lack of
interest
End
2 shares
Tyumen Oil
1998
Oil
1,624
47.5
State 49%, Alfa Group and Renova

Group 25.1% each, Alfa already bought
Opens
August 31
2.5% in March
Total
8,155 2
originally targeted, some are likely to be postponed the government to publish updated privatisation programme by September
$2.5bn planned for 2H98
59

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
PRIVATISATION SLOWED IN
1H98, BUT IS TO ACCELERATE
BY MID-1999
60
Russia has been extremely fast in listing major state-owned companies, continued
this year with the privatisation of the smaller stakes in several oil companies and
a 5.7% holding in Gazprom. The sell-off of 75% of the last state-owned holding
oil company, Rosneft, is likely to be postponed. Nevertheless, with previous stateowned companies having found their way onto the market fast; capitalisation of
the Russian market is unlikely to exceed 15% of GDP (compared with less than
10% now and 32% in Hungary and 31% in the Czech Republic). This clearly leaves
plenty of room for growth in the market, although the contribution from privatisation
will thereafter be less.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
RUSSIA SECTOR BY SECTOR

FIGURE 76: HOW SECTORS HAVE COPED RELATIVE TO 1990 (%)
90
80
MANY INDUSTRY OUTPUT

50%
BELOW 1990 LEVELS
LEVELS ARE ALREADY
77.2
65.8
70
57.2
60
54.9
43.1
50
37.3
40
Industry total 47.5

32.3
31.1
30
12.6
20
10
Textiles
Construction
materials
Forestry, timber,
pulp and paper
Machinery and
metal works
Chemical and
petrochemical
Non-ferrous
metallurgy
Ferrous
metallurgy
Energy
Power
generation
FIGURE 77: GDP BREAKDOWN vs MARKET CAP BY SECTOR
Other
11%
Food processing &

agriculture
15%
ENERGY PROPS
UP
R USSIAS
ECONOMY
Construction
materials
2%
Oil and gas

26%
Pulp and paper

3%
Chemicals
5%
Power
11%
Telecoms
3%
Metals
13%
Engineering
11%
Having abolished the price controls and restrictions on private ownership nearly
five years ago, the Russian economy has been significantly liberalised. Energy, power
generation and telecommunications, metallurgy, and transport were the first to benefit
from restructuring. The composition of the economy has undergone significant
changes as well. Agriculture and industry weightings in GDP have come down,
while the private sector has expanded to nearly 70% of GDP.
61

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
POWER GENERATION
FIGURE 78: ELECTRIC UTILITIES
UES
Mosenergo
Irkutskenergo
Lenenergo
Price
(US$)
0.0
1.5
1.0
0.2
Code
EESR
AOMOY US
IKSGY US
LSNG
Market cap
(US$m)
1,387.2
384.0
95.3
158.3
12mth
high
0.5
18.9
18.3
1.1
12mth
low
0.0
1.1
0.9
0.2
98 earnings
(US$)
0.044
18.9
0.6
(0.08)
PE
(x)
0.8
0.1
1.7
n.a.
1mth avg daily

turnover (US$'000)
13,741.8
1393.5
120.9
20.8
Sources: Bloomberg and CLSA Global Emerging Markets
THE
POWER INDUSTRY IS
CRUCIAL TO THE FUTURE

ECONOMIC DEVELOPMENT OF
THE COUNTRY
POWER
GENERATION
The electricity sector is the second largest sector in Russia (18% of total market
capitalisation), although very fragmented. In the mid-1990s the power generation
monopoly was divided into 74 regional energos and a holding company, Unified
Energy Systems (UES), which operates the national grid. The energos were
privatised, but the state retains control of most of them, directly (through local
government stakes) or indirectly (through UES, as it has a controlling interest
in 53 of them). The state also preserved a 52% stake in UES. The energos have
their own generating capacity and local transmission networks, and they top up
their revenues with the production and distribution of heat. Unified Energy System
consists of seven sub-systems. Six of them (apart from the Far Eastern one) are
interconnected through a grid by high-voltage transmission lines. Energy is
transmitted from regions with an energy surplus to those with a deficit. Currently
only 10-15 regions are net donors.
FIGURE 79: ELECTRICITY GENERATING CAPACITY
PRODUCTION HAS NOT YET

STABILISED
Electricity capacity (GW)

Growth (%)
Demand (bn kWt)
Growth (%)
Generation (bn kWt)
YoY %
Surplus (%)
1993A
203
n.a.
917
n.a.
957
n.a.
4
1994A
204
1
839
(9)
876
(8)
4
1995A
205
0
824
(2)
862
(2)
5
1996A
206
0
811
(2)
848
(2)
5
1997A
206
0
798
(2)
834
(2)
5
1998CL
206
0
742
(7)
770
(8)
4
Source: Goskomstat
FIGURE 80: CURRENT AND FUTURE POWER GENERATION MIX (%)

Installed capacity mix
Hydro
Thermal
Nuclear
Output mix
Hydro
Thermal
Nuclear
1993
21.0
71.0
8.0
1994
20.0
70.0
10.0
1995
20.0
70.0
10.0
1996
20.0
69.0
10.0
1997
20.0
69.0
11.0
2000CL
20.0
69.0
11.0
18.0
69.0
13.0
20.0
69.0
11.0
18.0
69.0
12.0
19.0
69.0
12.0
17.0
70.0
13.0
14.0
72.0
14.0
SAFETY
ISSUES ARE AN
ONGOING CONCERN
62
Russia also has 33 nuclear reactors with a total capacity of about 200GW. Reactor
maintenance and repairs have been delayed because of lack of funds. Safety issues
are an ongoing concern, especially with regard to the 16 relatively old reactors whose
design is similar to Chernobyls. Nevertheless, the Ministry of Atomic Energy is
planning to add 15GW of nuclear generating capacity by 2010.

I
N V E S T M E N T
1
5
Bilibino
Kola
St. Petersburg
Smolensk
Voronezh
6
1
A
T L A S
September 1998
63

U S S I A N
Beloyarsk
6
Kursk
Balakovo
Rostov
Kalinin
3
CLSA
Number of reactors
FIGURE 81: SOVIET-DESIGNED NUCLEAR POWER PLANTS
U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
THE
ELECTRICITY GRID IS IN
NEED OF MODERNISATION
PRICING STRATEGY IS SET BY

THE FEDERAL ENERGY AND
REGIONAL ENERGY
COMMISSIONS
CROSS-SUBSIDISATION OF
HOUSEHOLDERS BY
INDUSTRIAL CONSUMERS TO BE
ELIMINATED BY
2000
DEREGULATION SHOULD
IMPROVE EFFICIENCY
REAL TARIFF
Production capacity is slightly higher than demand. However, it is estimated that,

even if the economy grows, electricity demand is unlikely to exceed a Cagr of
1.5%. Therefore, investment is required for modernising the existing grid, rather
than for capacity expansion. At least 25% of total Russian generating capacity
should be replaced by the year 2000 at an estimated expense of US$1-3bn in
new capital annually.
The sector has a two-level pricing structure - selling to and buying from the wholesale
market (set by the Federal Energy Commission every quarter) and tariffs for end
users in the regions (set by the Regional Energy Commissions). UES controls about
33% of the total wholesale market and at least 75% of the retail one through shares
in local energos. The rest is controlled by the local governments (Tatarstan) and
privatised entities like Irkutskenergo and Tatenergo. At the retail level, low residential
tariffs are cross-subsidised by high industrial prices. Although residential customers
pledge higher growth and better collection rates in the future, they are currently
unprofitable because todays tariffs rarely cover production costs.
Most Russian electricity consumption is by the industrial (44%), residential (23%)
and transport (8%) sectors. It is expected that an increase in residential tariffs
will offset a decrease in industrial tariffs and that the cost gap in residential tariffs
will close within the next two to three years. We believe that future growth in
consumption should primarily stem from non-industrial customers, which should
further improve the energos top-line growth prospects. Electricity prices grew on
average by 22% in rouble terms or 19% above the inflation rate in 1997. In
1997, the average price of 1 kWh was $0.042, compared with a global average
of $0.075 and about half that level in developed countries. Per capita electricity
consumption is also low in Russia compared with other countries with similar
climatic conditions. Per capita consumption has dropped 25% from 7,297kW in
1990 to 5,652kW in 1996.
It is widely believed that the regulator is to start using an inflation less formula
(at the moment, it is a cost plus formula) for setting tariffs in order to encourage
the utilities to cut costs and become more efficient. Any increases in tariffs, which
exceed these expectations, would boost sector earnings.
CROSS-
FIGURE 82: DYNAMICS OF TARIFFS OF ELECTRICITY FOR

POPULATION AND INDUSTRIES (US)
SUBSIDISATION WILL
DISAPPEAR, LEADING TO A
RISE IN RESIDENTIAL AND A
DECLINE IN INDUSTRIAL
TARIFFS
6
5
4
3
2
1
0
Industrial
tariff
revenue per kWh
Residential
cost per kWh
Average tariff
Average cost
64

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
Similarly to the rest of the country, non-payment by customers has been a major
problem for the power industry - at least 30% of the heat and power delivered
in 1997 was not paid for. UES currently receives just 20% of payments in cash.
The rest is in barter or promissory notes. As Russian energos rely on natural gas
for 70% of its power production, the inability of power companies to pay for fuel
to run their plants has reduced output. Russian power generation fell by 2% in 1997,
and is expected to decline further by up to 6% in 1998. The drop in domestic
consumption was not offset by the rise in exports as power exports remain small.
Since 1991, Russia has exported electricity almost solely to Finland and the former
Soviet republics, accounting for just 2% of the total electricity produced. Some
potential export markets include Germany, China, Mongolia and China.
CONTINUING PAYMENTS
CRISIS
AFFECTS ENERGOS
PRODUCTION AND FINANCIAL
PERFORMANCE
FIGURE 83: PROJECTED ELECTRICITY

CONSUMPTION IN bn kWh (TWO SCENARIOS)
Base case
1995 (%)
382
44
Industry
Growth (%)
Agriculture
58
Growth (%)
Construction
15
Growth (%)
Transport
67
Growth (%)
Residential & service
198
Growth (%)
Total
720
Own use of output
142
Total consumption
862
CAGR 96-2000/2000-05 (%)
7
2
8
23
84
16
100
Scenario 1 - optimistic
2000CL (%) 2005CL (%)
397
44
474 45
4
19
57
6
71 7
(2)
25
18
2
21 2
20
17
71
8
80 8
6
13
215
24
243 23
9
13
758
84
890 84
146
16
168 16
900 100
1058 100
0.9
3.3
Scenario 2 - pessimistic
2000CL (%) 2005CL (%)
375 44
427 45
(2)
14
56
7
65
7
(3)
16
15
2
16
2
0
7
68
8
70
7
1
3
201 24
218 23
2
8
715 84
796 84
137 16
151 16
852 100
947 100
(0.2)
2.1
Source: Goskomstat
We believe that the sector has limited prospects for short- to medium-term earnings
growth. That is driven largely by low Russian GDP growth and unprofitable cross
subsidisation. Russia ranks third in the world in terms of total energy consumption
after the US and Japan, and already has relatively high electricity consumption per
capita. As revenue composition of the energos is rebalanced, there is potential for
a pick-up, as residents account for just 25% of total consumption. Gas is the most
widely used fuel (70%) for thermal power stations, hence volatility in oil prices
could have a significant impact on earnings.
THERE
ARE LIMITED
PROSPECTS FOR PORTFOLIO

