RUSSIAN STOCK MARKET REPORT 2006

UNCLAS MOSCOW 010855

SIPDIS

SIPDIS

STATE FOR EUR/RUS
TREASURY COX/ALIKONIS/BAKER
NSC FOR BROOKS

E.O. 12958: N/A
TAGS: EFIN ECON EINV RS
SUBJECT: RUSSIAN STOCK MARKET REPORT 2006

REF: A. SUPPLEMENT TO 9/22/06 ECONOMIC WEEKLY


B. MOSCOW 6926


1. Since its consolidation in 1996, the Russian stock market
has experienced growth that has led emerging markets and
rivaled developed markets. Capitalization was close to USD 1
trillion by the end of August, compared to USD 346 billion at
the end of August 2005, and USD 177 billion at the end of

2003. The Russian Trading System's (RTS) index of 40 common
and 10 preferred shares climbed from its 1998 low of 40 to an
all-time high of 1,765 in May.


2. Natural resource firms have fueled the vast majority of
this growth, thanks to a favorable ruble exchange rate
following the 1998 crisis and global increases in commodities
prices. The participation of foreign and domestic
institutional investors is rising, as are market trading
volumes and liquidity. Perhaps the most unsung factor
accompanying Russia's swelling market valuations has been the
trend among established and emerging firms in Russia to raise
primary market equity capital at home.


3. It is true that Federal Financial Market Service Chief
Oleg Vyugin lamented that Russia's capital was "escaping"
abroad when as much as 60 percent of trading in Russian
stocks occurred on foreign exchanges in the 2003-2004 period.
It is also true that, in an effort to regain this capital,
the FFMS instituted new rules in February to limit the
percentage of new stock issuances that Russian firms can list
abroad. Nevertheless, the apparent preference among Russian
firms for raising equity domestically had already
materialized. The decrease in net capital outflows during
2005 suggests that a portion of the increasing volume of
capital remaining in Russia is funding Russian companies
(Reftel B). Russian-sourced issuances in 2005 roughly
doubled those of 2004. More recently, Vyugin observed during
the 10th Annual Renaissance Capital Conference in June that a
bullish outlook on the market was justified. He said the
reason for optimism centered on results from 2005: growing
capitalizations; an increase in household demand for
ruble-denominated assets; and an increase in the number of
non-resource firms that had completed equity issuances.


4. And now the rest of the story. First, market
capitalization remains highly concentrated in the energy
sector. Gazprom alone claims around 25 percent of total
capitalization. The next four largest firms account for
another 40 percent. The stock market's fortunes,
consequently, have risen and fallen on traders' valuations of
these firms. Second, the GOR has approved a Financial Market
Development Strategy to address systemic deficiencies that
impede Russia's market competitiveness. A top priority in
this regard is the establishment of a central depository that
would improve efficiency in settlement activity. Since
settlements can take months in some cases, many foreign
investors opt to hold depository receipts. Finally, the
GOR's control over the shares of listed firms is
considerable, although estimates vary on just how much market
capitalization that is.


5. The Russian stock market, unlike the NYSE or the LSE, is
not driven by the "small, individual investor" whose presence
and diversified nature create "sticky stock prices" and more
capably copes with financial fluctuations. Although the
Director of the Moscow Interbank Currency Exchange (MICEX)
Aleksey Rybnikov has reported an increase in Russian
investors trading in Russian equities, particularly after the
liberalization in trading Gazprom shares last year, recent
studies indicate that less than five percent of Russians own
stocks or other financial investments. Consequently, the
Russian stock market is not yet "creating wealth" among small
investors, as has happened in western markets. This will be
the next step on its path to becoming a major player in the
global trading market.
BURNS