DAILY REPORT ON RUSSIA

AND THE FORMER SOVIET REPUBLICS

INTERCON INTERNATIONAL USA, INC., 725 15th STREET, N.W., SUITE 908,

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Daily intelligence briefing on the former Soviet Union

Published every business day since 1993

Wednesday, January 29, 1997

Russian Federation

Politics

Chubais Becoming Nationalistic?

· In an interview with Trud (Work) newspaper last week, Russian presidential chief-of-staff Anatoly CHUBAIS contended that Russian integration with Belarus was essential to counteract a foreign threat to Russia's security and its position within Europe. "We know that there are plans for establishing a kind of cordon sanitaire around Russia, beginning with Azerbaijan and ending with the Baltic states, designed to separate Russia from the civilized world, to isolate it. Some Republican politicians in the USA openly called for creating it. We cannot accept this under any conditions," Trud quoted him as saying.

CHUBAIS is considered one of the most powerful men in Russia. Many observers believe that he has essentially been running the country while President YELTSIN is incapacitated with illness. (The Russian press often refers to him as "the regent.") This circumstance, combined with the fact that he is normally progressive and pragmatic, makes his repetition of terms and conspiracy theories usually confined to hardline nationalists extremely disturbing. "Cordon sanitaire" was a term used by Bolshevik authorities during the Russian civil war of the 1920s to justify domestic repression. The dissemination of the idea that Russia is facing some kind of hostile encirclement is fraught with danger.

Fed. Council Moves Up Budget Debate

· Russia's Federation Council (upper house of parliament) has moved its debate on the draft 1997 federal budget to February 4, instead of the 12th, as originally scheduled, reported Russian public television (ORT) today. Council chairman Yegor Stroyev said he believed that the budget underestimated government revenues, but it was impor

tant that it was passed because Russia's regional governors need assurances of government budget policies for the year.

Economy

Ruble = 5,626/$1.00 (NY rate)

Ruble = 5,627/$1.00 (CB rate)

Ruble = 5,622|5,632/$1.00 (buy|sell rates)

Yavlinsky Predicts Further GDP Decline

· Russian liberal parliamentarian Grigory YAVLINSKY predicted on Tuesday that the Russian economy will continue to decline in 1997 as political uncertainty paralyzes economic reform efforts. In an interview with Reuters in New York, YAVLINSKY forecast that gross domestic product (GDP) would contract another six percent in 1997, while industrial output will decline about eight percent and overall capital investment will drop 18 percent.

"The political situation is very vague because [President Boris] YELTSIN is very unstable," YAVLINSKY told Reuters, stressing that YELTSIN's real problem was not his health, but his outdated mentality. "[YELTSIN's] time has passed two or three years ago because he is not prepared just now to solve any single problem in Russia.... He can't identify the task, he can't find a way of solving the task, and he can't find the people ... to solve it."

Furthermore, YAVLINSKY blamed certain powerful forces in Russia for holding back market reform. "It is nec

Today's News Highlights

Russia

More Eco. Figures for 1996

S&P on Russian Banking Sector

Russian Cos. and ADRs

Pioneer & Auerbach in Russia

European Republics

Ukraine Processing in 1996

US Buys Belarus Tube Maker

Latvia Premier Shkele Returns

South Caucasus & Central Asia

British in Azerbaijan for Oil

Politics-Economics-Business

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January 29, 1997

Intercon's Daily

essary to make some concrete things, like competition, like demonopolization, like free trade, like land reform," he said. "We have to overcome a very dangerous stage not to become a semi-criminal, oligarchic, monopolistic state, which we are now just becoming."

Specifically, YAVLINSKY said he was concerned about three main monopolistic groups in the areas of natural resources, weapons production, and a small group of banks, "which are close to the budget," according to Reuters.

YAVLINSKY is the leader of the Yabloko faction in the State Duma, which includes about 10 percent of deputies, and placed fourth in last summer's presidential elections. He was invited to speak to investors in New York by the Brunswick Brokerage firm, which specializes in Russia.

More on Russian Economy in 1996

· The Russian State Statistics Committee (Goskomstat) released statistics on the Russian economy, published this week in Rossiiskaya Gazeta, showing developments in the areas of investments in fixed assets, the consumer market, prices, the labor market, living standards, and foreign trade. The figures present a negative picture as the only significant progress in 1996 was the reduction of inflation.

