Fitch Affirms Russia's Yaroslavl Region at 'BB'; Outlook Negative
The Outlooks on the Long-Term IDRs and National Long-Term Rating are Negative. The region's outstanding senior unsecured domestic bonds have been affirmed at long-term local currency 'BB' and National long-term 'AA-(rus)'.
The affirmation with Negative Outlook reflects Fitch's unchanged view regarding the region's weak budgetary performance and our expectation that the region's direct risk will continue to grow on the back of a continuing fiscal deficit.
KEY RATING DRIVERS
The ratings reflect the region's increasing direct risk, which is partly mitigated by an increasing proportion of low-cost loans from the federal budget, and a weakened operating balance, which has been insufficient for debt interest coverage over the past three years. Nevertheless, direct risk remains moderate by international standards and this is further mitigated by the diversified economy of the region. The ratings also factor in a weak institutional framework for local and regional governments (LRGs) in Russia and a weakened macroeconomic environment.
Fitch expects the region to record a low operating margin at 1%-2% and the current balance will remain negative for 2016, which is weak compared with national 'BB' peers. Over January-August 2016 the region has accumulated a RUB3.7bn fiscal deficit. Fitch projects a RUB3.3bn deficit before debt variation at end-2016, which is equivalent to 6.3% of projected full-year revenue (2015: 4.5%).
Weak budgetary performance reflects continuous growth of operating spending and sluggish operating revenue growth, despite some recovery of income taxes. Fitch expects the region's operating revenue to grow slowly in 2017-18 and not exceeding operating expenditure growth.
Fitch expects the region's direct risk to reach 67% of current revenue by end-2016 (2015:62%). We expect the figure to rise in 2017-2018 to above 70% of current revenue. Positively, the region's debt structure is shifting towards a higher proportion of subsidised federal budget loans, which reduces refinancing pressure. The region has already received RUB10.3bn of federal budget loans so far in 2016 to replace part of its market debt. The budget loans bear 0.1% interest rates and have a three-year maturity. The proportion of budget loans in the region's debt portfolio increased to 43% as of 1 September 2016, from 15% at the beginning of 2015.
As with most Russian regions, Yaroslavl is exposed to refinancing risk in the medium term as it needs to repay 77% of its direct risk in 2017-2019, while immediate refinancing needs are offset by stand-by credit lines with banks. The region is an active participant on the domestic bond market and issued RUB4.5bn seven-year domestic bonds in May 2016. The region plans to issue RUB5bn and RUB3bn domestic bonds in 2017 and 2018 respectively, which will extend its debt repayment profile.
Yaroslavl has a diversified industrialised economy with wealth metrics in line with the national median. The economy mostly relies on various sectors of the processing industry, which provides a broad tax base. Tax accounted for 85% of operating revenue in 2015. The region is following the national negative economic trend and according to preliminary data gross regional product declined 3.2% yoy in 2015, close to the national decline of 3.7%. Fitch projects the national economy will continue to contract 0.5% in 2016, before returning to marginal growth in 2017.
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 the region's international peers. The predictability of Russian LRGs' budgetary policy is hampered by frequent reallocation of revenue and expenditure responsibilities between government tiers.
RATING SENSITIVITIES
Inability to restore the current balance to positive territory or an increase of direct risk to above 70% of current revenue, driven by short-term debt increase, could lead to a downgrade.
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