OREANDA-NEWS. Fitch Ratings has affirmed Russian Penza Region's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BB' with Stable Outlooks, Short-Term Foreign Currency IDR at 'B' and its National Long-Term rating at 'AA-(rus)' with a Stable Outlook.

The affirmation reflects Fitch's expectation that the region will maintain a sustainably positive current balance and moderate direct risk, whose growth will be limited by a narrowing fiscal deficit.

KEY RATING DRIVERS

The 'BB' rating reflects the modest size of the region's economy and budget, a weak institutional framework for local and regional governments (LRGs) in Russia and a deteriorated macroeconomic environment. The ratings also factor in the region's moderate direct risk, with limited exposure to immediate refinancing risk and satisfactory fiscal performance with a sufficient operating balance to cover interest payments.

Fitch expects the operating balance to be 7%-8% of operating revenue in 2016-2018, while the current margin will remain positive at 5%-6%. Penza demonstrated a moderate recovery of budgetary performance during 1H16 with the surplus before debt variation driven by faster than expected corporate income tax (CIT) recovery. We already incorporated a moderate recovery of CIT proceeds in our previous projection, so our base case scenario remained unchanged. Fitch projects the region's overall tax revenue growth of 8% in 2016 (2015: -1.4%), close to our projections of annual inflation of 7.5%.

Fitch assumes the deficit before debt will be moderate over the medium term at about 1%-2% of total revenue in 2016-2018 (2015: 3.6%). This will be supported by the region's intention to limit operating expenditure growth below inflation and cut capital spending.

Fitch expects direct risk will remain close to moderate 50% of current revenue in 2016-2018 (2015: 54%). As of 1 August 2016, the region's direct risk was composed of bank loans and federal budget loans amounting to RUB21.2bn, little changed since the beginning of 2015. Subsidised budget loans constitute 50% of total direct risk, and their 0.1% annual interest rates allow the region to save on interest payments.

Fitch views positively the smooth amortisation profile of the region's direct risk with bank loans concentrated in 2017-2019 and budget loans stretched until 2034. This puts Penza in a more favourable position than national peers in terms of refinancing pressure. However, as with most Russian regions, Penza's weighted average debt maturity is shorter than its international peers. As of 1 August 2016, Penza had to repay RUB1.6bn of budget loans for this year, which partially should be refinanced by the new budget loans and covered by RUB1bn outstanding cash.

Penza's economy is historically weaker than the average Russian region with a GRP per capita at 76% of the national median in 2014. This has led to a weaker tax capacity than its regional peers. Federal transfers constitute a significant proportion of finances, averaging 40% of operating revenue annually in 2011-2015, which limits the region's revenue flexibility. Fitch forecasts a 0.5% decline of national GDP in 2016, which will weigh on the region's economic and budgetary performance.

The region's credit profile remains constrained by the weak institutional framework for Russian LRGs, which 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 between tiers of government.

RATING SENSITIVITIES

A sharp deterioration of budgetary performance leading to an operating margin below 5%, coupled with an increase in direct risk to above 60% of current revenue, could lead to a downgrade.

A sustainable operating balance at 15% of operating revenue and stabilisation of direct risk at around 50% of current revenue accompanied by a Russian economic recovery could lead to an upgrade.