In 1996, 370 trillion rubles were invested in the development of the economy and the social sector, 18 percent less than the preceding year. The non-state sector accounted for 74 percent of the total volume of investment compared with 69 percent in 1995. Of the total, 60 percent of investment went into the construction, expansion, retooling, and reconstruction of industry. Housing construction, which experienced a boom over the last few years, fell in 1996 when 37 million square meters of housing was built, a 10 percent drop from 1995.

Consumer prices grew only 21.8 percent in 1996, down from 130 percent in 1995. During 1996, food prices rose 17.7 percent on average, non-food prices rose 17.8 percent, and prices of services grew by 48.4 percent. Producers' prices for industrial products increased by 25.6 percent last year. The national average cost of a basket of 19 major foodstuffs on December 30 was 255,500 rubles per month, a 10.4 percent (24,000 ruble) rise for the year

as a whole. The basket was most expensive in the Far East and least expensive in the Central Black Soil Region (Kursk, Tambov, Lipetsk, Belgorod, and Voronezh Oblasts).

At the end of December 1996, the Russian workforce totaled 72.7 million people, or 49 percent of the country's population. Of the total, 9.3 percent (6.8 million) would have been classified as unemployed using UN International Labor Organization (ILO) methodology, but only 2.5 million were officially registered as unemployed.

According to Goskomstat, the average standard of living did not change significantly from 1995 to 1996, with disposable income remaining practically the same. In 1996, the wealthiest 10 percent of the population accounted for about 34 percent of cash incomes (in 1995 it was about 31 percent) and the poorest 10 percent accounted for only 2.6 percent (in 1995 it was 2.3 percent).

In December 1996, an estimated 31.9 million people, or 22 percent of the population, lived below the poverty line of 379,000 rubles per person. The average monthly salary in 1996 was 800,000 rubles, up 60 percent from 1995.

Business

S&P on the Russian Banking Sector

· A recent assessment of the development of Russia's banking sector by Standard & Poor's was optimistic, despite recognition of the sector's continued difficulties in adjusting to market conditions. In an article published in this week's CreditWeek, S&P said the Russian banking system is only just beginning to take shape, anchored by about 20 stable banks among the over 2,000 currently operating, reported Futures World News on Tuesday.

According to S&P, Russia is recovering from hyperinflation and severe recession but is still very

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Politics-Economics-Business

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much in the early stages of this recovery. However, banks are beginning to get a grip on their infrastructure and managerial needs and future growth prospects are tremendous, with signs of real loan growth already visible. The development of Russia's banking system in the post-Soviet era has been marked "by a dizzying pace of change and considerable financial opportunity," said Tanya Azarchs, Director of Financial Institutions Ratings at S&P.

Banks in Russia have multiple affiliations with commerce, in a variety of forms. For example, financial- industrial groups (FIGs) are formed between banks and industrial enterprises as an incentive to restructure industrial sectors and improve the availability of financing to deserving ventures. But they also form formidable political interest blocks, which brings some negatives with it. Many of the largest banks are involved in such groups and also have large equity investments in corporations. Such interaction could be good for economic growth, but the possibility of added risk for the bank must be judged on a case-by-case basis, said Standard & Poor's.

The low levels and short-term nature of lending by Russian banks are typical for high-inflation economies and high real interest rate environments, said Azarchs. But there is a growth in real terms in bank lending, the future of which will depend on the banks' ability to make creditworthy loans. Many banks have significant problem loan portfolios, the level of which is difficult to determine due to lack of disclosure and inconsistencies in accounting for loans.

Capital ratios appear high, but "taking into consideration the riskiness of the operating environment and large equity portfolios, the risk-adjusted ratios are not high. The absolute levels of capital are also low," said Azarchs.

Following the collapse of the Soviet Union, three of the five large state-owned banks privatized themselves. Minimal capital and other regulatory requirements for obtaining a banking license resulted in the creation of thousands of new banks. Recently, however, a trend toward consolidation, which will be essential to compete and service the larger commercial clients, has emerged. Liquidity problems, reflecting a lack of confidence in most banks, are resulting in a high rate of failure and contributing to consolida

tion. Moreover, problem loans are difficult to quantify because of a lack of transparency in reporting.

Russian Companies Successful with ADRs

· The securities of Russian companies in the form of American Depositary Receipts (ADRs) are now selling well on the US market, according to Bank of New York vice president Thomas Sanford, reported Itar-Tass. Speaking at an international banking congress in New York, organized by Arthur Andersen, SANFORD said US investors purchased $5 billion worth of ADRs of Russian companies held by the Bank of New York last year. This figure represents two percent of the total volume of ADRs put on the market. Sanford said he had never witnessed such rapid success in 20 years of work with ADRs, noting that the first Russian ADRs were issued just over 12 months ago. He said the value of ADRs of some enterprises increased by 100-250 percent in the past year.

