Fitch Ratings has assigned Russia's Sverdlovsk Region Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) of 'BB+' and a Short-Term Foreign Currency IDR of 'B'. The agency has also assigned the region a National Long-Term rating of 'AA(rus)'. The Outlooks on the Long-Term ratings are Stable.
The region's outstanding senior unsecured bonds (ISIN RU000A0JS009, ISIN RU000A0JTDZ6) has also been assigned a Long-term local currency rating of 'BB+' and a National Long-term rating of 'AA(rus)'.
The 'BB+' ratings reflect Sverdlovsk's developed industrialised economy with above national median wealth metrics, moderate debt in line with 'BBB-' national peers and satisfactory operating performance with an operating balance sufficient for interest payment coverage. These factors are balanced against weak debt coverage compared with median 'BB+' national peers, deteriorated national economic environment and weak institutional framework for Russian sub-nationals.
KEY RATING DRIVERS
The ratings reflect the following rating drivers and their relative weights:
HIGH
Moderate Direct Risk
Fitch projects Sverdlovsk's direct risk will remain below 50% of current revenue over the medium term. It will be supported by the region's strong intention to limit the fiscal deficit and cut capital expenditure to limit the region's borrowing needs. Sverdlovsk's direct risk has increased notably over the last three years albeit from a low base and reached 38% of current revenue at end-2015, up from an average 10% during 2011-2012.
In its debt policy, Sverdlovsk relies on medium-term financing with bank loans dominating (53% of the direct risk at end-March 2016), followed by budget loans (45%), with the residual related to outstanding domestic bonds (2%). About 95% of maturities are spread in 2016-2019 and the weighted average maturity of the debt is estimated at three years, which is relatively short compared with international peers. Immediate refinancing needs – the region needs to repay RUB13bn by end 2016 – are covered by RUB24.9bn of undrawn bank credit lines. These committed facilities also fully cover full-year deficit before debt variation, which Fitch expects to reach RUB12.7bn in 2016 (2015: RUB16.6bn).
Satisfactory Budgetary Performance
Fitch forecasts Sverdlovsk's operating balance to recover to 6%-8% of operating revenue in 2016-2018 after a low 4.2% in 2015. This will be enough for interest expenditure coverage, but is notably below the historical peak of 17% operating margin in 2012. The expected recovery will be supported by the restoration of tax revenue growth from its developed tax base and strict control of expenditure. Due to cost-cutting measures implemented by the administration, Fitch expects the region's operating expenditure will increase by a low 4% annually in 2016-2018, amid national inflation of 8.2% in 2016, according to our projection.
A weak current balance resulted in a rapid deterioration of debt payback (direct risk to current balance) ratio to 16.6 years in 2015 from a strong less than a year during 2011-2012. Fitch expects moderate recovery of debt coverage to 10 years in the medium term amid restoration of its operating performance.
The deterioration of operating performance between 2013-2015 was caused by a significant boost in operating expenditure, mostly related to social support and salary increase of public employees. Opex has grown by 10% annually during the last three years and 2x outpaced operating revenue growth. The latter slowed down to average growth of 5% annually due to deterioration of national economic environment.
MEDIUM
Industrialised Economy
The region has a developed industrial economy weighted towards the metallurgical and machine-building sectors. Its wealth metrics are above median Russian region with GRP per capita 32% above the median in 2014. The tax base is moderately concentrated, with the top 10 taxpayers accounting for about 15% of tax revenue in 2015. However, the overall concentration on a few sectors of the processing industry exposes the region's revenue to economic cycles.
According to preliminary estimation regional GRP contracted by 5.2% in 2015, following the national negative economic trend (Russia's GDP fell by 3.7%). The administration expects close to zero GRP growth in the medium term.
Weak Institutional Framework
Fitch views the region's credit profile as being constrained by the evolving nature of Russia's institutional framework for local and regional governments (LRGs). It has a short track record of stable development compared with many of its international peers. Unstable intergovernmental set-up leads to lower predictability of LRGs' budgetary policies and hamper the region's forecasting ability.
The ratings also consider the following rating factors:
Extensive Public Sector
The region controls a large number of public-sector companies. This extends the region's contingent risk due to their debt, administrative expenses and subsidies. Fitch does not consider risk from the sector to be significant, due to the moderate indebtedness of the local PSEs and the large size of the region's budget. Fitch estimates overall contingent risk stemming from guarantees and PSE debt at about RUB5.3bn at end-2015, which is equivalent to a low 3.0% of current revenue.
RATING SENSITIVITIES
A weak operating balance, not sufficient to cover interest expenditure or continuous growth of direct risk toward 60% of current revenue without material operating balance improvement would lead to a downgrade.
An upgrade is unlikely due to the persistent pressure on the sovereign ratings (BBB-/Negative). However, restoration of the operating margin to the historical high of 15% or above, accompanied by sound debt metrics with a debt payback below five years (2015: 16.9 years) and a Russian economic recovery, could lead to an upgrade.
The material has been provided by InstaForex Company – www.instaforex.com