INVESTORS IN THE ENERGY
SECTOR
Only 21 of the 74 energos are actively traded, while the top five - Mosenergo,
UES, Irkutskenergo, Lenenergo and Bashkirenergo - have a joint market
capitalisation of just US$4bn, or over 20% of Russias total market capitalisation.
The very fact that most financing is attracted by just a handful of companies is
likely to trigger consolidation. Deregulation and rationalisation of tariffs may create
opportunities as well as further downside for investors. The largest of the financially
sound companies appear to be the strongest candidates for any cross-industry mergers
and, therefore, are the safest bets.
65

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
OIL PRODUCTION , REFINING AND GAS INDUSTRIES

FIGURE 84: OIL AND GAS
Gazprom local
Gazprom ADR
LUKoil
Yukos Hldgs
Sidanco Oil
Surgutneftegaz
Tatneft
Price
(US$)
0.1
6.8
3.9
1.0
6.5
0.1
2.8
Code
GAZP
RGZD LI
LKOH
YUKO
SIDA
SNGS
TNT US
Market cap
(US$m)
3,338
15,980
2,577
2,259
1,511
1,542
300
12mth
high
1.5
29.3
28.9
4.7
28.0
0.3
41.6
12mth
low
0.1
5.4
3.0
0.1
0.0
0.0
2.6
98 earnings
(US$)
(0.0)
(0.1)
0.3
n.a.
n.a.
0.0
1.2
PE
(x)
loss
loss
11.7
n.a.
n.a.
6.5
2.4
1mth avg daily

turnover (US$'000)
3,867
11,600
4,395
180
n.a.
2,472
1,155
16 MAJOR OIL COMPANIES ;

ONLY TWO STILL 100%GOVERNMENT OWNED
The oil and gas industry has long dominated Russias economy. Privatisation of
the oil industry started in 1993, when the Russian government broke the industry
into several state-owned E&P, refinery and distribution companies. At a later stage,
holding companies were created and were given a bundle of assets ranging from
oilfields and refineries to wholesaling operations and gas stations. Nine vertically
integrated companies (VICs) had been established by early 1997: Lukoil, Yukos,
Surgutneftegaz, Sidanco, Tyumen Oil Company, Sibneft, Slavneft, Eastern Oil and
Onako. The state is still to privatise nearly 17% of Lukoil; governmental stakes
in others range from 19-51%. In addition to the VICs, state-owned oil assets have
been divested and consolidated in four of Russias autonomous republics: Tatneft
(Tatarstan); Bashneft (Bashkortostan); Komitek (the Komi Republic); and Yunko
(Chechnya). The remaining majority state-owned companies are Rosneft (100% to be privatised later this year), Transneft (100% - due to be privatised, no indication
when) and natural gas monopoly Gazprom (35% - after a 5.7% stake to be sold
to a strategic investor). The oil transportation network Transneft is likely to remain
in state hands until at least next year. Several oil holding companies are at turning
point - TNK, Slavneft and Eastern Oil Company face difficulties in establishing
themselves as independent entities, although they are rapidly catching up to emerged
winners such as Lukoil, Yukos, Sidanco and Surgut Holdings.
FIGURE 85: OIL AND GAS PRODUCTION, 1993-98

Year to 31 Dec
Crude oil (m bpd)
YoY %
Natural gas (bcm)
YoY %
Coal (mt)
YoY %
Oil exports (m bpd)
Gas exports (bcm)
1994 1995 1996 1997 1Q97 2Q97 3Q97 4Q97 1Q98 2Q98 1998CL
6.22 5.98 5.88 5.96 1.46 1.49 1.51 1.50 1.46 1.46
5.82
(7)
(4)
(2)
1
2
1
(1)
0
(2)
(2)
607
595
601
571
163
133
116
159 164.6
137 578.2
(2)
(2)
1
(5)
(18) (13)
37
1
3
1
271
262
255
244
69
56 54.5 64.6 65.8 52.9 230.8
(11)
(3)
(3)
(4)
(19)
(3)
19
(5)
(6)
(5)
2.61 2.45 2.53 2.53
184
192
193
201
Source: Goskomstat
66

CLSA
8.
9.
10.
11.
12.
13.
14.
North Ustyurt
Amu-Darya
East Aral
Turgay
Chu-Sarysu
Tadzhik
Fergana
15.
16.
17.
18.
19.
20.
21.
Timan Pechora [Rosneft]

West Siberian [Surgut]
Yenisey-Khatanga [Rosneft]
East Siberian [Sidanco, Slavneft]
Lena-Vilyuy
Amur [Rosneft]
North Sakhalin [Rosneft]
U S S I A N
Carpathian
Dnieper-Donetsk Pripyat
Crimean [Lukoil]
Kolkhida
South Caspian
Pre-Caspian
Volga-Urals [Yukos, Sidanco, Lukoil]
1.
2.
Selected pipeline terminals
3.
4.
5.
Existing pipeline
6.
Planned or under construction pipeline 7.
Petroleum basin boundaries
Bering
Sea
North Sea
Laptev Sea
SWEDEN
DENMARK
Gulf of Bothnia
Barents Sea
Kara Sea
GERMANY
FINLAND
Baltic Sea
Ventspils
ESTONIA
LITHUANIA LATIVIA
Nasaeikiai
17
Tikhvin
15
Pechora
Sea of Okhotsk
1
2
MOLDAVIA
19
Urengoi
Moscow
UKRAINE
Okha
Odesa
21
Surgut
16
Black
Sea
Samara
Novorossiysk
Krasnodar
Tuapse
11
Aral
Sea
Lake
Baikal
Pavlodar
Kirkusk
KAZAKHSTAN
Irkutsk
CHINA
Vladivostok
MONGOLIA
10
UZBEKISTAN
12
NORTH KOREA
67
TURKMENISTAN
Askhabad
ISLAMIC REPUBLIC OF IRAN
SOUTH KOREA
13
14
KYRGYZSTAN

T L A S
Caspian
Sea
Sea of
Japan
Orsk
Guryev
Makhachkala
AZERBAIJAN Shevchenko
Baku
Khabarovsk
IRAQ
GEORGIA
ARMENIA
SYRIA
20
Kurgan
4
TURKEY
18
Ufa
3
Neftekum
N V E S T M E N T
Brest
BELARUS
Druzhba
POLAND
September 1998
FIGURE 86: OIL MAP OF RUSSIA - MAIN CRUDE OIL FIELDS AND PIPELINES
SIDANKO
Surgut
Holding
Sibneft
Rosneft
Slavneft
Eastern Oil
Tyumen Oil
ONAKO
KomiTEK
Orenburgneft
Orenburg NG
Geolog
TATNEFT
Exploration &
Production
Surgut NG
Noyabrsk NG
Purneftegas
Sakhalinmor NG
Krasnodar NG
Stavropol NG
Tamneft
Dagneft
Kalmeft
Megion NG
Meg NG -Geolog
Tomskneft
Tomsk NG -Geolog
Nizhnevarlovsk NG
Tyumen NG
Cb NG Geolog
Yaroslavl NOS
Yaroslavl Refinery
Mozyr Refinery
Achinsk Refinery
Tomsk Pet-Chem
Ryazan Refinery
Orsk Refinery
Ukhta Refinery
Yaroslavl NP
Kostroma NP
Ivanovo NP
Megion NP
Krasnoyarsk NP
Khakassia NP
Tuva NP
Tomsk NP
Novosibirsk NP
Ryazan NP
Kursk NP
Tula NP
Kaluga NP
Tyumen NP
Orenburg NP
Komi NP
Komineft
Refining
Perm NOS
Volgograd Ref
Kuybishev NOS
Syzran Refin
Kuybishev Rel
Novokuibyshev
Angarsk NOS
Saratov Refinery
Khabarovsk Ref
Kirishi NOS
Omsk Refinery
Komsomolsk
Tuapse Refinery
Krasnodar NOS
Onegoneft
Novgorod NP
Tver NP
Kirishi NP
Kaliningrad NP
Pskov NP
Len NP
Nefto-Kombi
Ruchyi
Krasny Neftyannik
Omsk NP
Source: Russian Energy Ministry

CLSA
Kurgan NP
Murmansk NP
Nakhodka NP
Smolensk NP
Stavropol NP
Dag NP
Mos NP
Yamal NP
Altal NP
Arkhangelsk NP
Krasnodar NP
Tuapse NP
Sever NP
T L A S
Volgograd NP
Adygeya NP
Abadzekhsk NP
Kirov NP
Chelyab NP
Vologda NP
Bryansk NP
Voronezh NP
Samara NP
Orel NP
Belgorod NP
Lipetsk NP
Penza NP
Tambov NP
Ulyanovsk NP
Sakhalin NP
Amur NP
Khabarovsk NP
BAM NP
Primor NP
Buryat NP
Irkutsk NP
Rostov NP
Kamchatka NP
Saratov NP
Magadan NP
Chukotka NP
Marketing
N V E S T M E N T
Yugansk NG
Samara NG
Chernogor
Kondopetroleum
Variegan NG
Udmurt NG
Saratov NG
Ural NG
Langespas
Kogalym NG
Perm NG
Nizhnevolzhskneft
Kaliningradmor NG
Astrakhanneft
U S S I A N
YUKOS
LUKoil
September 1998
68
FIGURE 87: RUSSIAN OIL INDUSTRY STRUCTURE
CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
The oil and gas companies, like many Russian corporates, face enormous cash flow
problems as most of their domestic sales are done for barter or cash. For example,
only 8% YTD of Gazproms domestic sales are for cash. This has the dual difficulty
of causing large working capital shortages at the oil companies and depriving the
government of tax revenue from the oil companies. The proposition to collect taxes
from oil companies and from Gazprom by taking the money directly from exports
to ensure prompt payment has received a mixed response. A swap of company debt
for equity has also been suggested, as in the case with the money Gazprom is owed
by several local electricity operators.
Russian oil production peaked at 11.4m barrels per day (bpd) in 1988. Since then,
Russian output tumbled to 6.2m bpd in 1994 and then more gradually to 5.6m
bpd in 1997. The dramatic production declines experienced since 1988 resulted
from several factors, including natural reserves depletion, insufficient investment,
stalled implementation of tax reform, and poor technical management (such as the
use of premature water injection). The bulk of Russian oil production comes from
a small number of large fields, which has tended to aggravate falls in output.
About 90 fields account for 75% of total Russian output. In West Siberia, four
large fields account for over half of the regions output. Tyumen Oils division
that operates the super-giant Samotlor field has been responsible for roughly 35%
of the production decline in Russia since 1988. Stabilisation of output followed
by gradual increases in production are expected for the next several years. The
well workover programme to revitalise old wells has resulted in a decline in the
number of idle Russian wells (still 40,000 idle) over the past year, and production
from joint ventures is gradually increasing as well. West Siberia now accounts
for about two-thirds of Russian oil production, with fields in the Volga-Urals region
producing less than 25% of the countrys total output. Russias Arctic region is
a far smaller producer, but is the location of many Western joint ventures. Most
of Russias new oil developments are in West Siberias Tyumen region as well
as near Sakhalin Island in the Far East.
NON-PAYMENTS
INVESTMENT IS LOW AND

TAXES REMAIN PUNISHING
RUSSIAN OIL OUTPUT HAS

1988
HALVED SINCE
T HE THREE
FIGURE 88: PRODUCTION vs EXPORTS (000 bbl)
BY
CONSUMERS REMAIN HIGH,
LARGEST
COMPANIES ACCOUNT FOR

OVER
400
350
300
250
200
150
100
50
0
47% OF
ALL CRUDE AND
GAS PRODUCED AND
1997 production
Yukos
Tyumen
Tatneft
SurgutNG
Slavneft
Sidanco
Sibneft
Rosneft
Onaco
KomiTEK
Eastern Oil
Bashneft
Lukoil
EXPORTED
Exports
69

