OREANDA-NEWS. Fitch Ratings has upgraded the Russian City of Samara's Long-term foreign and local currency Issuer Default Ratings (IDRs) to 'BB+' from 'BB' and affirmed the Short-term foreign currency IDR at 'B'. The National Long-term rating has been upgraded to 'AA(rus)' from 'AA-(rus)'. The Outlooks on the Long-term ratings are Stable.

KEY RATING DRIVERS
The upgrade reflects a reassessment of Samara's fundamental strength and its standalone profile, with an operating margin expected to remain at 15% of operating revenue and a budget close to balance over the medium term despite the deteriorating economic environment. The upgrade factors in the following rating drivers and their relative weights:

HIGH
Samara demonstrated a sound budgetary performance above Fitch's expectations in 2014. The city's operating balance improved to 16.3% of operating revenue in 2014 from an already strong 15.7% in 2013. Fitch expects the operating balance to stabilise at a sound 15% in 2015-2017. A strong operating balance underpins a high self-financing capacity for capex and leads to a low deficit before debt variation of 1.6% of total revenue in 2014. The city intends to conduct a prudent budgetary policy and keep the deficit under strict control. Fitch expects the city will demonstrate a moderate deficit before debt variation at 2%-3% of total revenue in 2015-2017.

The sound result of 2013-2014 was partly driven by a positive net effect of reallocation of expenditure responsibilities and revenue sources between municipal and regional budgets. Also the city possesses strong and diversified tax base and operating revenue to the large extent relies on tax revenues, which accounted for 58% of operating revenue in 2014. Personal income tax (PIT) - the major revenue source - is less dependent on the volatile business cycle and financial results of major taxpayers. However, Fitch expects the city could face a slowdown of PIT proceeds in 2015 due to the negative national macroeconomic environment.

The city receives steady flows of current transfers from the economically strong Samara region. In 2014, these accounted for 34% of the city's operating revenue. The bulk of current transfers is earmarked for financing delegated responsibilities (66% in 2014), mainly public employees' salaries and corresponds to the respective operating expenditure. Another 44% is used to match grants for co-financing of particular expenditures of the municipality. Samara receives an insignificant amount of financial aid in the form of general-purpose grants from the region as its budget capacity is higher than that of other municipalities in the region.

Samara's ratings also reflect the following key rating drivers:

Fitch expects the city's direct risk to remain low at 29.7% of current revenue (RUB6.4bn) by end-2015, almost in line with 30.7% (RUB6.3bn) a year earlier. The city's administration intends to continue its prudent budgetary policy and has budgeted close to a zero fiscal balance for 2016-2017. This should lead to the debt stock stabilising at 32% of current revenue by end-2017. Contingent risk is low as the city does not have outstanding guarantees and its public sector entities are self-sufficient.

Despite a low debt burden, Samara mostly relies on short-term bank loans for deficit financing. The city's direct risk stock as of 1 January 2015 was 82% composed of bank loans with less than one year to maturity. High refinancing needs will lead to increasing cost of borrowing due to tensions in the domestic financial market. Interest rates in 2015 will probably be at least double their 2014 level, making raising new debt much more expensive.

Although the short-term nature of loans contracted from local banks exposes the city to refinancing risk, it is mitigated by the city's strong current balance and liquidity, including committed lines of credit with local banks. Outstanding cash and committed credit lines amounted to RUB1.5bn as of 1 January 2015 and fully cover debt due in 1H15.

The city is the capital of Samara Region, which has a well-developed diversified economy, based on a strong industrial sector. Local companies' sound economic performance supports Samara's strong fiscal capacity. However Fitch forecasts 4% contraction of national GDP in 2015, as the country suffers weak oil prices and international trade and financial sanctions. The city will not be an exception so its tax revenue will suffer due to the sluggish economy.

The city's self-financing capacity is strong, with capital revenue and the current balance on average covering 94% of annual capex in 2014. Samara's capex is high relative to its national peers. It accounted for 25.9% of total spending in 2014 (2013: 30%) making the city's expenditure flexible in the light of expected pressure on the revenue side. Fitch expects the city's capex to gradually decline to 21% of total spending in 2015 following a deterioration of revenue proceeds and recover to 24% during 2016-2017.

RATING SENSITIVITIES
Positive rating action is unlikely due to the Negative Outlook on the sovereign's IDRs (BBB-/Negative/F3). However, continuous maintenance of strong budgetary performance and debt metrics, particularly lengthening of debt maturity profile could be positive for the ratings.

Deterioration of the budgetary performance leading to a significant increase in direct risk along with the inability to lengthening its maturity profile would lead to a downgrade.