Some 20 Russian corporations and banks have already issued ADRs or received permission to issue them, and this number is likely to increase to 50 by late 1997, said Sanford. He said virtually all of the 100 biggest Russian enterprises and corporations have requesting information from the Bank of New York on issuing ADRs. The most recent issuer of ADRs was Siberia's Irkutskenergo, while oil company Megionneftegaz said this week that it was planning an ADR issue in the first quarter of 1997.

The companies of other former Soviet republics, however, are not ready to issue ADRs, said Sanford. These countries do not have banks with the ability to hold securities and it is unlikely that local markets are liquid enough to launch ADR programs. He noted that one large Ukrainian company had hired an American US adviser to work out an ADR program, but an issue is not expected before the second half of this year.

Auerbach and Pioneer Team Up

· New York-based Auerbach Grayson & Company and Moscow-based Pioneer Securities have formed a trading alliance to provide US organizations with access to Russia's emerging securities market, said an Auerbach press release on Tuesday. The new relationship combines Pioneer's analysis of the Russian market with Auerbach Grayson's distribu

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tion capability in the US. "For a country of such vast natural resources, such a highly skilled workforce, and so many eager consumers, Russia is attracting only a small portion of the US investment flow it deserves," Pioneer's director of research Christopher SMART was quoted as saying. "The market index more than doubled last year, and the potential for further growth is extraordinary," he added.

Pioneer Securities is a subsidiary of Pioneer First Russia, holding company for Boston-based Pioneer Group, Inc. Pioneer acquired investment banking and brokerage operations in Moscow in early 1995.

Westray to Buy Belarus Plant

· US Westray Group will buy 67 percent of Belarus picture tube maker Korall for $24 million, reported Reuters on Wednesday. The Belarussian government will retain the other 33 percent of the company. A presidential decree lifts all duties and value-added and excise tax on machinery and equipment being imported to modernize the factory. The tubes will be manufactured for both local consumption and export.

South Caucasus & Central Asia

British Trade Delegation in Azerbaijan

· British Energy Minister Lord Fraser is in Baku from January 28-30 heading a business delegation seeking a role in the development of Azerbaijan's promising oil fields, primarily on the Caspian Sea shelf, and to provide technology for the modernization of its gas and oil industry, reported Itar-Tass and M2 Communications. The delegation, which includes the CEOs of nine major British oil companies, will hold talks with Azeri President Geidar Aliyev, Prime Minister Artur Rasizade, Trade Minister Gudrat Guliyev, and the head of Azerbaijan's state oil company (SOCAR) Natik Aliyev.

British officials noted that Azerbaijan produced over 50 percent of the world's oil at the beginning of this century and predicted that it will become one of the main sources of world oil production in the 21st century. The country has proven oil reserves of 20 billion barrels as well as potentially huge undiscovered reserves.

European Republics

Ukraine's Fuel Output Down

· Ukraine processed 20.1 percent less crude oil, 5.11 percent less gasoline, and 10.75 percent less diesel fuel in 1996 than in 1995, according to the Statistics Ministry, reported today's Journal of Commerce. Crude oil processing dropped to 13.46 million metric tons from 16.85 million metric tons in 1995, both far below the country's 62 million metric ton annual processing capacity. Gasoline output totaled 2.82 million metric tons, down from 2.97 million, and diesel fuel fell from 4.35 million to 3.88 million metric tons. In December alone, crude processing fell 11.65 percent from November, and 34.19 percent from December 1995.

Latvian President Asks Shkele to Stay

· Former Latvian Prime Minister Andris SHKELE told reporters today that President Guntis ULMANIS asked him to form a new government, reported Reuters. The request comes a week after SHKELE resigned over ULMANIS's opposition to his nominee for finance minister. ULMANIS stated that in talks with many of the parliament's 12 parties he determined that a majority of them would support the popular SHKELE. The old cabinet was required to resign when SHKELE stepped down. Prior to the resignation, SHKELE's eight-party coalition had the support of some 70 members of parliament.

Paul M. Joyal, President, Editor in Chief Clifton F. von Kann, Publisher Ellen Shapiro, Managing Editor

Rebecca Martin, Charles Lawrence, Contributing Editors

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