N V E S T M E N T
Moscow
Perm
CLSA

T L A S
Achinsk
Grozny
Orsk
Tuapse
Khabarovsk
Saratov
Ukhta
U S S I A N
Yaroslavl
Kirishi
Norsi
Angarsk
Samara
Syzran
Omsk
Salavat
Volgograd
Komsomolsk
Ufa
Novoufa
Ufaneftechim
Krasnodar
Nizhnekamsk
Ryazan
Mozyr
Rosneft
KomiTEK
Onako
Tatneft
Bashneft
Yunko
Norsi
Other
LUKoil
Yukos
Surgut
Sidanco
Slavneft
Sibneft
Tyumen Oil Company
Eastern Oil Company
September 1998
70
FIGURE 89: OIL REFINERIES AND THEIR OWNERS
CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
UNSOPHISTICATED
FIGURE 90: REFINING vs CAPACITY (000 bbl)
AND IN
NEED OF MODERNISATION
(000 bbl)
300
250
200
150
100
50
Actual
Yukos
Tyumen
SurgutNG
Slavneft
Sidanco
Sibneft
Rosneft
Onaco
KomiTEK
Eastern
Oil
Lukoil
Capacity
RUSSIAN OIL EXPORTERS

BREAK EVEN AT $12.55/BBL
FIGURE 91: CRUDE OIL ECONOMICS

Average break even crude price for Russian oil exporters: $12.5 bbl.
For every $1 rise (fall) in the price of oil, the company makes (loses) $0.75.
For every rise (fall) of $1 below the break-even point, the company earns (loses) $0.55.
Lifting costs are $4-6/bbl compared with just $2-2.5 by the Western majors.
Some of the Russian oil companies are not only unprofitable at current price levels, but generate negative cash flow.
FIGURE 92: COST STRUCTURE PER BARREL OF CRUDE OIL

Exports
(%)
Avg YTD crude price - export
VAT
Excise
Transport cost
Net
Royalty Tax
Mineral Resource Tax
Depreciation
Other fixed costs
Pre-tax
Profit Tax
Net profit
Operating cash flow
Total taxes
20
$1.23 bbl
28
8
10
15
40
35
81
(US$/bbl)
12.6
(1.2)
(3.5)
7.9
(1.0)
(1.3)
(1.5)
(4.0)
0.1
0.0
0.1
1.6
Domestic use
(%)
Avg YTD crude price - domestic
VAT
20.0
Excise
$1.23 bbl
Transport
Net
Royalty Tax
8
Mineral Resource Tax
10
Depreciation
15
Other fixed costs
40
Pre-tax
Profit tax
35
Net profit
Operating cash flow
73
OIL COMPANIES
ARE
DESPERATELY LOSING MONEY
(US$/bbl)
8.0
(1.6)
(1.2)
5.2
(0.6)
(0.8)
(1.5)
(4.0)
(1.8)
(1.8)
(0.3)
ON DOMESTIC SALES
Prior to 1995, oil exports were subject to a preferential quota system under which
roughly 20 oil companies were provided with tax breaks and special pipeline access
via licensed middlemen. In March 1995, President Yeltsin abolished this system
and allowed producers direct access to Transnefts pipeline system through the
establishment of throughput allocations. In July 1995, this new law was amended
to allow producers the right to resell their allotted pipeline space to trading
companies. This second set of changes was accompanied by legislation allotting
co-ordination of export terminal operations and crude oil markets to the seven
largest Russian independents. In October 1995, a Federal Energy Commission (FEC)
was established to regulate the new export system, provide pipeline access to smaller
traders, and offer about 400,000bpd of export capacity in competitive bidding. Under
ACCESS TO
OIL
TRANSPORTATION IS BY
TRADEABLE ALLOCATIONS
71

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
the new system, non-FSU crude oil shipments by oil companies, including Western
JVs, theoretically receive priority access to pipeline space. Russias integrated majors
receive second priority for up to 35% of their output. Any remaining space on the
pipelines is auctioned. Also, the quality of crude oil is tested at various points along
the pipeline system, and price adjustments made for variations in quality. In 1996,
however, high world oil prices resulted in decreased access for JVs to export
pipelines, as Russian majors competed for space through restricted export outlets.
GOVERNMENT
In recent years, oil producers have also lost access to pipelines because of increasing
volumes of state oil exports. Under this system, the Russian government funds special
federal programmes by buying oil at internal Russian prices, which are below
international prices. The oil is then exported and sold at international prices, with
the difference used to fund projects suggested by government officials. President
Yeltsin signed a decree (July 1997) ending state exports of crude oil from 1998.
RAISING
MONEY VIA BECOMING

AN OIL TRADER
...
. . . ALTHOUGH THIS HAS

SUPPOSEDLY BEEN ENDED
FURTHER OIL PIPELINES IN

WORKS
THE
In December 1996, Russia and China were reportedly close to signing a deal that
would provide for the construction of an export pipeline linking oil fields in the
Irkutsk region to China via Mongolia. A possible sea link to South Korea is also
possible. The pipeline would have a target completion date of 2005. Russia is also
favoured by Iraq to receive oil exports in exchange for humanitarian goods. Of
the first 37 contracts approved by the United Nations in the oil-for-food sale, seven
went to Russian companies, representing almost 20% of the volume of oil in the
sale. Iraq expects to earn more than $80bn from its contract with Russia for the
development of the West Qurna oil field in southern Iraq. The contract calls for
560 wells that will produce 4.4bn barrels over 23 years. According to the official
statement, the part of the field being developed with Russia has 11.5bn barrels in
reserves and the entire West Qurna field has reserves of 38bn barrels. The official
states that production will begin soon (250,000 bpd, increasing to 600,000 bpd).
In light of the recent devaluation of the rouble, there is increasing speculation that
Russian crude oil producers are likely to increase their oil exports. Boosting crude
exports will be technically difficult. The state-owned monopoly Transneft, which
runs Russias exports pipeline network, claims that it is operating at only 60%
capacity, hence the current throughput of 290,000 bbl a day could be increased
to between 315,000 and 340,000 bbl per day. Although Transneft has ample room
to increase exports, pipelines leading to Black Sea oil terminals are full. Of course,
exports could be increased either through the Baltic Republics or through the Druzhba
pipeline to Slovakia, Hungary and The Czech Republic. But since the Druzhba
pipeline leads to countries whose economies have been hard hit by global commodity
deflation, and where overfull storage demand is unlikely to change, Russian
companies have little encouragement to boost their exports. Lukoil, Yukos and
Surgut, three of the largest Russian oil producers, do not expect a drastic increase
in the domestic consumption of oil, which would make them pump more of the
crude produced abroad. Demand for gasoline and diesel produced by the countrys
refineries has not fallen yet, but the rapidly contracting Russian economy will
dramatically change that situation. Crude oil prices at 10-year lows and increasing
demand from the Russian government to raise tax revenues have forced Russian
oil majors to cut output, as many wells were operating at a loss. We do not expect
the situation to change much in the 2H98. Though rouble devaluation will free up
more oil for exports and boost earnings, falling domestic demand could depress
export crude prices even further.
72

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 93: PEOPLE POWER: NET INCOME PER EMPLOYEE

IN FY1997 (US$)
Yukos
Yukos
Tyumen
Tatneft
Tatneft
SurgutNG
Slavneft
Slavneft
Sidanco
Sibneft
Onaco
KomiTEK
Eastern Oil
Bashneft
Lukoil
Gazprom
Gazprom ADR
(6,000)
(4,000)
(2,000)
2,000
4,000
6,000
8,000
10,000
FIGURE 94: MAJOR RUSSIAN OIL OPPORTUNITIES

Field
Sakha Republic, Russia - 30 fields
(include gas fields - Srednevilyuyskoye,
Srednetyungskoye, Chaiyadinskoye &
Srednebotuobinskoye Talakanskoye gas & oil fields)
Krasnoyarsk Region, Russia
Yurubchenskoye field
Irkutsk Region, Russia
Verkhnechonskoye
Koviktinskoye fields
Reserves
2.2 tcm gas in place
1.2 tcm recoverable
1.1bn bbl oil recoverable
Total 14.9bn boe in place
5.5bn bbl proven oil
2.6bn bbl recoverable
4.6 bn bbl oil
1.6bn bbl recoverable
1.2 tcm gas
0.6 bn bbl proven oil
Partners
Vostochno-Sibirskaya Oil & Gas Co

(Eastern Oil) - 100%
Russia Petroleum - Sidanco main shareholder

Irkutsk Region
Irkustenergo
Angarsk refinery
East Asia Gas Co
Total in place
12.7 bn boe
Sakhalin - 1 @$15bn cost
Odoptu, Chaivo (gas) & Arkutun-Dagi (oil) fields
Sakhalin - 2 @$850m cost

Lunskoe (gas, associated oil & condensate) &
Piltun-Astokhskoye (oil & associated gas) fields
4 years ahead of schedule
60,000 bpd in 2001, rising to 500,000 bpd by 2005
280 bcm - gas

0.75bn bbl - oil
Total 2.5 bn boe in place
460 bcm - gas

2.5bn bbl - oil
Total 5.4bn boe in place
90,000 bpd after 2001
Tumen-Pechora @$20bn
(Western Siberia Central Khoreverskaya fields)
1.1bn boe oil in place
Exxon 30%
Sodeco 30%
Rosneft 17%
Sakhalinmorneftegas 23%
About 70-80% of the crude oil pumped form the field
will be shipped to Japan. Thus expecting to reduce
Japans reliance on crude imports from the Middle East
Marathon Sakhalin 30%
McDermott 20%
Mitsui 20%
Shell 20%
Diamond Gas 10%
Rosneft 20%
Conoco
Amoco 20%
73

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
FIGURE 95: RUSSIAN OIL MATRIX FINANCIAL VALUATION

Market capitalisation in $m
180,000
160,000
Exxon
140,000
120,000
Royal Dutch Shell
100,000
80,000
BP Amoco
60,000
40,000
20,000
ENI
Elf
Repsol
0
0
MOL
5,000
HUGE POTENTIAL FOR

FOREIGN INVESTMENT
NATURAL GAS: A MONOPOLY

...
MARKET
. . . BUT
ARE
GAZPROMS
GOLDEN YEARS OVER?
74
Sibneft
Texaco
Total
Tatneft
YPF
Surgut
Tyumen
10,000
Oil and gas reserves in m boe
Yukos
Lukoil
15,000
Sidanco
20,000
The oil and gas sector has several major advantages for the portfolio and direct
investor. The entire Russian oil sector is being capitalised at just US$20bn odd given that Royal Dutch/Shell is valued at US$140bn despite both Lukoil
and Sidancos reserves being just as large. How long will it be before western
oil majors issue paper (or use cash) at US$8/bbl of reserves to buy Russian
oil assets at US$0.2/bbl? When do the oligarchs start feeling the cash crunch
and begin to open towards foreign investment? It may be too early yet, but at
the slightest sign of structural reform and stabilisation of the political situation,
greed is likely to get the better of investors. Most Russian oil and gas companies
are liquid and tradable, with an average free float of 35%. Oil companies also
have the potential for a serious injection of foreign management expertise: the
Russian government has recently abolished the 15% foreign ownership limitation
on oil companies, thus the upcoming privatisations of Rosneft and sale of a 5.7%
stake in Gazprom open up several doors for private equity investments. Also,
the exploration and production projects require significant capital investment and
new infrastructure. For companies supplying equipment and services, these are
major opportunities. As the majors are attempting to diversify their production
base away from Russia, there are clear opportunities for oil majors like Elf and
Total to swap reserves in places like Angola in exchange for stakes in the Russian
companies and their reserve potential. Lastly, of the seven fields to be developed
under the Production Sharing Agreements (PSA), only one is open to foreign
investors - the Prirazlomonye field being developed by Rosshelf, Gazprom, and
BHP in the Barents Sea. The other fields include the Samotlor, Kransnoleninsk
and Romashkinskoye fields, and several fields off Sakhalin Island. However, several
amendments to the PSA law are still being debated by the Duma and other fields
may be opened to foreign investment. By some estimates, at least $60bn worth
of potential foreign investment awaits the passage of acceptable legislation.
The natural gas sector in Russia requires separate treatment because of Gazproms
monopoly. Unlike restructuring of the oil and gas sector, production and transport of
natural gas remained controlled solely by Gazprom. Combining production, pipelines
and research centres, Gazprom is a vast enterprise, controlling at least 33tr cubic
meters of proven gas reserves (30% of the worlds total) and operating enough
pipelines to wrap nine times around the globe. Political patronage ensured the company
had a unique legal structure and benefited from considerable tax privileges. However,
Gazprom has recently come under greater scrutiny. Faced with the problem of filling
the holes in its budget, the government has demanded prompt payment of overdue
taxes. Russia may go even further by reducing Gazproms monopoly to help gas

