Abstract
This Selected Issues paper for the Russian Federation reviews trends in private capital flows to Russia by decomposing the flows into its subcomponents. Russia became a net lender to the international banking system, as a complement to the prolonged period of large current account surpluses. The nonbank corporate sector in Russia began to have better access to both bank and nonbank sources of external finance, with improving investor perceptions and a favorable external environment. The relatively lackluster performance of equity issuances and foreign direct investment has been an outcome of both global and local factors.
I. Private Capital Flows to Russia in Perspective1
1. This chapter reviews trends in private capital flows to Russia in recent years by decomposing the flows into its subcomponents. While the balance of payments data present trends in capital flows in an aggregated form, the focus in this chapter is on private capital flows from a sources perspective, putting the various subcategories of flows within the broader context of overall emerging market financing,
2. The main finding of this chapter is that there has been a significant shift in private market financing to Russia since 2002. First, Russia became a net lender to the international banking system, as a complement to the prolonged period of large current account surpluses. Second, the nonbank corporate sector in Russia began to have better access to both bank and nonbank sources of external finance, with improving investor perceptions and a favorable external environment. This pattern began in late 2001, while interest rate sensitive borrowing by Russian banks showed an upturn later, around mid-2002. Syndicated loan and bond financing, after resuming in relatively modest amounts in early 2000, showed a significant upturn from late 2001, in a pattern broadly consistent with overall emerging market financing. The relatively lackluster performance of equity issuances and foreign direct investment (FDI) has been an outcome of both global and local factors. Structural reforms that improve access to international equity financing and FDI would diversify the funding base for the corporate sector and improve the overall liabilities in their balance sheets.
3. The remainder of this chapter is organized as follows. It begins by looking at the role of international bank lending into the Russian economy, which comprises the largest category of capital flows between Russia and the rest of the world. This is followed by a review of trends in international bond issuances, which are increasingly becoming a sizable source of financing for Russian non-sovereign entities. The relatively modest role of syndicated lending and the narrow focus of international equity issuances round out the discussion of international capital market access by Russian entities. The chapter concludes by offering an overview of recent developments as well as drawing out implications for further integration with international capital markets.
A. Recent Trends
4. After several years of large but declining private capital outflows2, the year 2003 was the first year when net private outflows declined to negligible amounts. As Table 1 shows, the main factors underlying this development were the sharp increases in commercial bank borrowing from overseas ($10.3 billion) and in borrowing by the nonbank corporate sector (“corporations”) in international markets ($12 billion). Portfolio investment registered a modest outflow (-$0.8 billion), while net foreign direct investment continued to be negative (-$3 billion). Capital flight is believed to comprise a major proportion of unclassified capital outflows, including substitution from domestic to foreign currencies by households and possibly enterprises. Trade credit is also a sizable component of “other private capital,” the bulk of which tends to be between international banks and their domestic counterparts.
Russian Federation: Capital Account Developments, 2000-03
(In billions of U.S. dollars, unless otherwise indicated)
Russian Federation: Capital Account Developments, 2000-03
(In billions of U.S. dollars, unless otherwise indicated)
| 2000 | 2001 | 2002 | 2003 | ||||
|---|---|---|---|---|---|---|---|
| Capital and financial and account | -21.8 | -13.9 | -10.9 | -0.6 | |||
| Capital transfers | -0.3 | -0.5 | -0.5 | -1.0 | |||
| Federal capital | -4.3 | -6.8 | -6.6 | -4.4 | |||
| Budgetary | -5.4 | -5.2 | -4.9 | -7.4 | |||
| Disbursements | 1.1 | 0.6 | 0.9 | 0.8 | |||
| Amortization | -6.6 | -5.8 | -5.7 | -8.2 | |||
| Non-budgetary | 1.1 | -1.6 | -1.8 | 3.0 | |||
| Local Governments | -0.8 | -0.2 | -0.5 | -0.2 | |||
| Private sector capital | -16.3 | -6.4 | -3.3 | 5.0 | |||
| Direct investment | -0.4 | -0.2 | -1.2 | -3.0 | |||
| Portfolio investment (net) | -0.2 | 0.6 | 2.0 | -0.8 | |||
| Commercial banks | -2.1 | 1.0 | 2.2 | 10.3 | |||
| Corporations | -1.0 | 0.4 | 8.3 | 12.0 | |||
| Other private capital | -12.7 | -8.2 | -14.7 | -13.4 | |||
