OREANDA-NEWS. Fitch Ratings has assigned the Polish City of Chorzow Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) of 'BB+' and National Long-Term rating of 'A-(pol)'. The Outlooks are Stable.

The ratings reflect small size of the city's budget, which makes the city more exposed to negative economic shocks in comparison with its peers, which is a concern as there are extensive investments to be debt financed in medium term. The ratings also reflect an expected sharp increase in direct debt that will lead to a deterioration of debt payback ratio. However, despite debt growth we expect debt service will not be put at risk in the medium term.

KEY RATING DRIVERS

The ratings reflect the following key rating drivers and their relative weights:

HIGH

As a result of the extensive investment plan, we expect the city's direct debt to grow rapidly in the medium term to around PLN380m in 2018 or 67% of current revenue from PLN120m in 2015 (26%). Chorzow plans to construct a ring-road with an estimated total value of PLN1.5bn. The city will apply for EU funds, they may receive up to 85% (PLN1.2bn) of co-funding. The rest of the financing will come from long-term debt (PLN120m), which the city plans to take on from an international financial institution and from two other Silesian cities.

The projected increase in direct debt will lead to a deterioration of debt ratios. In the medium term, we expect the payback ratio (debt to current balance) to rise to 13 years from 3.8 years at end-2015.

Fitch projects that Chorzow's operating revenue will grow moderately by 3% on average in 2016-2018 (excluding transfers for new central delegated tasks, which distort comparison from 2016). Fitch projects that Poland's real GDP will grow by 3.4% annually in 2016-2017. National economic growth should support the development of the local economy and revenue from income taxes (26% of operating revenue in 2015). Revenue growth from local taxes will stem from the efforts made by the city to receive overdue taxes rather than expanding local tax base, which is limited, in our view.

In its base case scenario, Fitch assumes that operating expenditure will grow in line with operating revenue growth, given that the city's management will continue to control operating expenditure as it has in the past, resulting in operating margins at around 6% in the medium term. This corresponds to average operating balances of PLN30m, which will be sufficient to cover annual debt service requirements (capital plus interest).

The city's liquidity is satisfactory and we expect this will be maintained in the medium term. Cash and liquid deposits on the city's account at month-ends averaged PLN18m in 2015. The municipal companies sector is limited and it is not expected to pose significant risks for the city's budget. Chorzow has a majority stake in only three companies, of which only one reported debt at end-2015 but it is self-supported.

MEDIUM

The city's authorities present a safe approach to budgeting. The city's operating revenue budgeting is prudent and actual revenue is usually higher than originally planned at the beginning of the year. Operating expenditure is monitored during the year and Chorzow is able to make some savings during the financial year. We believe that the city's ability to increase its revenue is rather limited, so sustained control over operating spending in medium term will be key to maintaining the ratings at their current level.

Chorzow's economy is relatively weak, in our view. Historically, the local economy has been dominated by heavy industry, mainly coal-mining and steel plants, which have gradually turned into a more service-oriented economic base. The data for gross regional product for Chorzow itself is not available. Gross regional product per capita in 2013 (latest available data) in the Katowicki subregion where Chorzow is located was 38% above the national average. However, this ratio is fuelled mainly by the City of Katowice (A-/Stable), the capital of the Slaskie Region and does not reflect properly Chorzow's economy.

The ratings also reflect the following key rating factors:

In 2016, the National Parliament introduced the '500+ programme', a cash benefit of PLN500 per month per child for families with more than one child. This will be a new central delegated task. The central government will provide transfers that will go through the local government's (LG) budget This programme will be neutral for the city's operating balance because it will influence both revenue and expenditure but will inflate operating margin and debt/current revenue ratio from 2016.

The regulatory regime for Polish LGs is relatively stable. Their activities and financial statements are closely monitored and reviewed by the central administration. There is good disclosure in the LGs' accounts. The main revenue sources, such as income tax revenue, transfers and subsidies from the central government are centrally distributed according to a legally defined formula, which limits the central government's scope for discretion. Additionally, local tax rates such as real estate tax, which some LGs are entitled to collect, are capped by the state. This makes LGs somewhat reliant on decisions made by the central government and limits their revenue-raising flexibility.

RATING SENSITIVITIES

A downgrade could result from a sharp increase in debt leading to a payback ratio (direct debt/current balance) consistently exceeding 12 years coupled with a deterioration of operating performance.

The ratings could be upgraded if the city demonstrated good operating performance with operating margin at 6% coupled with stabilising direct debt below 50% of current revenue.

KEY ASSUMPTIONS

Fitch assumes that city will start construction of a ring-road in medium term, but only if it obtains at least 85% of EU funds for co-financing this investment.