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
producers. As part of the terms of its approval of the $1.5bn loan from the World
Bank, Russia will have to guarantee access to Gazproms pipelines for other producers.
Gazprom currently favours its own subsidiaries in allowing access to its pipelines.
Independent oil producers (4.8% of total gas sales in the country) currently burn off
gas. The World Bank is demanding the government reduce Gazproms dominance of
the industry and encourage competition and make the industry more transparent. As
of 1 August this year, Gazprom was ordered to charge independent gas producers the
same prices for gas transportation as it charges its own subsidiaries.
FIGURE 96: TOTAL RESERVES vs GAS RESERVES

OF THE WESTERN MAJORS
(bn boe)
30,000
207,570
25,000
20,000
15,000
10,000
5,000
Oil && Gas

gasRes.
res (m
(mboe)
boe)(LHS)
(LHS)
IS AHEAD OF THE
PACK
(%)
100
90
80
70
60
50
40
30
20
10
0
Gazprom
Texaco
Chevron
Exxon
Norsk
Hydro
Total
Repsol
ENI
RDutch/
Shell
Shell
Elf
BP
Amoco
YPF
GAZPROM
% of
of Gas
gas(RHS)
(RHS)
FIGURE 97: GAZPROM AT A GLANCE

It controls more than 95% of Russias gas production, oversees eight production associations, owns and operates
Russias 86,000-mile gas pipeline grid, runs 26 trading houses and marketing joint ventures in 13 European
countries.
Gazprom is 40.7% government owned; a 5.7% stake is to be sold, theoretically, by end-1998.
New gas pricing system (introduced in February 1997) differentiates gas prices by geographic regions to reflect
transportation costs (the maximum difference between regions is 10%). Gazprom lost its monopoly right to develop
new gas deposits (which instead will be allocated at tenders open to competitors), and now offers equal access
and competitive rates on its national pipeline network to all producers giving other companies the opportunity to
compete in the gas business.
The Urengoy, Yamburg, Orenburg fields account for 80% of the countrys gas production.
New Yamal field is being developed to start production by 2000. This output will be targeted at European markets
via the planned 2,500-mile Yamal-Europe pipeline. It will consist of seven parallel pipelines running from Yamal
to Frankfurt/Oder, Germany via Belarus and Poland .
Russian gas exports were equal to about 34% of its natural gas production. Of this amount, about 60% are destined
for European markets and the remainder for CIS countries. Western Europe relies on Russian gas to meet about
25% of its consumption needs. Even though shipments by Gazprom to CIS countries are relatively small and are
partially subsidised, a few countries, such as Ukraine, Belarus and Moldova, have amassed large arrears since
1993. In 1996, Gazprom estimated that it was owed the equivalent of $15bn by CIS countries for past gas deliveries
to both Russian and CIS customers. Over 90% of Russian gas exports to Europe run through Ukraine and the Czech
Republic. The Yamal pipeline will allow Russia to bypass its current shipment routes across Ukraine.
New projects include Iranian gas field developments, new export contracts with China, and a new gas pipeline
linking Russia and Turkey via the Black Sea.
Gazprom ADRs are the only way for foreigners to invest in the company, although they trade at an average 200%
premium to local shares (ownership of which is barred to foreigners).
75

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
HIGH BARRIERS TO ENTRY

RUSSIAN GAS MARKET TO
REMAIN
76
IN
Foreign producers are unlikely to succeed in the Russian market, given the low
price of Russian gas, high transportation costs and traditional links between domestic
and gas consumers and producers. Nevertheless, opportunities exist in the area of
gas distribution. Investment is needed not only to finance improvements of Yamal
European pipeline but also to modernise Russias domestic gas pipelines network.
During the Soviet Era, the gas distribution system was developed using imported
equipment. Thus, it is possible that orders for foreign equipment may be forthcoming
as pipelines and compressor station units are replace or refurbished.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
TELECOMS
FIGURE 98: TELECOMMUNICATIONS
Price
(US$)
3.9
11.0
157.0
5.4
0.6
Code
ROS US
VIP US
MGTS
URL GR
SPTL
Rostelekom
Vimpelcom
Mostelecom
Uralsvyazinform
St Petersburg Tel
Market cap
(US$m)
459.6
282.8
150.4
182.4
233.2
12mth
high
23.1
59.4
2,540
34.5
2.6
12mth
low
3.6
8.8
150.0
4.5
0.4
98 earnings
(US$)
1.7
2.6
73.9
n.a.
0.1
PE
(x)
2.3
4.2
2.1
n.a.
8.5
1mth avg daily

turnover (US$'000)
1,996
4,775.7
1
23.4
45.2
The Russian fixed line telecommunication industry consists of the long-distance

operator Rostelecom, 88 regional telecom operators (including seven city networks)
and the Svyazinvest government holding company. New operators must obtain
licences from the State Committee on Communications. Although there are no formal
barriers to market entry, there is no policy on granting network access to potential
competition. Increasing demand is helping the telephone penetration rate to grow
quickly, aided by the countrys already high urbanisation rate of 75%. Russias
penetration rate is expected to reach 26% from its current 19% by 2000, with further,
considerable growth thereafter. As the EU rate is over 52% - Russia still has a
long way to go. Although mobile telephony is developing quickly, it has not
developed to the point where it could be considered a substitute for the fixed network,
although in some regions it could soon rival fixed-line networks for the number
of new subscribers.
FRAGMENTED
STRUCTURE,
BUT TIGHT CONTROL
TELEDENSITY IS
FIGURE 99: INTERNATIONAL TELEDENSITY AND

AFFORDABILITY: REGRESSION ANALYSIS
HIGH FOR
SUCH A LOW-INCOME
POPULATION
Teledensity
70
60
MY - Klang Valley
50
KR
40
Hungary
Rest of
CN
Malaysia
TW
SG
Russia
30
HK
20
TH
10
PH
0
0
ID,IN,PK
5,000
10,000
15,000
20,000
25,000
(US$ adjusted per capita GDP)
30,000
35,000
Regional telecommunication companies provide basic telephone services, and some

offer value-added services through joint ventures with international operators or
through subsidiaries. The majority of regional telecoms suffer from an outdated
network, a problem that is evident in a low digitalisation level and poor
communications quality. Approximately half of their revenues are generally derived
from long-distance services, which are carried by Rostelecom. It has a different
revenue sharing agreement with each regional telecom. Penetration rates are very
low in most regions, apart from Moscow and St Petersburg, and long waiting lists
are common for telephone installation.
APPROXIMATELY HALF THE

TELECOM REVENUES ARE
DERIVED FROM LONG DISTANCE SERVICES
77

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
S VYAZINVEST HOLDS
CONTROLLING STAKES IN ALL
BUT A HANDFUL OF THE
REGIONAL TELECOMS
SIMILAR
The state holding company Svyazinvest was created by presidential decree in 1995
to attract investment in the telecoms industry. The holding company owns voting
stakes of just 50% in 80 of the regional telecoms and 51% in Rostelecom. The
holding also directly owns three long-distance gateways and four telegraph operators.
To date, Svyazinvest has not wholeheartedly supported regional operators in terms
of financing or lobbying for tariff increases. Most telcos see additional share issues
as a promising method of financing their capital expenditure needs compared with
expensive debt financing on the domestic lending market. Only a few, however,
have been allowed to do so by Svyazinvest, which wants to maintain its controlling
stake in most of the telecoms. Bashinformsvyaz and the as-yet-to be privatised
Ministry of Telecommunications of Tatarstan are the largest telecoms in the
Svyazinvest structure.
TO OTHER
FIGURE 100: AVERAGE GROWTH

IN MONTHLY FEES (% in US$ terms)
INDUSTRIES, TELEPHONE
COMPANIES ARE ELIMINATING
CROSS-SUBSIDIES OF TARIFFS
90
80
70
60
50
40
30
20
10
0
Residential tariffs
95/96
Business tariffs
96/97
97/98
RE-CENTRALISATION TREND IS
LARGELY POSITIVE FOR
CREATING SHAREHOLDER
VALUE
78
Following the break up of the telecommunication system in 1992, the role of the
Federal Ministry of Telecommunications was reduced to licensing and initiating
legislation. The regulatory authorities affiliated with local government assumed the
regulation of fees and tariffs. The operations, strategic planning and investment were
largely left to the management of the regional telcos and Rostelecom. Recent
government intervention in the regulation of residential telephone companies is likely
to eliminate the cross-subsidisation of services. While local fees and tariffs remain
regulated by local authorities, the intervention of the federal government significantly
reduced their discretion. Local regulation of tariffs is inherently difficult for local
politics and it has often led to unjustifiably low residential subscription fees (such
as in Moscow and St Petersburg). In our opinion, the federal Ministry of
Telecommunications aims to maximise the cash flow generated by Russias telcos,
hence speeding up the restructuring. As these goals are consistent with increasing
shareholder value, we feel that the increased role of the federal government is a
positive move.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
FIGURE 101: ONE-YEAR COSTS OF FIXED LINE SERVICES REGIONAL COMPARISON (US$)
600
RUSSIA STILL HAS A LONG

WAY TO GO!
528
478
500
400
300
202
200
168
161
133
123
117
116
110
100
77
70
34
Indonesia
Malaysia
India
Taiwan
Singapore
Russia
Russia
Thailand
Pakistan
Philippines
Hong Kong
Korea
Shanghai
Beijing
The performance of the sector is likely to mirror the overall performance of the
Russian economy in the short to medium term. Telecoms share of GDP should
grow as services expand and more customers gain access to networks. Almost all
telcos are actively traded, but the majority are small cap due to the sectors
fragmentation. Liquidity has significantly improved, although it still remains low.
As many companies turn to releasing IAS accounts and sector disclosure improves,
it is becoming easier to tap external financing. On top of our lists would be
Vimpelcom and Nizhnovsvyazinform - some of the most liquid and financially
sound stocks.
PERFORMANCE LIKELY TO
BE
IN LINE WITH ECONOMY
79