| Errors and omissions, net | -9.2 | -10.2 | -7.5 | -5.2 | |||
Russian Federation: Capital Account Developments, 2000-03
(In billions of U.S. dollars, unless otherwise indicated)
| 2000 | 2001 | 2002 | 2003 | ||||
|---|---|---|---|---|---|---|---|
| Capital and financial and account | -21.8 | -13.9 | -10.9 | -0.6 | |||
| Capital transfers | -0.3 | -0.5 | -0.5 | -1.0 | |||
| Federal capital | -4.3 | -6.8 | -6.6 | -4.4 | |||
| Budgetary | -5.4 | -5.2 | -4.9 | -7.4 | |||
| Disbursements | 1.1 | 0.6 | 0.9 | 0.8 | |||
| Amortization | -6.6 | -5.8 | -5.7 | -8.2 | |||
| Non-budgetary | 1.1 | -1.6 | -1.8 | 3.0 | |||
| Local Governments | -0.8 | -0.2 | -0.5 | -0.2 | |||
| Private sector capital | -16.3 | -6.4 | -3.3 | 5.0 | |||
| Direct investment | -0.4 | -0.2 | -1.2 | -3.0 | |||
| Portfolio investment (net) | -0.2 | 0.6 | 2.0 | -0.8 | |||
| Commercial banks | -2.1 | 1.0 | 2.2 | 10.3 | |||
| Corporations | -1.0 | 0.4 | 8.3 | 12.0 | |||
| Other private capital | -12.7 | -8.2 | -14.7 | -13.4 | |||
| Errors and omissions, net | -9.2 | -10.2 | -7.5 | -5.2 | |||
B. International Bank Lending
5. International bank data from the Bank for International Settlements (BIS) show that Russia has become a net lender to the international banking system since 2002 (Figure 1). The total position of BIS reporting banks vis-à-vis Russia was marked by an increase of liabilities of international banks since the beginning of the period under review, with assets showing a consistent increase only since the second half of 2002. Since that time, net international liabilities of banks vis-à-vis Russia turned positive. This is consistent with the long and sustained period of sizable current account surpluses in Russia and reduction in external debt ratios.
Russian Federation: External Position of BIS Reporting Banks vis-à-vis Russia, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).Russian Federation: External Position of BIS Reporting Banks vis-à-vis Russia, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).Russian Federation: External Position of BIS Reporting Banks vis-à-vis Russia, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).6. While the overall picture highlights Russia’s role as net lender to the international banking system, the composition of this aggregate position differs markedly between banks and nonbank corporates (Figure 2). International banks have been net lenders to the nonbank corporate sector in Russia, and this development has been amplified markedly since early 2002. The small size of the domestic banking system, coupled with the improved access to international borrowing in terms of both volumes and pricing, for larger corporates since 2002, has been a key driver in allowing domestic corporates to diversify their sources of funding on attractive terms. While the nonbank sector’s placement of funds with international banks has been broadly stable at around $6–8 billion, the international banks’ asset position vis-à-vis the nonbank sector has doubled from around $14 billion to $28 billion. Based on this measure, international banks have lent some $12 billion in net terms to the nonbank sector in Russia over the period 2000–03.
Russian Federation: BIS Banks’ Position vis-à-vis Nonbank Sector, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).Russian Federation: BIS Banks’ Position vis-à-vis Nonbank Sector, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).Russian Federation: BIS Banks’ Position vis-à-vis Nonbank Sector, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).7. The picture regarding the Russian banking system is starkly different in comparison (Figure 3). Here, international banks have gone from being net lenders to being net borrowers from early 2001 onwards. Russian banks’ net lending to the international banking system has increased from $1 billion at the beginning of 2001 to $28 billion by end-2003. Much of this lending is believed to be in the form of interbank deposits placed by Russian banks with BIS banks and trade credit by Russian exporters, which take the form of lending by Russian-based banks of exporters with the importing countries’ banks. The apparent discrepancy between this picture and the balance of payments data on commercial bank’s net borrowing can in part be explained by the fact that trade credit (recorded in the balance of payments under “other private capital”) has increased in recent years (in net terms an outflow of $9.7 billion in 2000–03). The increase in lending by international banks to Russian banks since mid-2002 (the “assets” of international banks) coincides with the period of fairly predictable exchange rates, which allowed Russian banks to participate in the carry trade by borrowing at attractive rates overseas with little perceived exchange rate risk. The increase in Russian banks’ deposits overseas appears to have been driven more by client needs for providing trade credit and depositing the proceeds of current account surpluses.
