Russian Daily Monitor

IP growth slows

August industrial production growth slipped to 3.4% y-o-y from 4.9% y-o-y
in July, far lower than the 9.7% y-o-y posted in August 2004. The slowdown
in manufacturing was accompanied by an inert mineral mining sector, which
dampened the pace of industrial production expansion seen in recent
months. As a result, IP growth for the first eight months fell to 3.7%
compared with 7.6% a year ago. So far it is not clear whether the spurt
seen in production early this summer is over, possibly making way for a
softer patch. However, one of the main impediments for a speeding up of
manufacturing growth is rising competition from imports amid the
strengthening rouble.

Oil products

Ministry of Industry and Energy on Monday reached an agreement with
LUKoil, Surgutneftegaz, Sibneft, TNK-BP, Tatneft and Rosneft to freeze
retail gasoline and diesel prices, although no rigid commitments were
announced. The parties stressed that no administrative pressure was
involved, and the ministry added today that it would like other market
players to join the moratorium.
Meanwhile, the Finance Ministry said it did not object to the taxation
changes aimed at stimulating greenfield oil production and domestic
refining, although the concrete measures are still subject to discussion.
The most viable option at this stage seems to be Mineral Extraction Tax
differentiated by province (maybe up to a zero rate for toughest and
farthest away fields), with the overall tax load somewhat redistributed
towards crude exports.
The developments should benefit strong refiners such as LUKoil, especially
as a rising wholesale gasoline price coupled with retail price cap could
drive out smaller retailers.

Money market

As euro-dollar dynamics continue to direct the Russian FX market, two
global factors look likely to become major drivers of the rouble rate: The
U.S. Federal Reserve
,s assessment of the prospects of U.S. economic
growth, due after its rate decision on Tuesday, and the attempts to form a
coalition government in Germany that would allow the implementation of
reforms. As for local factors, we see the Central Bank as the main force
underpinning the rouble
,s value. If inflation looks like it will exceed
last year
,s levels, the Central Bank will likely tamper in order to
strengthen the nominal value of the national currency.
At present, the dollar looks quite strong, although its further
appreciation would require a shift in interest rate expectations, likely
toward continuing interest rate hikes. A dollar value of 28.5 roubles up
from the current 28.4 still seems realistic in the coming days.

Bond market

The domestic bond market made a feeble attempt at a correction on Monday,
but exorbitant rouble liquidity prevented a deeper plunge. Nevertheless,
the market seems highly correction-prone: a good chunk of the liquidity
pie seems to have been amassed ahead of a flurry of placements are due
this week (with one regional and six corporate bonds due to place RUB 18
bn worth between them), as well as end-of-month tax dates.
Other factors likely to bring out the bears include the weakening euro,
falling on the back of German instability and exerting downward pressure
on the rouble. Also, the room for the compression of spreads between
Russian Eurobonds and U.S. Treasuries is getting smaller all the time. And
the beginning of the fourth quarter could see international investors take
the fat profits that their Russian investments have brought them in 2Q-3Q.
Although the FOMC decision on the key U.S. interest rate due Tuesday seems
unlikely to surprise
* another 25 bps hike is expected
* the comments
accompanying the decision should carry a lot of weight. As the market
currently expects some pause in monetary tightening to support businesses
and consumers amid surging energy costs, the indication of a further rate
hike should push the bond market lower. We do not rule out this scenario
as the latest data on productivity gains and labor costs point to rising
inflationary pressure. Besides, some Federal Reserve estimates have
indicated that the U.S. economy will likely approach full employment by
the end of the year, which would mean that higher borrowing costs would be
needed to temper such a shift. However, all of the above data and
estimates came prior to Hurricane Katrina.
On Monday the yield of indicative Russia
,30 was marginally up by 1 bps to
5.33%, while the yield of 10-year UST fell 1 bps to reach 4.25%. The
sovereign credit spread widened by 2 bps to 104.

Equity market

The Russian equity market reached new highs on Monday, triggered by demand
for Russian oil and gas stocks, virtually the only climbers in recent
days. Demand was created by strong oil prices, supported by the expected
disruption of Hurricane Rita (the price of Brent soared 6.6% to 64.06),
and enthusiasm about Lukoil financials. Lukoil gained 4.8% on the day,
Surgut climbed by 6.8%, while Gazprom
,s local shares and ADRs added 2.81%
and 4.1% respectively. On the ADR market, there was also strong demand for
Russian oil and gas names.
Huge demand for the Russian oil and gas stocks both at home and abroad,
coupled with strong oil prices and good performance of the GEM equity
indexes, suggests further growth on Tuesday. However, it looks like
investors in non-oils have decided to take their profits after the recent
rally. A further decline in fixed-line telecoms and consumer sector looks
very likely. The fact that Lukoil financials may turn out to be worse than
expected is another downside risk for Tuesday trading.