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
BANKING AND INSURANCE

FIGURE 102: BANKING SECTOR
Price
(US$)
40.0
19.0
4.0
Code
SBER
MBR GR
IKO GR
Sberbank
Bank MENATEP
Inkombank
Market cap
(US$m)
520.1
436.4
243.4
12mth
high
334.0
87.0
31.0
12mth
low
30.0
17.0
3.0
98 earnings
(US$)
81.1
3.0
4.1
PE
(x)
0.5
6.3
1.0
1mth avg daily

turnover (US$'000)
467
1
132.9
RUSSIAN MARKET
FOR
BANKING SHARES VERY

UNDERDEVELOPED
...
. . . AS ARE RUSSIAN BANKS

THEMSELVES
THE LARGEST BANK,

SBERBANK , HOLDS 77% OF
RETAIL DEPOSITS
BANKING SECTOR ASSETS

EQUAL ONLY 30% OF GDP,
AND EQUITY CAPITAL LESS
THAN
80
6% OF GDP
The Russian market for banking shares is underdeveloped, due to the private nature
of some of the leading banks, the small size of free floats (if any) available for
trading and restrictions on attracting foreign equity capital. However, the
development of the ADR issues by some of the top Russian banks such as
Inkombank, Menatep and Vozrozhdenie has made their stocks more attractive to
investors. The CBR continues to restrict the size of depository receipts that Russian
banks are allowed to issue (up to 3% of the banks authorised capital), because
of the general fear that they deprive the securities market of capital. The liquidity
of banking shares is expected to improve due to new share issues planned by many
to meet new requirements for capital adequacy introduced by the Central Bank.
The banking sector in Russia has been one of the most dynamic of the new private
sectors of the economy. financial institutions have demonstrated spectacular returns.
These returns were not, however, based on fantastic bottom-line growth, but on
the availability of easy money. The Russian banking sector has undergone
fundamental changes since. As the monolithic Soviet-style state banks broke up,
many of their branches were transformed into independent banks or folded and a
large number of private banks were created. At the end of 2Q98 there were 1,607
licensed banks in Russia, from large full-service institutions in Moscow and St
Petersburg to small regional banks providing fairly limited services in a single region.
Over 30% (from 2,250 just three years ago) have since lost their licences, as they
failed to meet capitalisation requirements. Mandatory reserve requirements for rouble
deposits were reduced in May 1997 and those for hard currency deposits increased.
The minimum capital requirement for banks is to gradually rise to ECU 5m by
1999 from ECU 2m in 1996. The minimum risk weighted capital adequacy ratio
is to rise to 7-11% by 1999 from 6% in early 1997. Liquidity ratios and exposure
limits have also been tightened.
The Russian banking system consists predominantly of private banks, with only
Sberbank and Vneshtogbank, the two largest, remaining in majority state
ownership. The largest 30 account for around 65% of total bank assets. Because
it is the only bank with government deposit insurance, Sberbank accounts for
more than 77% of Russias retail deposits. Sberbank also controls 30% of all
Russias banking assets and about half of interbank lending. There are several
limitations on ownership of Sberbank shares - no investor can own more than
1% of the banks share capital, plus foreigners are limited to just 5% of Sberbank.
The banking system still remains undercapitalised, oversized and mostly illiquid.
The number of banks is expected to shrink substantially in the next few years
as banks consolidate or fold.
The banking sector remains small in relation to the total economy. The aggregate
assets of the Russian banking sector were just $135bn or 30% of GDP at the end
of 1Q98, compared with 63% in Hungary and 140% in the Czech Republic. The
key function of a bank in a market economy is to serve as a financial intermediary
(attract deposits from savers and lend them to borrowers) and to facilitate payments

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
and transactions. The Russian banking sector is still underdeveloped - retail deposits
are extremely low, there is no mortgage lending, plus many Russian firms trade
with each other using barter rather than cash. Loans account for less than 40%
of total banking assets. The share of medium- and long-term loans in the banks
portfolios is increasing but is still below 10%.
Only 35% of the banks licensed were regarded by the CBR as financially sound
and post devaluation that number is likely to shrink rapidly. At least 30% are
considered to be insolvent, as they sit on large unrealised GKO losses, reflecting
the yield hikes. These shortcomings are further exacerbated by the fact that several
banks borrowed heavily in US$, whilst keeping most of their assets in roubles,
and as much as 35% of the banking assets could also be tied up in interbank
credits. Most of them are likely to be liquidated or taken over by stronger
institutions. Mergers are already being seen, the largest being Alfa-MenatepUneximbank. It seems that although some banking assets have risen through the
use of foreign currency loans, the largest exposure in the top ten banks does
not exceed 20-25%. The majority of the 1,607 banks derive their income from
lending to the government. As the state is weaning itself off banking loans by
rescheduling domestic debt and bringing tax collection in order, the banks will
be forced to find new borrowers. A new generation of corporate and retail
customers can only be ensured by introducing foreign competition to the retail
banking sector. There are 13 wholly foreign-owned banks in Russia and over
150 joint-venture banks. The share of foreign banks in the total capital of the
sector continues to be restricted to a mere 12%.
In a key step for the long-term growth of the banking sector, the Central Bank
of Russia recently abolished restrictions on retail deposits. Previously, only Sberbank
was exempt from the restriction that limited a banks total deposits to the size of
the institutions equity capital. Clearly, in the medium to long term, the move should
open up the retail market for commercial banks, stimulate growth in total deposits
and increase liquidity in the banking sector as a whole. Sberbank, which currently
controls at least 77% of the retail deposit market, will most likely experience erosion
in its position, although the lack of a deposit insurance scheme is likely to hinder
the fast growth of retail deposits in other banks. Heavy losses suffered by retail
depositors during the rouble devaluation are also likely to set back public acceptance
of using banks as savings vehicles for years to come.
Russia has the largest hoard of US$ currency outside the US, with local dollar
deposits standing at nearly $40bn. The view that Russians are converting less and
less of their savings into hard currency is incorrect. Although it has dropped from
the highs of over 21.3% in Jan-May last year, hard currency deposits were 14%
of the total this year, but this figure shot up to 19% in July 1998. Personal savings
totalled Rbl308bn at the beginning of June, compared with Rbl305bn a month earlier
and Rbl281.8bn at the beginning of the year. Bank savings also grew, representing
over 54% of savings.
65% OF LICENSED BANKS

CENTRAL
BANK AS FINANCIALLY
REGARDED BY THE
UNSOUND
RETAIL DEPOSIT RESTRICTIONS

LIFTED . . .
. . . BUT
DEVALUATION-
RELATED RUNS AND LOSSES

WILL SET BACK PUBLIC
ACCEPTANCE OF BANKING FOR
YEARS
RUSSIANS
HAVE EVEN MORE
DOLLARS THAN THE
JAPANESE
81

U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
FIGURE 103: TOP TEN RUSSIAN BANKS (US$m, as at 1 Jan 1998)
Bank
Sberbank
Inkombank
Mosbusinessbank
SBC-Agro
Uneximbank
Rossyisky Credit
Menatep
Vneshtorgbank
Promstroybank
Alfa Bank
Assets
29,000
4,800
4,200
4,100
4,000
3,300
3,200
3,100
2,500
1,900
Total retail Total retail Total retail Total retail % retailTotal deposits/
Equity deposits
deposits
deposits deposits deposits in total equity
No. of
capital (Rbl+$)
(Rbl +$) (Rbl only) (Rbl only) total liabs
(%) branches Personnel
3,330 123,869
20,306
111,775
18,324
79
610
32,910
211,565
428
5,573
914
1,505
247
21
213
68
7,300
324
579
95
453
74
2
29
52
5,627
445
4,975
816
2,844
466
22
183
1,213
4,663
981
290
48
7
1
2
5
n.a.
n.a.
n.a
1,126
185
346
57
6
43
62
5,800
348
1,305
214
681
112
8
61
n.a.
n.a.
1,127
641
105
382
63
5
9
n.a.
n.a.
n.a.
595
98
889
146
20
144
70
4,070
n.a.
405
66
55
9.08
4
39
n.a.
n.a.
INSURANCE
SECTOR REMAINS
UNPRIVATISED
NINE LICENSED MUTUAL FUNDS
Reforms in the insurance business tend to lag those of the banking sector. That
is certainly true for Russia. There are around 2,450 insurance companies in Russia
at present. This number has decreased by at least 200 over the last 15 months.
The government has announced its intention to privatise at least 50% of Rosgosstrakh
insurance, once strategic restructuring has been completed. Rosgosstrakh is and
remains the largest insurer in the country. However, the market is still small, with
just $5bn in insurance premiums collected annually. Foreign participation is restricted
to a maximum 49% of a companys capital. The governments recent decision to
allow companies to deduct insurance costs from the taxable base should increase
interest in insurance. The number of private pension funds is around 1,000, with
at least $630m in total assets as 1 January 1997 (over 60% have not been officially
licensed). It appears that current legislation is frequently violated, especially in the
protection of the assets.
Another new angle for expansion in the non-banking financials are mutual funds.
Nothing similar has existed in Russia before, and over nine mutual funds have been
licensed to operate, including two foreign funds.
As the Russian banking sector is undergoing a health check, banks have found other
ways to avoid what the chairman of the CBR called the velvet nationalisation.
Gazprom-controlled National Reserve Bank and Inkombank announced a de-facto
merger. The newly created entity would form Russias second largest banking
institution, with an estimated US$7.27bn in assets and US$960m in equity capital.
If Rossisky Kredit and Avtobank are also interested in joining the group, the assets
would rise to more than US$11bn.
Uneximbank, Bank Menatep and MOST-Bank - Russias fourth, seventh and 17th
largest banks by assets - also announced they would pool 51% of their shares to
form a new holding company. The banks will hold equal 33.3% stakes in the new
company, whose board will consist of nine members headed by a representative
of Uneximbank. This alliance could potentially become the largest of the FIGs in
the country, effectively controlling close to 35% of GDP.
82

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
AUTOMOTIVE
SECTOR
FIGURE 104: AUTO SECTOR
GAZ Auto Plant

AvtoVAZ
KamAZ
Pavlovsky Bus
Price
(US$)
25.0
3.1
0.4
12.0
Code
GAZA
AVST
KMAZ
PAZA
Market cap
(US$m)
112.8
83.1
43.8
18.8
12mth
high
154.0
n.a.
4.3
66.3
12mth
low
0.7
n.a.
0.4
12.0
98 earnings
(US$)
29.73
n.a.
n.a.
n.a.
PE
(x)
0.8
n.a.
n.a.
n.a.
1mth avg daily

turnover (US$'000)
155
n.a.
3.9
1
Unlike many other branches of the economy, the auto sector has inherited a market
with huge potential. It is widely tipped to be the fastest growing in the world, with
sales expected to rise about 7% a year, doubling car purchases to 2m by 2005.
The prospect hardly comes as a surprise, when in 1990 Russia had one of the lowest
car ownership rates in Europe with just 50 cars per 1,000 citizens. Seven years
later, Russias growing middle class is fuelling a boom in car ownership. Russian
consumers bought roughly 1m cars in 1997 but the number is still lower than in
Poland (180 cars registered per 1,000 people), a country with a similar per capita
income. The sector consists of a handful of large enterprises, which manufacture
a variety of products from cars to trucks and buses. However only the car plants
are working now at or around full capacity - and although the potential may be
huge, uncompetitive Russian industry will likely face a very difficult time as the
worlds auto giants move in.
A HUGE
POTENTIAL MARKET
FIGURE 105: MAIN AUTOMOTIVE PRODUCERS

Company
AvtoVAZ
GAZ
Ulyanovsk (UAZ)
Kamaz
Moskvtich
PAZ
UralAZ
Zil
Product line
Zhiguli (Lada) cars
Volga cars
Gazelle trucks
UAZ mini-buses
Light trucks, cars
KAMAZ trucks
Moskvtich cars
Buses
Chelyabinsk
Moscow
Location
Tolyatti
Nizhny Novgorod
1997 production
688,800
214,200
Ulyanovsk
66,100
Naberezhnie Chelny
Moscow
Pavlovo
Heavy trucks
Trucks
33,630
20,000
8,861
FIGURE 106: VEHICLE REGISTRATION IN RUSSIA, 1996