Russian Federation: BIS Banks’ Position vis-à-vis Banking Sector, 2000-03
(In millions of U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).Russian Federation: BIS Banks’ Position vis-à-vis Banking Sector, 2000-03
(In millions of U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).Russian Federation: BIS Banks’ Position vis-à-vis Banking Sector, 2000-03
(In millions of U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).8. Finally, a look at the consolidated data gives a more detailed picture of the composition of international bank flows to Russia (Figure 4).3 Looking at the claims of the foreign banks towards Russian entities, the proportion of short term exposure of foreign banks towards Russia has increased notably since the second half of 2002, coinciding with an upturn in foreign borrowing by Russian banks in the carry trade. Discussions with market participants suggest that the bulk of the increase in short term lending to Russia is related to the increase in borrowing by Russian banks, which would be consistent with the short-term nature of the carry trade, while the nonbank sector appears to be able to access funding at longer maturities for working capital and investment needs. This suggests that any change in the lending environment such as increases in global interest rates or rises in global risk aversion, affecting short term borrowing disproportionately, would likely see a reduction in foreign borrowing by Russian banks.
Russian Federation: BIS Banks’ Consolidated Claims by Maturity, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).Russian Federation: BIS Banks’ Consolidated Claims by Maturity, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).Russian Federation: BIS Banks’ Consolidated Claims by Maturity, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).9. The perception that interest rate sensitive borrowing is more driven by Russian banks than by corporates is reinforced by the data on consolidated claims by sector (Figure 5). These data suggest that the upward trend in corporate borrowing began in 2001, after ratings upgrades by the major agencies, while the banks’ carry trade only started to increase from 2002 onwards, when U.S. policy rates had stabilized after the sharp cuts of 2001 and long-term rates had declined to near-record lows.
Russian Federation: BIS Banks’ Consolidated Claims by Sector, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).Russian Federation: BIS Banks’ Consolidated Claims by Sector, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).Russian Federation: BIS Banks’ Consolidated Claims by Sector, 2000-03
(In million U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Source: Bank of International Settlements (BIS).10. In sum, this section reviewed the role of bank financing in private capital flows to Russia. While the Russian banking system has been a net lender to the international banking system, the corporate sector has begun to increase its borrowing from abroad financed by banks. The recent upward trend in borrowing appears to have begun in earnest in late 2001, with creditor perceptions of Russia appearing to show what may be a fundamental positive shift around that time. The low interest rates in global financial markets became entrenched in 2002, allowing Russian banks to access interest rate sensitive flows as the ruble exchange rate became more predictable.
C. International Issuances of Bonds, Loans and Equities
11. Nonbanking flows from international markets to Russian entities have primarily taken the form of syndicated lending and bond issuances (Figure 6). While bonds, particularly by the public sector, were prominent before the 1998 crisis, the recovery of market access since 2000 has shifted the balance of borrowing toward syndicated loans. Nevertheless, bonds outstanding have continued to grow, with public sector issuances declining and the private sector and the financial sector increasing their share of total issuances.
Russian Federation: Gross International Issuances of Bonds, Equity and Loans, 1998-2004
(In billion U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Capital Data and Fund staff calculations.Russian Federation: Gross International Issuances of Bonds, Equity and Loans, 1998-2004
(In billion U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Capital Data and Fund staff calculations.Russian Federation: Gross International Issuances of Bonds, Equity and Loans, 1998-2004
(In billion U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Capital Data and Fund staff calculations.12. The pattern of issuances has been broadly consistent with overall flows to emerging markets (Figure 7). However, in terms of Russian borrowing from international markets, the proportions remain small, suggesting that there is little risk of saturation of the markets at the aggregate level.
Gross Bond, Equity and Loan Issuance: Russia vs Emerging Markets, 1998-2004
(In billion U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Capital Data and Fund staff calculations.Gross Bond, Equity and Loan Issuance: Russia vs Emerging Markets, 1998-2004
(In billion U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Capital Data and Fund staff calculations.Gross Bond, Equity and Loan Issuance: Russia vs Emerging Markets, 1998-2004
(In billion U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Capital Data and Fund staff calculations.13. While the outstanding stock of government bonds has been declining, the stock of bonds issued by financial institutions and the corporate sector has been rising (Figure 8). Taking advantage of improved investor perceptions towards Russia, as well as the improved outlook for emerging market bonds in general, Russian private entities began accessing international bond markets in earnest from late 2001 onwards, around the same time that bank flows began to show large increases. While the stock of government bonds declined from 85 percent at the beginning of 1999 to 52 percent by end-2003, that of the corporate sector grew from 2 percent to 20 percent over the same period. The proportion of bonds issued by financial institutions declined from 12 percent to 6.8 percent by end-2002, and increased to 28 percent by end-2003.
