OREANDA-NEWS. Fitch Ratings says the ratings of Russian local and regional governments (LRGs) are under pressure from increasing debt to fund their structural fiscal deficits.

The budget deficits of most Russian subnationals are driven by an uncertain economic outlook, which compresses tax proceeds, and by higher operating expenditure due to new spending obligations imposed by the federal government. New tax regulation allowing financial loss deductions from corporate income tax is also leading to deceleration in tax revenue growth.

Fitch forecasts that Russian regions' direct risk will grow 20% in 2014, only slightly lower than the rapid growth of 29% in 2013. Short- and medium-term bank loans will remain the key funding tool for budget deficits, keeping refinancing risk high. Higher debt stock will also lead to an increase in interest expenses while a weak current balance will result in a weak self-financing capacity of capex.

Fitch assesses the debt burden of Russian regions as moderate on a consolidated basis, but expects direct risk to increase over the medium term. The debt burden varies substantially across regions: net debt (debt net of cash available) varied from zero to even negative for investment grade-rated LRGs to 70% of operating revenue for lower-rated LRGs in 2013. Additionally, low-rated LRGs often rely on short-term borrowing, leading to high refinancing needs and significant liquidity risks.

The maturity profiles of short-term market and state budgetary loans (i.e. direct risk) are a source of refinancing risk for most Russian LRGs. Bank loans were the main source of deficit funding in 2013, with an average tenor of between one to three years. Short-term bank loans represented 42% of Russian regions' direct risk at end-2013.

Fitch believes that Russian President Vladimir Putin's recent recommendations to ease the debt burden of Russian regions would only contain, but not reverse, the structural deterioration in the regions' debt metrics. The recommendations were for market funding to be replaced with subsidised federal budget loans and federal government guarantees to be provided for subnational debt. In Fitch's view reversing the deteriorating debt metrics can only be achieved by eliminating the regions' structural imbalance between spending obligations and revenue sources that arose in 2012-2013.

The report, 'Russian Subnationals: Increasing Debt Intensifies Pressure on Ratings', is available at www.fitchratings.com or by clicking on the link above.