Cars
Buses
Trucks
Domestic
11,187,753
534,843
399,456
Foreign
549,065
63,628
19,750
Total
11,736,818
598,471
419,206
Domestic (%)
95
89
95
Foreign (%)
5
11
5
Source: Goskomstat
Excessive tariff protection from foreign competition in the mid-1980-90s discouraged

the development of new models. Design and testing of a new model took at least
10-12 years, compared with an average of 3-5 years in the West. An inability to
diversify production and obsolete equipment led to output declines; add this to
Russias high labour costs and profit margins virtually disappeared. The output of
trucks, buses and cars also declined. Passenger car production remained stable, while
large and heavy trucks feared worse.
A MARKET
HEAVILY
PROTECTED FROM IMPORTED

COMPETITION
ONCE A LADA, ALWAYS

LADA
83

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
OUTPUT SPIRALLING
EVER
FIGURE 107: AUTOMOBILE INDUSTRY OUTPUT,

1994-1997 (000 units)
LOWER
Trucks
YoY %
Cars
YoY %
Buses
YoY %
1994
145.5
272
798
(17)
46.8
(1)
1995
115.1
(21)
835
5
40.8
(13)
1996
136.1
18
868
4
38.2
(6)
1997
146.2
7
985
13
45.8
20
1Q97
33.2
224
9.5
2Q97
37.9
14
236
5
11.4
20
3Q97
37.2
(2)
265
12
11.8
4
4Q97
37.9
2
260
(2)
13.2
12
1Q98
37.6
13
232
4
12.63
33
2Q98
33.4
(12)
226
(4)
10.6
(7)
SMALL
PLAYERS ARE GETTING
FIGURE 108: BREAKDOWN BY PRODUCT
KNOCKED OUT AS THE BIG

FOUR CONSOLIDATE THEIR
MARKET SHARE
1Q97
2Q98
% chg
97A
98CL
Trucks
GAZ
KAMAZ
Share of total prod (%)
19,551
4,338
69
21,687
364.5
10.9
(92)
87,482
12,748
94,043
12,000
Cars
AvtoVAZ
GAZ
KAMAZ
172,701
30,405
4,305
91
173,277
30,466
4,768
0.3
0.2
10.8
749,509
124,339
17,933
757,004
124,463
19,009
Buses
GAZ
PAZ
1,608
2,080
38
2,863
2,262
78.0
8.7
8,596
8,861
12,894
9,747
FOREIGNERS
SETTING UP
IMPORTS ARE
MAINLY OF
JVS
SECONDHAND CARS
CHEAP WAGES FOR

MANUFACTURERS
84
FOREIGN
The rapidly rising domestic demand for cars has spurred several foreign companies
to set up JVs with the largest vehicle manufacturing plants. It is expected that the
number of passenger vehicles produced will be around 1.5m in 2000 (compared
with 1996 production of 868,000). The largest Russian manufacturer, AvtoVAZ,
held 16th place in the hierarchy of the worlds manufacturers, producing 650,000
cars per annum.
Imports numbers are hard to track, but according to estimates, the number of second
hand imported cars varies from 100,000-250,000 annually. The largest number of
those are delivered by individuals, who are reselling imported cars and applying
various schemes to minimise taxes (which currently stand at 100%).
Foreign manufacturers enthusiasm for producing in Russia reflects the significant
difference in wage costs (one-tenth of the level in Germany). The following deals
have already been announced - Fiat and GAZ have singed an $850m JV to produce
vehicles in Nizhny Novgorod; Kia cars are being assembled in Kaliningrad (and
the company said back in 1996 that it would invest $1bn over the next five-six
years). Renault has agreed a $420bn deal in Moscow to assemble 120,000 Megane
Classic cars a year with Moskvitch (the first to be produced by 2001), Daewoo
may set up plant in Rostov, Ford is deciding on a $150m plant in St Petersburg,
while General Motors and AvtoVAZ have been in talks on building a plant in the
St Petersburg or Central Russia regions. Therefore, $2bn worth of investment in
the automotive sector over 1998-2000 would appear to be well within reach. In
the same sector, Continental is considering buying or setting up a tyre factory in
Russia to produce some 5m units a year.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
A car has been and remains a symbol of prosperity in Russia. Low ownership rates
and thus high demand, as well as excellent infrastructure for distribution and services
make the automobile industry attractive for investors. High import tariffs should
encourage domestic producers to be price-competitive in the short to medium term.
In the meantime, Russia is negotiating WTO membership by 2000. Although new
tax and tariff incentives to foreign investors who assemble autos inside the Russian
Federation are probably in violation of World Trade Organisation rules, the worlds
auto leaders are still comfortably positioned to gain a piece of the Russian market.
50% of the cars parts must be produced in Russia, while the tariffs for most auto
imports are about 30%, more than 10 times the level in developed countries and
high enough to deter trade in any model that competes with Russian-made products.
In the past, the US has protested local content rules which are used to help spur
development of a countrys auto industry. Having launched sales in Russia of its
Ka, Ford will have to contend with that 30% tariff, since the Ka is only manufactured
in Spain and Brazil. The Big Three US auto companies have taken note of the
decree, but arent saying much so far.
CARS ARE
A SYMBOL OF
PROSPERITY
When an established auto company first enters a market, it initially sources most
of its parts from outside. As expertise and a parts industry develops in that country,
local content tends to rise. Thats the first problem. The second is that the auto
industry is moving rapidly towards global production, where different factories in
different countries tend to specialise more, increasing the demand for trade. While
most auto companies assume that major assembly operations will be the price of
admission to Russia, none will want to make all their vehicles there. The
governments Auto Decree offers tax and tariff incentives to foreign investors who
assemble autos inside Russia. But to qualify, 50 per cent of the cars contents must
originate in Russia. The preferences last for five to seven years.
PROSPECTS NOT ROSY

RUSSIAN CARMAKERS
The revenues of the Russian automotive sector may get a short-term boost if a
proposed import tariff increase goes through - but many producers are in long-term
trouble. The approval of a proposed 5% increase in tariffs on all imported vehicles
would benefit Russian automobile manufactures in the short term, but the longer
term pain is likely to be more severe. The hike would translate into an additional
Rbl 4.3bn ($700m) in the coffers of the State Customs Committee. While import
tariffs on foreign automobiles may reach as high as 100% under the present tax
regime -which will shield relatively inefficient Russian automobile manufactures
from the necessity of cutting back production - the tariff structure and thus the
auto sector will need to experience the pain of restructuring if it is serious about
joining the WTO. Even with present tariff levels, the countrys largest producer
of autos has announced that it intends to reduce production by 17% or at least
125,000 in 1998 on the back of plummeting demand for its Zhiguli car, despite
a recent 25% price cut. We believe that the Russian automobile manufacturers most
likely to survive the industry shake-out in the coming years will be those with wideranging and comprehensive joint ventures involving extensive foreign investment,
as well as expertise transfers - such as the $850m GAZ-Fiat deal.
MANY PRODUCERS
FOR
IN LONG-
TERM TROUBLE
85

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
CEMENT AND CONSTRUCTION

FIGURE 109: CEMENT AND CONSTRUCTION
Spasskcement
Code
SPAS
Price
(US$)
0.04
Market cap
(US$m)
23.3
12mth
high
0.055
12mth
low
0.0059
98 earnings
(US$)
n.a.
PE
(x)
n.a.
1mth avg daily

turnover (US$'000)
n.a.
Note: Novoroscement, Volskcement and Voskresenskcement are also listed but illiquid
RUSSIA CONTROLS A SIZEABLE

PORTION OF THE WORLD S
CEMENT OUTPUT
FROM
OVER
A TOTAL CAPACITY OF
80M
RUSSIA
33%
TONNES A YEAR,
IS UTILISING JUST
Russian cement industry accounts for 7% of the worlds output. The future potential
depends largely on the countrys economic growth and resolution of the non-payment
crisis. The share of electric power in the overall cost structure for cement production
rarely falls below 20%. Add to that an allocation of at least 30-40% for fuel expenses
and delivery costs. Thus, the industry is highly sensitive to changes in power fuel
and transportation tariffs. Almost 90% of the Russian companies tend to use wet
mud as the main method for producing cement as it is the least energy consuming.
To keep fuel costs down, companies generally switch to gas, but that requires access
to gas pipelines, and therefore substantial investment. Cement plants located in coal
basins are eager to switch to coal, even at a cost to the environment. Environmental
issues have not caught on in Russia as yet.
FIGURE 110: CONSTRUCTION MATERIALS - BASIC DATA

Year to 31 December
Cement (m t)
YoY %
Pre-fabricated concrete units (m m3)
YoY %
Building brick (units)
YoY %
Window glass (m m2)
YoY %
1993
49.9
34.2
17.1
102
1994
37.2
(25)
23.7
(31)
13.1
(23)
58.2
(43)
1995
36.4
(2)
21.1
(11)
12.6
(4)
58.8
1
1996
27.8
(24)
14.3
(32)
9.8
(22)
44.4
(24)
1997
26.6
(4)
16.2
13
9.9
1
37.8
(15)
Source: Goskomstat
WHY THE MASSIVE CAPACITY?

MISSILE SILOS AND
BUNKERS . . .
The Russian cement industry has inherited a huge production capacity from being
tailored to the needs of the military and capital production of the Soviet Union.
Demand for cement is largely driven by the domestic market. Although forecast
demand growth is far from being robust, supplies are further aggravated by customer
insolvency. Hence the decline in production.
FIGURE 111: CONSTRUCTION MATERIALS - YoY % COMPARISONS

Year to 31 December
Cement (m t)
YoY %
Pre-fabricated units (m m3)
YoY %
Building brick (units)
YoY %
Window glass (m m2)
YoY %
1Q97
4.5
3.9
1.9
8.6
2Q97
6.7
49
4.1
5
2.5
32
9.1
6
3Q97
8.8
31
4.1
0
3
20
9.1
0
4Q97
6.6
(25)
4.1
0
2.5
(17)
11
21
1Q98
4.2
(7)
3.1
(21)
1.8
(5)
10.2
19
2Q98
6.8
1
4.3
5
2.3
(8)
9.3
2
Source: Goskomstat
. . . COAL, CLAY AND

DEPOSITS DETERMINE
INDUSTRY LOCATION
86
CHALK
In choosing a plant location, the key consideration is the distance from chalk and
cement deposits, coal source and markets. Typically, companies try to locate their
plants near railway routes to reduce transportation costs. Major raw materials for
cement production - carbonates, clay and chalk - are extracted across Russia. The
Urals and the Far West are rich in clay, while the Voronezh, Bryansk and Belgorod
regions and Volga river region have plenty of chalk. Industrial waste - metallurgical
slag and ash from power stations - is also used. Only 2% of total Russian cement
production is exported and 90% of that goes to other CIS countries. Exporting is
an option only to plants located near sea ports, as is the case with Novorosscement
in Novorossisk, and Spasskcement in Primorsk.

