Russian Overview. August 27-September 2

FX September 2, 2005 Russian Overview. August 27-September 2 FX USD/RUB continued to reflect USD moves against the euro, being stable against CBR s USD-euro basket Rubble appreciation against the trade-weighted currency basket stopped in August The market to continue watching EUR/USD dynamics and CBR s interventions CBR s FX reserves resumed to rise, a new increase is likely MONEY MARKET The overnight interest rates returned to low levels after the finalization of the monthly tax payments. Liquidity restored and is likely to rise further on ruble strengthening against the USD. Interest rates to be low in the coming week. ECONOMY The expansion of the monetary base continued to outpace the last year rates Deflation is expected in August A poll showed a faster expansion in the manufacturing sector FEDERAL BUDGET The federal budget 2005 draft details: The budget to rise mostly in line with the GDP Surplus to sustain, but at a lower level Non-interest spending to increase The Stabilization Fund to rise further Dependence on the energy sector to increase The spending for defense and law enforcement, public utilities and health care to rise their share in the total The government to continue the line on the centralization of the budget resources The government borrowing program: the domestic debt will continue to replace gradually the foreign debt New foreign borrowing is to be tiny. The scheduled foreign debt payments to reduce. The government foreign debt outstanding to decrease. USD/RUB continued to reflect USD moves against the euro, being stable against CBR s USD-euro basket USD/RUB continued to follow the USD dynamics against the euro. It moved in the range of 28.25-28.58, as EUR/USD hovered between 1.2170 and 1.2580. During the week the CBR again could buy the USDs in the market. 31 30 29 28 27 Exchange Rates of Ruble to USD and Euro in 2005 Feb-05 Mar-05 Apr-05 May-05 Jun-05 Jul-05 Aug-05 USD/RUB (USD-EUR)/RUB* EUR/RUB (right axis) The change of EUR/USD rate for the week (1.5%) was * Euro share in the USD-EUR basket was set at 10% from 02/01/05, split between changes in 20% from 03/15/05, 30% from 05/16/05 and 35% from 8/1/2005 USD/RUB and EUR/RUB in the proportion of 35/65, respectively. At the same time, the exchange rate of CBR s bi-currency basket versus the ruble rose just 0.08%. On Friday the ruble traded around 28.25 against the USD, as EUR/USD tended to 1.26. 38 37 36 35 34 1

In August (when euro share in the basket rose to 35%) the synthetic exchange rate of the euro-usd basket against the ruble stood stable around 30.76, while USD/RUB dropped 0.3% and EUR/RUB rose 0.5%. For comparison, in July (when the basket was composed of 30% euro and 70% USD) the basket/ruble rate rose just 0.1% from 30.4277 to 30.4587. This accompanied with a 0.13% USD/RUB drop and a 0.56% EUR/RUB rise. Overall, the synthetic exchange rate was noticeably smoother than each of two underlying rates EUR/RUB and USD/RUB (see chart above). The official CBR s USD/RUB rate dropped 0.5% and was fixed at RUB28.3037 for September 6 (on Monday, September 5, there is a public holiday in the U.S.). The MICEX average daily trading volume increased by 5% to $1.7 bn. FX MARKET 9/2/05 Change,% YTD Average Expected 1-week 1-month YTD YTD Real* Average End of Year USD/RUB (UTS) 28.2901-0.6-0.4 2.6-3.52 28.1464 28.2 28.2 Volume-MICEX, USD million 1755.5-1.0 9.3 83.4 1606.9 CBR's FX and gold reserves, USD bn 148.2 0.1 2.7 19.0 182 *Estimate. For reference: real RUB/USD change YTD 3.65% RUBLE EXCHANGE RATE FORECASTS for 2005-06 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 USD/RUB, eop 28.32 28.15 27.9 27.7 27.6 27.5 EUR/RUB, eop 35.26 36.04 36.3 36.7 36.8 37.0 ZAO Citibank Moscow As of 2-Sep-05 Rubble appreciation against the tradeweighted currency basket stopped in August The market to continue watching EUR/USD dynamics and CBR s interventions CBR s FX reserves resumed to rise, a new increase is likely First Deputy CBR s Governor Alexei Ulyukaev said on September 2 that the real effective exchange rate (REER) of the ruble slightly eased in August (to 9.0-9.1% YTD from 9.3% a month ago). According to our estimates the REER of the ruble stood stable in August. This happened due to the recent euro strengthening, and given the expected further euro rise (to around 1.28 by the end of the year), we anticipate the REER appreciation of the ruble at not higher than 10% for