OREANDA-NEWS. March 30, 2015. Fitch Ratings has affirmed Russian Kaluga Region's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BB' with Stable Outlooks, and its Short-term foreign currency IDR at 'B'.

The agency has also affirmed the region's National Long-term rating at 'AA-(rus)' with Stable Outlook. Kaluga's outstanding senior unsecured domestic bonds (ISIN RU000A0JRHN7) have also been affirmed at 'BB' and 'AA-(rus)'.

KEY RATING DRIVERS
The ratings reflect the administration's efficient and proactive management, the region's rapid economic development and sound budgetary performance. The ratings also factor in increasing pressure on operating expenditure and a growing debt burden, including contingent risk stemming from the liabilities of public sector entities (PSEs), although the maturity profile of these liabilities is long-term.

Fitch expects Kaluga to continue to demonstrate solid operating performance, supported by further expansion of its tax base. The agency expects operating balance to be at 12% of operating revenue in 2015-2017, in line with the 12.9% reported in 2014. This was down slightly from an average of 15.4% during 2010-2012, due to increasing operating expenditure pressure and sluggish revenue from corporate income tax in 2013 and 2014. Operating spending will remain under pressure as a result of the national government's decision to increase public sector salaries and reduce transfers from the federal budget. However, the administration expects tax revenue growth to accelerate in 2015 on growing industrial output and increased tax rates.

In line with our expectations Kaluga's direct risk, including the liabilities of the Development Corporation of Kaluga Region (DCKR), increased 20% to RUB27.5bn in 2014, fuelled by a RUB4.5bn deficit before debt variation. Over the medium term the region intends to narrow the budget deficit and limit debt growth. Fitch therefore forecasts direct risk growth to decelerate in absolute terms during 2015-2017, while operating revenue growth should allow the overall debt burden to gradually decline below 70% by end-2017, from 73.6% in 2014.

We project the region's debt coverage (direct debt to current balance) to be close to four years in 2015-2017. This would be a modest improvement from the 5-6 years reported in 2013 and 2014 but still above the region's average direct debt maturity profile of 2.5 years. As with most Russian regions Kaluga is exposed to refinancing pressure in the medium term as it faces repayment of about 80% of its outstanding direct liabilities (RUB16.4bn) in 2016-2017, mostly bank loans and loans from the federal budget.

Fitch expects the region will roll over maturing budget loans and substitute part of maturing bank loans with new loans from the federal budget. The remaining maturing bank loans will be rolled over with the same banks. However, the cost of borrowing is likely to increase due to the depressed national debt capital market. Interest rates in 2015 could double their 2014 levels, making new debt more expensive.

The regional government is focused on local economic development and on expanding the tax base. Kaluga has been successful in attracting foreign investments, and promoting industrial production and innovation. These policies have allowed the local economy to grow at a cumulative 23.4% in 2011-2014, well above the 10.5% average for the Russian Federation. The government forecasts economic growth of 2% p.a. in 2015-2016.

Kaluga actively uses PSEs to finance local investment projects. It established DCKR, which at end-2013 borrowed RUB6.8bn to finance the development of regional industrial zones. Two other regional public companies incurred a combined RUB1bn debt at end-2013 to finance various investment projects. The region provides subsidies to cover the principal and interest on the debt of these PSEs. Consequently, Fitch considers the liabilities of those PSEs as the region's direct risk. Positively, PSEs' liabilities have a long-term maturity profile till 2022.

RATING SENSITIVITIES
Maintaining sound operating performance with an operating margin of 12%-14% and restoring direct debt coverage to be in line with the region's average debt maturity could lead to an upgrade.
Continued deficit before debt variation leading to direct risk increasing above 75% of current revenue and deterioration in direct debt coverage beyond 10 years would lead to a downgrade.