CLSA
U S S I A N
N V E S T M E N T
T L A S
September 1998
TOP
FIGURE 112: TOP TEN COMPANIES BY

CEMENT PRODUCTION (000 tonnes)
Year to 31 Dec
Novoroscement
Sukholozhcement
Ulyanovsk Cement
Oskolcement
Sebryakovecement
Volskcement
Lipetskcement
Zhigulevsk
Voskresenskcement
Iskitimcement
Location
Novorossisk,
Krasnodar Region
Sukhoi Log,
Sverdlovsk Region
Ulyanovsk
Stary Oskol,
Belgorod Region
Mikhaylovka,
Volgograd Region
Volsk,
Saratov Region
Lipetsk
Zhigulevsk,
Samara region
Voskresensk,
Moscow Region
Iskitim,
Novosibirsk region
TEN CEMENT PRODUCING
COMPANIES ACCOUNT FOR
1996
1997
Cement brand
1,204
1,341
M-500
1,400
762
1,320
1,230
M-500
M-500
1,033
1,150
M-500
842
1,034
M-500
879
403
775
752
M-400
M-500
607
696
M-500
753
592
M-400
488
531
M-400, M-500
OVER
35% OF TOTAL
PRODUCTION
The Russian cement industry remains only 33% utilised. Some regions have already
enjoyed construction booms, but this was not widespread. The types of cement Russia
produces have yet to change. Brand 400 accounts for the highest percentage of
total cement produced (over 60%), and brand 500 represents about 20%. Production
of high-strength cements (M-500, 600) accounts for no more than 10% of the total
output. That is likely to change in the future, as the industry is undergoing
modernisation. Thus, cement companies have to cut product prices to attract buyers.
Many enterprises stopped selling packaged cement and switched exclusively to bulk
sales. The price then is almost halved, as packaging for 50kg plastic and paper
bags that meet international standards for strength and water resistance have to be
imported. The variable nature of the construction industry due to the Russian climate
leads to under-utilisation of production capacities. We believe that access to a good
transportation network, giving geographical sales flexibility and cost containment
ability, are the key factors investors should look for in a cement company. Alfa
Cement qualifies on these factors. Alfa is Russias only cement holding company
and has controlling stakes in eight cement plants. Its total capacity is at least 10m
tonnes or about 12% of total Russias cement capacity. In 1997, the holding produced
2.34m tonnes of cement. It is a non-traded company, but plans to tap the capital
markets with an IPO next year.
GOOD TRANSPORTATION
FACILITIES ARE CRUCIAL TO
PROFITABILITY
ALFA CEMENT HOLDING

9% OF
RUSSIAN CEMENT PRODUCTION
IN FY97
ACCOUNTED FOR
87

U S S I A N
N V E S T M E N T
CLSA
T L A S
September 1998
METALS AND METALLURGY

FIGURE 113: STEEL SECTOR
Price
(US$)
5.5
15.0
9.0
0.0
Code
CHMF
MAGM
SVY GR
NTMK
Severstal
Magnitogorsk FM
Seversky Tube
Nizhny Tagil
Market cap
(US$m)
121.4
99.6
43.3
7.2
12mth
high
29.0
41.5
92.0
0.2
12mth
low
0.5
0.0
9.1
0.0
98 earnings
(US$)
11
n.a.
11
n.a.
PE
(x)
0.5
n.a.
0.8
n.a.
1mth avg daily

turnover (US$'000)
1
n.a.
37.7
n.a.
RUSSIAN METALLURGY
INDUSTRY WAS HIGHLY
PROTECTED IN THE PAST
PER
CAPITA CONSUMPTION
DROPPED DRAMATICALLY
IRON AND STEEL
Iron and steel were the backbones of an economy dominated by military

manufacturing. Like most heavy industries, it was overdeveloped under communism
and suffered a sharp decline in the wake of political and economical changes.
Even after a sharp drop in demand between 1992 and 1995, domestic demand
has levelled off at around 15-20m tonnes annually from 45m tonnes in 1990.
Demand for steel rose last year, driven largely by a boom in the auto industry.
As we indicated in the section on automobile production, 12-14% YoY growth in
output is very impressive.
Russian steel consumption used to be almost three times the world average and
one of the highest in the world. Now at 130kg, it hardly compares with 600kg
in Japan, 360kg in the US or 340kg in Germany. This significant tail-off is easily
explained by a dramatic fall in output in the machine-building and defence industries.
PRODUCTION
FIGURE 114: FERROUS METALLURGY

YEARLY PRODUCTION (000 tonnes)
HAS LEVELLED
1993
40,519
Cast iron
YoY %
Steel
YoY %
Rolled metal
YoY %
Pipes
YoY %
58,838
42,804
5,843
1994
36,116
(11)
48,769
(17)
36,530
(15)
3,568
(39)
1995
39,229
9
51,323
5
39,068
7
3,722
4
1996
35,593
(9)
49,161
(4)
68,843
76
3,503
(6)
1997
37,327
5
48,441
(1)
37,845
(45)
3,465
(1)
MOST
PLANTS OPERATE
UNDER CAPACITY
FIGURE 115: TOP FERROUS METALS

PRODUCERS IN RUSSIA (m tonnes pa)
Installed capacity
Magnitogorsk (MMK)
Cherepovetsky (Severstal)
Novolipetsky (NLMK)
Nizhny Tagil (NTMK)
West Siberian (ZSMK)
Chelyabinsk (Mechel)
Kuznetsky (KMK)
Orsko (NOSTA)
Oskolsky plant
1993
16.2
14.0
9.9
8.3
7.9
7.0
4.8
4.0
1.5
1994
9.9
8.5
5.9
5.3
4.8
4.5
3.2
3.2
1.5
1995
6.6
7.1
5.6
4.9
4.7
3.0
3.1
3.3
1.6
1996
7.6
8.2
7.1
5.1
4.8
2.5
3.6
2.9
1.6
1997
6.7
8.9
7.1
5.2
4.0
3.1
3.6
2.5
1.5
BIGGEST STEEL
CONSUMER IS
THE AUTO INDUSTRY
88
Russias main consumer of steel remains the auto industry. But, similar to other sectors
in the economy where barter and non-payment are flourishing, the vital source of cash
revenues remains exports. Russian steel exports in FY97 totalled 30m tonnes,
including 26m tonnes of rolled steel products. That is more than 67% of the sectors
entire production! Russias total metals exports account for nearly 22% of export
volume. Steel accounts for over half of that (worth around US$10-12bn), while exports
of copper, nickel, aluminium and other products accounted for another $6.5bn in 1997.

R
U S S I A N
Copper
Aluminium
Lead and zinc

Other
Cherepovets
Norilsk
Moscow
Nizhny Tagil
Komsomolsk
Petrovsk
Zabaikalsky
Rudnaya
Pristan
Novosibirsk
Novokuznetsk
A
T L A S
September 1998
89

N V E S T M E N T
Krasnoyarsk
Magnitogorsk
Bratsk
Chelyabinsk
Volgograd
Izhevsk
Lipetsk
Monchegorsk
Kandalaksha
CLSA
Ferrous
FIGURE 116: RUSSIAN METALLURGURY INDUSTRY
U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
95% OF STATE STEEL

COMPANIES HAVE BEEN SOLD
AND ARE NOW JOINT STOCK
COMPANIES
ASIAS SLUMP AND EU ANTI DUMPING LAWS ARE BITING

INTO
RUSSIAS
EXPORTS
A REVIVAL?
90
STEEL
Since the reforms of the early 1990s, more than 95% of the state-owned metallurgical
companies have been sold and transformed into open joint-stock companies. Some
are undergoing significant modernisation and restructuring. Despite these changes,
much remains to be done. There are approximately 40 steel mills in Russia, yet
the lions share of the output comes from only five: Magnitogorsk, Nizhny Tagil,
West-Siberian, Cherepovetsky (Severstal) and Novolipetsky (NLMK). Russian
steelmakers differ from their Western counterparts: the share of transportation and
energy expenditure as a proportion of Russian metal producers total costs is nearly
three times that of their Western counterparts, and Russian producers tend to focus
production at a single location. The huge single-product capacity of these enterprises
precludes any flexibility in restructuring production to accommodate new product
lines fast. Another challenge for Russian manufacturers is the age of their fixed
assets. Only 15% of Russias steel is produced using the electric method of
production, compared with over 30% in the West. While only a third of Russianmade steel is made using continuous casting, 75% of American and 95% of Japanese
steel made by this method.
Anti-dumping European legislation and economic problems plaguing Asia are
significant flaws in the prospects for the industry. With very few exceptions, the
anti-damping taxes have been set at levels that make Russian steel products
uncompetitive. That is likely to lead to a further decline in rolled steel products
exports for the next several years. The extent of this decline could fall anywhere
in the region of 11-50%. The main goal of Russian exporters will be to preserve
their market share, as the composition of exports from intermediate to highly
processed products takes its toll. The shift in export mix should increase revenue
even as export volumes decrease.
The Metallurgical Department of the Ministry for Industry projected 200% growth
in domestic demand for steel by 2005 - equivalent to some 30-38 tonnes per year.
The 1H98 numbers, however, do not bear this out. Tumbling commodity prices
and non-payments brought the overall production of steel down by 5% compared
with 1H97. The main hope is that growth in the machine-building sector, as well
as the engineering and automobile industries, will fuel additional domestic demand.
The better picks in the sector will be integrated players that have a flexible product
mix and exposure to different segments of the ferrous metal market. Nizhny Tagil
Metallurgy Kombinat fits the bill and is our top pick in the sector.

U S S I A N
Krasnoyarsk
Blagoveshensk
Omsk
Tomsk
Volgograd
Automobiles and trucks
Other transport equipment
Other machine building and metal plants
Monchegorsk
Arkhangelsk
Moscow
Cherepovets
Sakhalin
Tula
Nizhny Novgorod
Khabarovsk
Novosibirsk
Irkutsk
A
T L A S
September 1998
91

N V E S T M E N T
Samara
Komsomolsk
Yekaterinburg
Chelyabinsk
Kazan
Ufa
Voronezh
Magadan
St. Petersburg
CLSA
Tractors, farm equipment
Viadivostok
FIGURE 117: RUSSIAN MACHINE BUILDING AND METAL PLANTS
U S S I A N
N V E S T M E N T
T L A S
CLSA
September 1998
PULP AND PAPER

FIGURE 118: PULP AND PAPER
Price
(US$)
10.8
20.0
0.1
20.0
Code
KPPP
SLPK
KCBK
BRLP
Kondopoga
Syktyvkar Timber
Kotlass Pulp
Bratsk Forestry
Market cap
(US$m)
63.9
19.4
37.6
39.0
12mth
high
32.5
100.0
0.3
40.0
12mth
low
0.0
2.5
0.0
0.1
98 earnings
(US$)
n.a.
n.a.
n.a.
n.a.
PE
(x)
n.a.
n.a.
n.a.
n.a.
1mth avg daily

turnover (US$'000)
n.a.
n.a.
n.a.
n.a.
RUSSIAN PULP
INDUSTRY
SUFFERS FROM OVERCAPACITY
The Russian pulp and paper industry continues to suffer from overcapacity. Western
markets are mature and demand is flat or - in the case of some paper grades such
as newsprint - in decline. Excess supply in the traditional key paper markets in North
America and Europe makes producers dependent on exports to developing regions.
FIGURE 119: PULP AND PAPER VOLUME PRODUCTION, 1994-1998

Wood timber (m m3)
YoY %
Saw-timber (m m3)
YoY %
Wood particle boards (000m3 )
YoY %
Paper (000t)
YoY %
1994 1995 1996 1997 1Q97 2Q97 3Q97 4Q97 1Q98 2Q98
74.8 75.5 59.7 61.9 21.6 13.1 12.6 14.6 19.7 13.5
(33)
1 (21)
4
(39)
(4)
16
(9)
3
19.3 16.8 13.5 18.1
4.6
4.3
4.4
4.8
4.5
4.8
(30) (13) (20)
34
(7)
2
9
(2)
2
2,614 2,199 1,456 1,478
365
322
366
425
403
336
(33) (16) (34)
2
(12)
14
16
10
4
2,215 2,771 2,293 2,229
487
539
597
606
592
636
(23)
25 (17)
(3)
11
11
2
22
18
Source: Goskomstat
ROUBLE HURTS RETURNS
FOR
THE PULP COMPANIES
POOR ABILITY TO
GENERATE
ACCEPTABLE RETURNS
SECTOR IN RUSSIA DOES

LOOK PROMISING FOR THE
PORTFOLIO INVESTOR
92
NOT
From a rating perspective, the cost structure of a company is key. Important variables
include the size, age and quality of its paper machines; other input costs such as
labour and energy; and its control of the main raw material, wood. The business
risk is generally perceived to be lower the more highly value-added a companys
products. Such paper grades tend to be more consumer biased, with closer
relationships and longer term contracts lending relative stability to markets.
Conversely, the commodity nature of pulp makes it sensitive to sharp price
fluctuations and, hence, volatile profit and cash generation. In this respect, the rouble
exchange rate has a major influence - especially as some of Russias biggest lowcost pulp and paper competition, the Indonesians, have devalued their currency.
The industry has displayed a poor ability to generate acceptable returns over a cycle.
The increasing focus by investors generally on shareholder value and the forthcoming
European single currency are putting pressure on managements ability to attract
capital. In addition to consolidation, strategies are beginning to change from cost
and product driven motivation to market and customer orientation.
Eastern Europe and Russia have seen pulp and paper output dwindle in line with
most other sectors in the face of economic difficulties. There are substantial foreign
investor interests and the sector has good opportunities in the long term. However,
rapid progress is unlikely. Asia is a growing market but also presents a competitive
threat due to its low cost production. In the aftermath of the recent crises, producers
may utilise their devalued currencies to increase exports to the West. This would
put downward pressure on prices, which have been recovering only slowly since
the trough in 1995-1996. At the same time, the relative cheapness of many of them
show that opportunities for acquisitions by Western companies exist.