the whole year. In the coming week the market will continue watching USD dynamics in the world market and CBR s interventional behavior. In case of a EUR/USD fall to 1.22, USD/RUB can be seen around 28.65, should EUR/USD rise to 1.30, USD/RUB will tend to 27.85. During the week ended August 26 the FX and gold reserves of the CBR (excluding CBR s short-term obligations) increased by $100 million to $148.2 bn. The next reserves reading due on the coming Thursday is likely again to show their rise. MONEY MARKET The overnight interest rates returned to low levels after the finalization of the monthly tax payments The average overnight interest rates reached 7% in the last days of August, as end-ofmonth tax payments continued to cause liquidity strains. However, the situation normalized after the finalization of the payments by Friday, when the interest rates fell below 1%. The daily average commercial banks correspondent account balances with the CBR increased to RUB287 bn from RUB271 bn a week ago. On Friday the balances rose to hefty RUB307 bn, which provided comfortable liquidity conditions in the market. 2

Average Date MONEY MARKET Current Value 1-week 1-month YTD 1-year MIACR overnight, % 1.34 4.14 2.54 2.85 2.49 9/1/05 MIACR 1-month, % 2.77 3.86 3.53 3.46 3.53 9/2/05 Commercial banks' balances with CBR, RUB bn Commercial banks' deposits with CBR, RUB bn 306.5 287.4 273.5 240.7 271.7 62.2 56.5 52.0 132.1 126.0 Volume, RUB million Average Yield at Auction, % Date OPERATIONS with CBR Maturity Date Auctioned Demand Placed Current Previous 8/31/05 Repo overnight: morning,% 1.9 6.13 6.06 afternoon 1, % 12.4 6.33 6.14 Liquidity restored and is likely to rise further on ruble strengthening against the USD By Friday the total amount of commercial banks funds, attracted by the CBR (through deposits, reverse repo deals and OBRs), increased by RUB22 bn compared with previous week to RUB155 bn ($5.5 bn). The total liquidity with the CBR (in the correspondent account balances and attracted by the CBR through deposits, reverse repo deals and OBRs) increased by RUB94 bn to RUB461 bn ($16.3 bn). RUB bn Liquidity of the Banking System with CBR 455 410 367 600 460 461 400 200 0 89 88 86 52 93 40 278 272 234 93 93 51 62 317 307 3 month ago 1 month ago 1 week ago 1 day ago 2-Sep-05 CBR's Liabilities to Repurchase Securities Banks' Deposits with CBR Banks' Correspondent Account Balances with CBR M IACR overnight, % % 6 4 2 0 Liquidity restored after the finalization of the regular monthly tax payments. Moreover, the latest ruble rise against the USD will encourage the market participants to sell the USDs. If the CBR resumes USD purchases, ruble liquidity will further increase. Interest rates to be low in the coming week In the coming week the overnight interest rates are likely to be low amid ample liquidity. FIXED INCOME SECURITIES The government ruble bonds rose again across the board (see table and chart below). The OFZs volume outstanding amounted to around $17 bn. The spread on the Russian sovereign Eurobonds 2030 narrowed to 95 bps (as of 5:00 p.m. Moscow time on September 2) from 117 bps a week ago, being noticeably lower than a year ago 238 bps. OFZ 9/2/05 Average, % 1-week 1-month YTD 1-year Yield 3-month, % 4.00 4.07 4.11 3.37 3.41 Yield 9-month, % 4.35 4.40 4.50 4.37 4.25 Yield 18-month, % 5.75 5.81 5.92 5.36 5.33 Yield 15-year, % 7.20 7.44 7.69 7.93 7.92 Trading volume, RUB million 3803.0 1410.1 3

% 10 8 6 4 2 0 Average GKO-OFZ Yields 22-Jun 6-Jul 20-Jul 3-Aug 17-Aug 31-Aug 3 months 9 months 18 months 13 years 10 % 8 6 4 2 Jan- 03 Apr- 03 Russia's Eurobonds 2030 vs. the U.S. Treasury Benchmark Spreads -current -1-week -1-year 95 117 238 bps 350 Jul- Oct- Jan- Apr- Jul- Oct- Jan- Apr- Jul- 03 03 04 04 04 04 05 05 05 Spread Yield-Russia 2030 Yield-Treasury 275 200 125 50 STOCK INDEX RTS-INTERFAX STOCK INDEX Current Value Change, % 1-week 1-month YTD 1-year 9/2/05 906.76 3.9 16.1 47.7 54.5 ECONOMY The expansion of the monetary base continued to outpace the last year rates A greater expansion of the aggregate looks acceptable under the current macroeconomic parameters The monetary base shrank 0.9% to RUB1941.4 bn in the week ended August 29. The aggregate rose 18.0% YTD well outpacing the rate of the previous year (5.6%). In the year-on-year terms, the aggregate s rise (32%) also well exceeded the last year figure (23%). We expect that this year the monetary base will rise 31-33% compared