OREANDA-NEWS. Fitch Ratings has affirmed the Autonomous Region of Sardinia's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'A-' with Stable Outlooks and Short-Term Foreign Currency IDR at 'F2'.

The affirmation reflects Sardinia's sound and stable budgetary performance, underpinned by strong financial autonomy that is reflective of the region's special status, as well as the region's low debt and satisfactory liquidity.

The Stable Outlook reflects our expectation that the region will maintain its special status and that its direct debt will continue to moderately decline while budgetary performance will remain stable over the medium term. It also takes into account expected economic recovery, supporting the regional tax base.

KEY RATING DRIVERS

Autonomy Underpins Ratings

Sardinia is rated above Italy (BBB+/Stable), as its financial and fiscal autonomy entitles it to receive fixed shares of major national taxes, ranging from 70% of personal income tax to 90% of VAT. Its constitutionally protected special autonomous status underpins the region's tax resilience, shielding the revenue structure from the risk of unilateral interference from the state, including annual budgetary appropriations.

Nevertheless, as with all other Italian regions, Sardinia contributes to Italy's budget consolidation efforts, which somewhat reduces the predictability of inter-governmental relations.

Solid Fiscal Performance

According to 2015 official data, despite a EUR681m annual contribution to national budget consolidation, Sardinia posted an operating margin of nearly 11%. Even if Fitch conservatively assumes the operating margin to decline to 7% (or EUR500m) over the medium term, this will still be sufficient to cover nearly 2x debt service requirements. Residual budgetary flexibility accounting for about 3% of operating revenue, and a robust tax base will also help maintain the region's healthy budget.

Following an extraordinary clean-up of outstanding receivables and payables, the free fund balance was negative at EUR1.4bn at end - 2015. This is not expected to add pressure to regional accounts due to the long time frame (30 years) allowed by law to restore a positive fund balance and given expected robust regional performance.

Sustainable Risks, Healthy Liquidity

In its central scenario, Fitch expects Sardinia's debt to decrease towards EUR1bn by 2018 (or 15% of total revenue), from EUR1.13bn at end-2015, despite forecasted EUR600m new borrowing in 2016-2018 being only partially offset by EUR450m early debt repayment.

We expect Sardinia to maintain sound debt metrics, with debt servicing requirements (including early repayments) at around 4% of current revenue and payback (debt coverage by current balance) stable at around 2.5 years. Liquidity, which was at a sound EUR340m at end-2015, is expected to stabilise over the medium term, providing a buffer against unexpected shortfalls.

Recovering Economy

Sardinia's socio-economic profile was weaker than the national average in 2015, with the unemployment rate at around 17.5% (12.9% nationally) and the employment rate at 50% (56.3%). After almost stagnant GDP growth in 2015 (0.3%), Fitch expects a slight improvement in 2016, mainly driven by tourism and, to a lower extent, by industry and commerce, while projects from new public infrastructures as well as tax relief and bureaucratic simplifications, will be key to revitalising local economic activity over the long-term.

Active Management Sustaining Economy

The administration remains committed to revitalising the local economy, without increasing the stock of debt in the medium term.

The healthcare sector continues to be a challenge for the region, with a EUR345m deficit in 2015, which was consolidated in the regional budget. However, management expects a balanced healthcare budget by 2018, based on the rationalisation of hospitals and pharmaceutical aiming at streamlining operating costs.

RATING SENSITIVITIES

A downgrade of Italy, a prolonged economic downturn or economic shock with unemployment rate rising above 20%, jeopardising tax revenue generation could result in a downgrade of Sardinia. A structural deterioration of the operating margin to below 5% over the medium term, with debt rising above Fitch's projections could also lead to a downgrade.

An upgrade would be contingent on the operating margin being consistently above 6%, coupled with an improvement in socio-economic indicators towards EU averages, supporting greater budget flexibility.