ADDITIONAL INFORMATION AVAILABLE UPON REQUEST.

The information and statistical data herein have been obtained from sources we believe to be reliable but
in no way are warranted by us as to accuracy or completeness. We do not undertake to advise you as
to any change of our views. This is not a solicitation or any offer to buy or sell. We, our affiliates, and
any officer, director or stockholder or any member of their families, may have a position in and may from
time to time purchase or sell any of the above mentioned or related securities. For private circulation only:
this material has been prepared by Credit Lyonnais Securities (USA) Inc. For EU clients only: This publication
has been approved for issue under section 57 of the Financial Services Act 1986 by Credit Lyonnais Securities,
London, England regulated by SFA. All information and advice is given in good faith but without legal
responsibility. Credit Lyonnais Securities or companies or individuals connected with it may have used
research material before publication and may have positions in or may be materially interested in any of
the securities mentioned. This publication is not for distribution to, or to be used by, private clients.

Hong Kong
Credit Lyonnais Securities (Asia) Ltd
33/F Lippo Centre, Tower 2, 89 Queensway
Tel: (852) 2810-9338 Fax: (852) 2868-0189
USA
Credit Lyonnais Securities (USA) Inc
Credit Lyonnais Building, 1301 Avenue of The Americas,
New York, New York 10019
Tel: (1) 212 408-5888 Fax: (1) 212 261-2502
Singapore
Credit Lyonnais Securities (Singapore) Pte Ltd
16 Collyer Quay, Hitachi Tower #32-00, Singapore 049318
Tel: (65) 534-3268 Fax: (65) 533-8922
United Kingdom
Credit Lyonnais Securities
Broadwalk House, 5 Appold Street, Broadgate, London EC2A 2DA
Tel: (44) 171-214-5414 Fax: (44) 171-214-5403
Argentina
Credit Lyonnais Argentina
Torre Bouchard, Bouchard 547, Piso 11, 1106 Buenos Aires
Tel: (541) 311 9949 Fax: (541) 311 9926
Malaysia
CLSA (Malaysia) Sdn Bhd
Suite 15-2 Level 15, Menara PanGlobal, 8 Lorong P Ramlee,
Off Jalan P Ramlee, 50250 Kuala Lumpur
Tel: (60) 3-232-4288, (60) 3-466-3242 Fax: (60) 3-238-4868
Brazil
Credit Lyonnais Brazil
Avenida Brigadeiro Faria Lima, 1355-21 Andar,
01452-919 Jardim Paulistano, So Paulo/SP
Tel: (5511) 3030 7800 Fax: (5511) 3030 7930
Mexico
Credit Lyonnais Mexico
Monte Sinai 120, p.b., Colonia Lomas de Chapultepec,
C.P. 11000, Mexico D.F.
Tel: (525) 202 0900 Fax: (525) 202 9101
China - Shanghai
Units 02 & 04, 11/F, Shanghai Bund International Tower,
99 Huangpu Road, Shanghai 200080
Tel: (86 21) 6393-1118 Fax: (86 21) 6393-3533/3534
Pakistan
No. 410 4/F Clifton Centre, Khayaban-e-Roomi, Clifton, Karachi
Tel: (92) 21 587-1074/587-1011 Fax: (92) 21 586-2802
China - Shenzhen
Room 3111, Shun Hing Square, Di Wang Commercial Centre,
333 Shennan Road East, Shenzhen 518008
Tel: (86) 755 246 1755 (4 lines) Fax: (86) 755 246 1754
Philippines
Credit Lyonnais Securities Philippines, Inc
17/F, Trafalgar Plaza, 105 H. V. dela Costa Street,
Salcedo Village, Makati City, Metro Manila
Tel: (63) 2 848-3772 thru 81 Fax: (63) 2 848-3697
India
Credit Lyonnais Securities India Pvt Ltd
8/F Dalamai House, Nariman Point, Bombay 400 021,
Tel: (91) 22 284-1348
Fax: (91) 22 284-0271
Switzerland
Credit Lyonnais Securities (SE Asia) Limited
2/F, 7 Rue de la Croix DOr,1204 Geneva
Tel: (41) 22-818-3030 Fax: (41) 22-311-0807
Indonesia
PT Credit Lyonnais Capital Indonesia
WISMA GKBI Suite 1501
Jl. Jendral Sudirman No.28, Jakarta 10210
Tel: (62) 21-574-2626, (62) 21-574-2323 Fax: (62) 21-574-6920
Taiwan
6/F, No. 117, Sec. 3, Min-sheng E. Road, Taipei
Tel: (886) 2-2717-0737 Fax: (886) 2-2717-0738
Japan
Credit Lyonnais Securities (Japan)
Hibiya Kokusai Building 7th Floor, 2-2-3 Uchisaiwai-cho,
Chiyoda-ku, Tokyo 100 0011
Tel: (81) 3-5510-8650 Fax: (81) 3-5512-5896
Thailand
10th Floor, Ploenchit Center Building, Two, Sukhumvit Road (Soi 2), Bangkok 10110
Tel: (662) 656 8628 Fax: (662) 656 8640
Korea
Credit Lyonnais Securities (Korea)
9/F Youone Building, 75-95 Seosomun-Dong,
Chung-ku, Seoul 100-110
Tel: (82) 2-3708 7300 Fax: (82) 2-771-8583
Venezuela
Credit Lyonnais Venezuela
C. C. El Parque - Piso 10, Avenida Franciso de Miranda,
Los Palos Grandes, Caracas 1060
Tel: (582) 285 5574 Fax: (582) 285 3254
A presence via the CL Bank network

Chile
Credit Lyonnais Chile
Alcantar 44, Piso 5, Las Condes, Santiago
Tel: (562) 207 3454 Fax: (562) 207 3898
Colombia
Credit Lyonnais Colombia
Calle 98 9-03, Of. 702, Santa F de Bogot
Tel: (571) 218 2637 Fax: (571) 616 7250
Czech Republic
Credit Lyonnais Czech Republic
A.A. Myslbk Building, 6th Floor, Ovocny Trh8 1100,
Prague, Czech Republic
Tel: (4202) 220 76101 Fax: (4202) 220 76109
Hungary
Credit Lyonnais Hungary
Jozsesnador No. 7, Budapest, Hungary
Tel: (361) 266 9000 Fax: (361) 267 4182
Panama
Credit Lyonnais Panam
Calle Elvira Mendez No. 10, Panam 9A
Tel: (507) 263 6522 Fax: (507) 263 5904
Peru
Credit Lyonnais Peru
Paseo Rep. de Panama, Piso 12, Of. 1202, Lima 27
Tel: (511) 441 8177 Fax: (511) 411 4379
Poland
Credit Lyonnais Poland
Al. Jerozolinskie 6579, Warsaw, Poland
Tel: (4822) 630 6888 Fax: (4822) 635 4500
Russia
Credit Lyonnais Russia
Nicolo Yamskaya 15,109240 Moscow, Russia
Tel: (00) 7502 221 8500 Fax: (00) 7502 564 8549
Turkey
Credit Lyonnais Turkey
Haktan Is Merkezi Kat 4, Set Ustu - Kabatas, Istanbul
Tel: (90212) 251 6300 Fax: (90212) 251 8166
Ukraine
Credit Lyonnais Ukraine
Ukranian House, 4th Floor, No. 2 Khreschchatyk Street, 252001 Kiev, Ukraine
Tel: (00) 380 44 22 95 400 Fax: (00) 380 44 22 83025
This report is produced by Credit Lyonnais Securities Asia for private circulation. All information, views and advice are given in good faith but without legal
responsibility. Credit Lyonnais Securities Asia or companies or individuals connected with it may have used research material before publication and may have
positions in or may be materially interested in any of the stocks in any of the markets mentioned.
MITA (P) No. 156/05/98

Clsa Russia

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Clsa Russia

Uploaded by

Copyright:

Available Formats

R U S S IA R E S EA R C H

RUSSIAN INVESTMENT ATLAS

FIGURE 1: RUSSIA: KEY FACTS

US$1 = 11.3 Rbl

1997 inflation (year-end)

Coal and electricity

Machinery & equipment

1997 GDP per capita

Cagr real GDP (1992-98)

8.7 (per sq km)

Main exports (%)

Main imports (%)

Clothing & household goods

Machinery and equipment

Main trading partners

Ukraine, Germany, Eastern Europe

1997 Private sector % of GDP

Dec 1999 - parliamentary

1997 Foreign exchange reserves

1997 Budget balance % of GDP

1997 Trade balance % of GDP

No. of months of import cover

June 2000 - presidential

Source: CLSA Global Emerging Markets

Overview - Why an atlas? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Oil production, refining and gas industries . . . . . . . . . . . . . . . . . . . . . 66

Banking and Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

Cement and Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

Metals and Metallurgy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

Pulp and Paper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

FIGURE 2: RUSSIAN EQUITY MARKET STATISTICS

Source: CLSA Global Emerging Markets

FIGURE 3: RUSSIAN GDP STATISTICS

Source: CLSA Global Emerging Markets

FIGURE 4: AVERAGE RUSSIA WEIGHTINGS IN EASTERN EUROPEAN EQUITY FUNDS

MOSCOW TIMES (US$ return, rebased)

Weighted avg weightings (RHS)

Simple avg weightings (RHS)

Source: CLSA Global Emerging Markets

OVERVIEW - WHY AN ATLAS?

IT TOOK CHINA 20 YEARS TO

WILL TAKE AS LONG

BANKING SYSTEM AND

FIGURE 5: THE MARKET PLACE

FIGURE 6: THE BORDERS OF THE FORMER SOVIET UNION

FIGURE 7: RUSSIAs 89 ADMINISTRATIVE DIVISIONS

Source: CLSA Global Emerging Markets

GEOGRAPHY - THE 21 CLUB

LANDMASS, BUT ONLY

FIGURE 8: POPULATION AND POPULATION GROWTH

1993A 1994A 1995A 1996A 1997A 1998CL 1999CL 2000CL

Source: CLSA Global Emerging Markets

FIGURE 9: REPUBLICS & AUTONOMOUS AREAS

THE MAJORITY GROUP

FIGURE 10: NUMBER OF RUSSIANS

FIGURE 11: NATIONALITIES IN THE RUSSIAN FEDERATION (%)

REGIONS: A LOOSE AND VARIED ALLIANCE

Krays were unique administrative entities, something in between a republic and

Oblasts were originally administrative subdivisions in Russia, without any power of

Autonomous areas were created to give political recognition to relatively small

HIGHLY VARIED WEALTH

Note: Income figures as at end-1997

Black Earth Belt

over US$ 901