with 18% in 2004.and 49% in 2003. The slowdown of 2004, above all, was related to a radical cut of reserve requirements to commercial banks, which led to a reduction of the banks reserve portion of the monetary base by 56%. At the same time, the cash portion of the aggregate rose 34%. Therefore, the acceleration of the monetary base expansion this year should not be treated, as an extraordinary inflation-threatening tendency. Should the expansion stay within the expected bounds, it follows mainly the economy s growth and a rise of the population s money incomes under the expected inflation level. The CBR forecasts that in 2006 the monetary base will rise 17-20%. MONETARY BASE, RUB bn 2005 2004 8/30/2005 Change, % 8/30/2004 Change, % 1-week YTD YOY 1-week YTD YOY 1941.4-0.9 18.0 32.0 1470.4-2.2 5.6 23.0 Deflation is expected in August A poll showed a faster expansion in the manufacturing sector First Deputy Governor of the CBR Alexei Ulyukaev has estimated deflation in August at 0.3% MOM. He has not ruled out that deflation will sustain also in September. If this happens, chances to see inflation below 13% (our forecast), closer to 11% (government s target) would rise. The CPI increased by 8.5% in January-July YTD. In August Russia s Manufacturing Purchasing Managers Index (PMI) rose to a year high of 53.0 from 52.6 previous month, indicating an expansion in the sector. The index is calculated by the British NTC research company for the Moscow Narodny Bank (MNB) and is based on a poll of 300 Russian purchasing managers. The index reading above 50 suggests economic expansion, while below 50 decline. 4

FEDERAL BUDGET The acceleration in the sector was associated above all with increasing domestic demand. A rise of the production output remained robust, although slowed slightly compared with July. The employment component of the index demonstrated a slower shrinkage of the workforce, confirming increasing optimism in the sector. Inflationary pressure from increasing input prices intensified again amid persisting deficit of suppliers. This inflated output prices, which rise, nevertheless, compensated increasing costs only partially. The federal budget 2005 draft details: --the budget to rise mostly in line with the GDP, --surplus to sustain, but at a lower level, The Finance Ministry has published the federal budget 2006 draft details. It is planned that the budget surplus will amount to RUB776 bn ($27 bn) or 3.2% of GDP, down from about RUB1500 bn ($52 bn) or 7.0% of GDP expected in 2005 (we expect the surplus of 8.5% in 2005 and 6.0% in 2006). The nominal volume of the budget revenues is planned to increase by 52% to RUB5046 bn or $176 bn. The level of the revenues is expected to decrease to 20.7% of GDP in 2006 from 23.7%, anticipated in 2005, due to an expected decrease of the average oil prices to $40 p/b from $48 p/b. We consider such a projection as too conservative and expect that the budget revenues can again reach around 23.5% of GDP or $210 bn, while the average oil price (Urals blend)--$54 p/b. FEDERAL BUDGET 2006 draft RUB bn USD bn Structure Percentage of GDP Change, % YOY 2005. 2006 pr. 2005 2006 pr. 2005 2006 pr. 2005 2006 pr. 2006 to 2005 p. REVENUES 3326.0 5046.1 118.0 176.4 100.0 100.0 15.8 20.7 51.7 Taxes 1947.6 3144.8 69.1 110.0 58.6 62.3 9.3 12.9 61.5 --Tax on profit 259.0 344.8 9.2 12.1 7.8 6.8 1.2 1.4 33.1 --VAT 1120.8 1634.3 39.8 57.1 33.7 32.4 5.3 6.7 45.8 --Excises 84.8 110.2 3.0 3.9 2.5 2.2 0.4 0.5 29.9 --Taxes on extraction of natural resources 458.2 731.6 16.3 25.6 13.8 14.5 2.2 3.0 59.7 Export and import duties 868.0 1607.8 30.8 56.2 26.1 31.9 4.1 6.6 85.2 Other revenues 510.5 293.5 18.1 10.3 15.3 5.8 2.4 1.2-42.5 --Utilization of the state property 73.0 85.8 2.6 3.0 2.2 1.7 0.3 0.4 17.5 --Foreign economic activities 51.1 55.1 1.8 1.9 1.5 1.1 0.2 0.2 7.7 --UST* 266.5 302.1 9.5 10.6 8.0 6.0 1.3 1.2 13.4 SPENDING 3047.9 4270.1 108.1 149.3 100.0 100.0 14.5 17.5 40.1 State and local governance 460.4 647.0 16.3 22.6 15.1 15.2 2.2 2.7 40.5 --State Debt Service 244.2 202.5 8.7 7.1 8.0 4.7 1.2 0.8-17.1 --Domestic 52.2 66.1 1.9 2.3 1.7 1.5 0.2 0.3 26.6 --Foreign 192.0 136.4 6.8 4.8 6.3 3.2 0.9 0.6-29.0 Defense 531.1 667.3 18.8 23.3 17.4 15.6 2.5 2.7 25.6 Law enforcement and state security 398.9 540.3 14.2 18.9 13.1 12.7 1.9 2.2 35.5 National economy 242.1 338.6 8.6 11.8 7.9 7.9 1.2 1.4 39.8 Public utilities 8.6 31.6 0.3 1.1 0.3 0.7 0.0 0.1 265.9 Environmental protection 4.6 6.3 0.2 0.2 0.2 0.1 0.0 0.0 36.1 Education 155.3 206.0 5.5 7.2 5.1 4.8 0.7 0.8 32.6 Culture, cinema, mass media 39.2 50.4 1.4 1.8 1.3 1.2 0.2 0.2 28.7 Health care and physical culture 85.7 145.8 3.0 5.1 2.8 3.4 0.4 0.6 70.2 Social policy 167.4 209.6 5.9 7.3 5.5 4.9 0.8 0.9 25.2 Financial aid to other budgets and off-budget funds 954.5 1427.1 33.9 49.9 31.3 33.4 4.5 5.9 49.5 SURPLUS / DEFICIT, +/- 278.1 776.0 9.9 27.1 1.3 3.2 179.0 Stabilization fund, eop 719.5 2242.3 25.5 78.4 3.4 9.2 211.6 GDP exp. 21000 24380 USD/RUB average, exp. 28.2 28.6 *UST-unified social tax 5

