OREANDA-NEWS. Fitch Ratings has revised Russian Kostroma Region's Outlook to Stable from Negative while affirming the Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'B+', National Long-Term Rating at 'A-(rus)' and Short-Term Foreign Currency IDR at 'B'. Kostroma region's outstanding senior unsecured domestic bonds have been affirmed at 'B+' and 'A-(rus)'.

The Outlook revision reflects Fitch's expectation that Kostroma's operating balance will recover and that the region's fiscal deficit will narrow over the medium term. The ratings also factor in the region's high direct risk, a weak local economy and an evolving Russian institutional framework.

KEY RATING DRIVERS

The Outlook revision reflects the following rating drivers and their relative weights:

HIGH

Fitch projects that Kostroma's operating balance will further improve to 6%-7% of operating revenue in the medium term, from 2.9% in 2015 and 0.2% in 2014. This should be sufficient for interest payments, which should therefore allow the current balance to return to a small surplus.

We forecast Kostroma's deficit before debt variation will gradually narrow to 6%-7% of total revenue from a high average 14% in 2013-2015, due to extensive cost-cutting in operating and capital expenditure. We expect the region to follow the strict cost control policy imposed by the Ministry of Finance as a condition for granting state support to the regional government.

Fitch expects Kostroma to keep operating expenditure growth below 4% over the medium term, while freezing capital expenditure. Operating revenue, which will be weighed down by a sluggish national economy, is projected by Fitch to grow 4%-5%, as a result of inflation-driven nominal tax-base expansion.

The region's operating margin improvement in 2015 was driven by strict control on operating expenditure - which fell 4.6% yoy - offsetting weak operating revenue. Operating revenue declined 2% as corporate income (CIT) tax fell 14% on a weak economy. Fitch expects CIT to recover in 2016 and projects 4%-5% annual tax revenue growth in 2016-2018.

MEDIUM

Fitch expects the region's direct risk to continue to grow to 103% of current revenue by end-2016, which is slightly lower than its previously projected 110% in January 2016. This is due to a smaller expected deficit of RUB1.7bn (January forecast: RUB2.5bn) based on budget execution during January-June 2016. We expect the region's direct risk to continue to increase in 2017-2018, towards 110% of current revenue, which will nevertheless remain commensurate with current ratings.

Kostroma's direct risk has risen over the last five years to RUB17.7bn or 97% of current revenue at end-2015 (2014: RUB15.9bn and 86%). The region is among the most indebted Russian regions and its debt metrics are weaker than the 'B+' peer median.

Kostroma's debt profile is short-term, with 95% of total direct risk maturing in 2016-2018. Fitch expects the region's current balance to be weak over the medium term, leading to more capital market funding. However, Fitch believes the region will be able to attain the required funding in advance of the existing debt maturity given its reasonable access to domestic capital markets.

Refinancing risk is partly mitigated by the region's reliance on federal budget loans, which accounted for 46% of direct risk at 1 June 2016. Maturing federal budget loans are likely to be rolled over by the federal government.

The region's ratings also reflect the following key rating drivers:

The region's economic profile is weaker than the average Russian region. Gross regional product (GRP) per capita was 77% of the national median in 2014 and average salary was 80% of the national median in December 2015. Fitch forecasts national GDP will fall 0.7% in 2016, which in turn will weigh on the region's economic and budgetary performance.

Russia's institutional framework for sub-nationals is a constraining factor on the region's ratings. It has a shorter record of stable development than many of its international peers. The predictability of Russian LRGs' budgetary policy is hampered by frequent reallocation of revenue and expenditure responsibilities within government tiers.

RATING SENSITIVITIES

Improvement in the operating balance towards 10% of operating revenue and stabilisation of direct risk below 100% of current revenue on a sustained basis could lead to an upgrade.

The region's inability to curb debt growth, accompanied by persistent refinancing pressure and a negative operating balance, would lead to a downgrade.