Russian Federation: International Bonds Outstanding by Sector, 1998-2003
(In billions of U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Bank of International Settlements (BIS) and Fund staff calculations.Russian Federation: International Bonds Outstanding by Sector, 1998-2003
(In billions of U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Bank of International Settlements (BIS) and Fund staff calculations.Russian Federation: International Bonds Outstanding by Sector, 1998-2003
(In billions of U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Bank of International Settlements (BIS) and Fund staff calculations.14. Russian access to the syndicated loan market has been growing sharply, while Russian access to the international equity market has been relatively small. On the one hand, issuance of syndicated loans to Russia grew rapidly, and picked up to unprecedented levels in the first half of 2004. However, their generally floating rate structure makes them vulnerable to rising interest rates in mature markets. As a result, the potential debt servicing costs of this could rise substantially. On the other hand, Russian access to the international equity market has been relatively small in contrast with other flows,. Equity placements have been even smaller and sporadic, reflecting in part the concentration of ownership for the big Russian firms that potentially could access international capital markets. While syndicated loans have been overwhelmingly concentrated in the energy sector, followed by mining and some activity in the financial sector, international equity issuances have been distributed in relatively small amounts among the telecom, healthcare, aerospace, energy, consulting and banking sectors.
D. Foreign Direct Investment
15. Based on balance of payments data, net FDI into Russia has turned negative, with FDI abroad rising, while FDI from overseas remained at relatively low levels (Figure 9). To some extent, the outward FDI reflects Russian entities booking investments into offshore fully-investments back in some part. Furthermore, some FDI investments, such as the landmark deal between BP and TNK in 2003 was recorded offshore and did not show up in balance of payments data. The huge energy sector surpluses have also obviated the need for FDI into the oil sector, and have given the oil companies the resources to fund acquisitions abroad, especially in the CIS. Finally, continued concerns about corporate governance are also reflected in low rates of inward FDI.
Russian Federation: Foreign Direct Investment, 1994-2003
(In billion U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Central Bank of Russia and Fund staff estimates.Russian Federation: Foreign Direct Investment, 1994-2003
(In billion U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Central Bank of Russia and Fund staff estimates.Russian Federation: Foreign Direct Investment, 1994-2003
(In billion U.S. dollars)
Citation: IMF Staff Country Reports 2004, 316; 10.5089/9781451833119.002.A001
Sources: Central Bank of Russia and Fund staff estimates.E. Conclusions
16. Since 2002, Russia has enjoyed increased capital inflows and greater capital market access. First, there has been an increase in overall borrowing, ranging from bilateral bank loans to bonds, syndicated lending, and some equity issuances. This diversification is a welcome development, given the limited extent to which the private sector can borrow at attractive rates from the domestic banking system and the ruble bond market. Moreover, accessing international markets requires the borrowers to meet international standards for reporting and disclosure, which can be expected to contribute to the improvement of the overall corporate governance environment. Second, the upgrading of Russia by the major rating agencies in 2001 and improved perceptions of country creditworthiness appears to have enhanced access by Russian corporates to international markets since late 2001. Third, with the subsequent decline in global interest rates to near-historic lows in 2002, the increase in short-term borrowing, particularly by banks engaging in the carry trade, has added to the overall trend..
17. Two areas that have notably lagged in this broader trend have been equity issuances and FDI. With the bursting of the global equity bubble in 2000, conditions for equity issuance remained subdued until late 2003 across all emerging markets. But with improvements in recent quarters, the scope for greater equity issuance by emerging markets has improved. However, both equity issuances and FDI are affected much more than international debt flows by perceptions of corporate governance, protection of minority shareholders, and a stable and predictable domestic legal framework. This suggests that structural reform efforts in these areas, besides improving the overall business environment, would also allow corporates to diversify their funding sources with a better balance between equity and debt financing. Within debt financing, better access to bond markets would also allow for longer-term fixed rate financing that corporates would need, particularly for infrastructure and long-term capital investments.
This chapter was prepared by Subir Lall.
Private capital flows are defined in the balance of payments as the sum of “private sector capital” and “errors and omissions.”
Unlike the preceding international banking statistics which are based on location, and conform more closely to balance of payments definitions, consolidated statistics look at exposures by ownership, therefore, including local branches and subsidiaries of foreign banks as part of the foreign banks’ overall claims position.