--non-interest spending to increase, the Stabilization Fund to rise further, It is planned that the non-interest spending of the budget should increase to 16.7% of GDP in 2006 from 15.6% of GDP expected in 2005. The Stabilization Fund is expected to increase to $78 bn in 2006 from $50 bn in 2005. We expect that by the end of this year the fund will reach $55 bn, and it is likely to exceed $100 bn in 2006 (unless extra massive foreign debt prepayments are made). GDP growth is planned at 5.8% (down from 5.9% expected by the government in 2005), inflation to decrease to 7.0-8.5% from 11% (by the government plans). The budget projections imply stable USD/RUB rate of around 28.60. However, normally, the exchange rate, implied in the budget, plays just an indicative role and may diverge significantly from the actual market rate. For example, the budget 2005 implies USD/RUB rate of RUB30.0, while the expected rate should be around 28.20. We forecast the average USD/RUB rate of around 27.70 in 2006. the dependence on the energy sector to increase, the spending for defense and law enforcement, public utilities and health care to rise their share in the total, the government to continue the line on the centralization of the budget resources The budget 2006 revenues are planned to increase by 52% in absolute terms compared with 2005 plan (see table below) and 1.5% compared with the expected revenues in 2005. The budget dependence on revenues from the energy sector will increase. The energy revenues only from the tax on extraction of natural resources, excises and export duties should make up 40% (including 33% for oil and oil products) of the total compared with 33% (25%) planned in 2005. The budget 2006 spending is planned to increase by 40% in absolute terms compared with 2005 plan (see table below) and 22% compared with the expected spending in 2005. Among the spending items: Public utilities and health care sectors will be leaders in terms of spending increase (266% and 70%, respectively) although their shares in the spending structure will remain quite low (0.7% and 3.4%, respectively). Nevertheless, the level of the defense spending relative to GDP will remain quite moderate 2.7%, despite the target of 3% set several years ago. Transfers to budgets of lower levels (37% of the total transfers) and to off-budget funds (63% of the total) from the federal budget will increase by almost 50%, and their share in the total spending will reach 33.4% (including subsidies to regional budgets over 10% of the total spending). This reflects the process of centralization of financial resources, which has been taking place during the years of Vladimir Putin s presidency. The spending on the law enforcement and state security and the defense will increase by 36% and 26%, while their shares will be 12.7% and 15.6% of the total, respectively. The share of the debt service should decrease noticeably (to 4.7% of the total spending from 8.0% planned in 2005) due to decrease in the level of the foreign debt service to 3.2% from 6.3% of the total. 6

The government borrowing program 2006: the domestic debt will continue to replace gradually the foreign debt The government borrowing program draft for 2006 envisages further gradual replacement of the foreign government debt for the domestic debt and a lengthening of the state debt. In the domestic part, the program has provided for: The total maximum rise of the net borrowing by RUB169.7 bn ($6 bn) compared with the maximum of RUB125.1 bn planned in 2005 The total government domestic debt should reach the maximum of RUB1143.2 bn ($41 bn) by the end of 2006 from RUB937.2 bn ($33 bn) at the beginning of the year The total marketable debt outstanding should reach RUB770.5 bn by the end of 2006 (from RUB530 bn currently) It is planned that the average yields on the bonds will vary from below 6% for shortterm bonds to 8.5% for long-term bonds The government plans to stop the issuance of short-term securities (shorter than 1- year), leaving this option for the CBR. The latter can provide the shorter end of the yield curve at the expense of OBR (CBR s bonds) issues and open market operations with government bonds from own portfolio. The saving bonds (GSOs) will be intended to the State Pension Fund (SPF) (RUB10-12 bn 1-1.5-year bonds), as well as to companies, managing the pension funds the state owned Vneshekonombank (RUB45 bn over 15-year bonds) and private companies (RUB3-5 bn 7-10-year bonds). Domestic Borrowing Program Draft for 2006 of the Finance Ministry (as of August, 2005), RUB bn Issuance Maturity Net Issuance Debt Service OFZ-PD (fixed coupon bonds) 81.0 0.0 81.0 11.5 OFZ-FK (fixed coupon bonds) 25.3 36.1-10.8 10.4 OFZ-AD (amortizing bonds) 61.0 23.9 37.1 37.9 GSO (savings bonds) 70.9 8.5 62.4 6.2 Total 238.2 68.5 169.7 66.1 New foreign borrowing is to be tiny The program of foreign borrowing proceeds from the minimization of the borrowing and accelerative finalization of the current projects with International Financial Organizations (IFO) with the aim to finish them in 2006-08. Particularly, the foreign borrowing limit for financing the current and planned projects, implemented with the IFOs, is set at $960 million (up from $952 million in 2005), while the limit for loans from foreign governments, banks and companies at $153 million ($175 million in 2005). The government plans to agree with the World Bank a partial (not less than 90% of the project value) substitution of the foreign financing with the local one, using the federal budget funds for these purposes. It is planned to offer $83 million guarantees of non-commercial risks in two projects, as well as $1.0 bn guarantees for exporters of manufacturing production. In contrast to previous years, an issuance of Eurobonds is not planned. In reality, despite the options for Eurobond issues were included into budgets of 2000-05, they were not exercised, as the budget executed with surpluses. The scheduled foreign debt payments to reduce The program of the foreign debt provides for $13.3 bn scheduled foreign debt payments (after around $18 bn in 2005), including the $4.8 bn debt service next year. It is expected that the government will again seek the debt prepayments (similar to 2005). Their volume may be $10-15 bn. 7

The government foreign debt outstanding to decrease The Duma to begin budget readings in three weeks The upper limit of the government foreign debt is set at $79.2 bn as of the end of 2006 compared with $86.2 bn at the beginning of the year. At the beginning of 2005 the total foreign debt of the government amounted to $110.5 bn. It is planned that the Duma will consider the federal budget 2006 draft in the first reading (of the total of four) on September 22. This communication is made by ZAO Citibank ( the Firm ) exclusively to its clients, and any investment services, strategies or products offered herein are made available solely to market counterparties. No other person may rely on the contents of such communication nor have access to any such investment services or products. Such commentary and ideas are based upon generally available information. On occasion, information provided herein might include excerpts, abstracts, or other summary material derived from research reports published by the Firm's [Fixed Income Research] Department. Readers are directed to the original research report or note to review the Fixed Income Research Analyst s full analysis of the Subject Company. Although all information has been obtained from and is based upon sources the Firm believes to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. Any opinions attributed to the Firm constitute our judgment as of the date of the material and are subject to change without notice. This material is for your sole use and is for informational purposes only and does not constitute a recommendation by the Firm. Neither the Firm nor any other person accepts any liability whatsoever for any loss (howsoever arising and whether direct or consequential) from any use of the information contained herein or otherwise arising in connection herewith. Citibank NA., 2003. All rights reserved. Any unauthorised use, duplication, redistribution or disclosure is prohibited by law and will result in prosecution. 8