OREANDA-NEWS. Fitch Ratings has downgraded Russian Murmansk Region's Long-term foreign and local currency Issuer Default Ratings (IDRs) to 'BB-' from 'BB' and its National Long-term rating to 'A+(rus)' from 'AA-(rus)'. The Outlooks are Stable. The region's Short-term foreign currency IDR has been affirmed at 'B'.

KEY RATING DRIVERS

The downgrade reflects Murmansk's weakened operating performance and a twofold increase of the region's direct risk over 2013-2014. The Stable Outlook reflects our expectation of stable budgetary performance in 2015-2017, with a small positive operating balance and gradual narrowing of fiscal deficit.

The downgrade reflects the following rating drivers and their relative weights:

HIGH

Murmansk has recorded continuously weak budgetary performance in the last three years. In 2014, its operating margin turned negative at 1.1%, from a small positive 1.9% a year earlier. Deficit before debt variation peaked at 17.9% of total revenue, following an already high average of 15% in 2012-2013. The deterioration was mostly due to stagnating tax revenues amid growing operating expenditure. As with most Russian regions Murmansk faces high pressure on expenditure following the federal government's election pledges, including the decision to align public sector salaries with the region's fairly high average salary.

Fitch forecasts that deficit before debt variation will remain hefty at 12% of total revenue in 2015, before gradually narrowing to 8% during 2016-2017. The region's budget has low flexibility, with operating expenditure representing a high 99% of total revenue in 2014. Murmansk's capital outlays historically lag behind those of national peers at below 15% of total expenditure.

We expect the region's operating balance to recover to low positive values during 2015-2017, but the current balance to remain negative. The budgetary performance will be underpinned by increasing corporate income tax proceeds as the region's major export-oriented taxpayers benefit from a sharp rouble depreciation in 4Q14.

MEDIUM

Fitch expects direct risk will continue to grow and will exceed 65% in 2017, from 22% at end-2012. Despite the expected increase Murmansk's debt burden should remain consistent with the region's ratings. However, the expected rise in debt, coupled with higher cost of borrowing and the region's short-term debt profile, put additional pressure on the budget.

The region's debt profile remains fairly short-term as direct risk is dominated by bank loans with maturity of between one and three years. Bank loans accounted for 78% of direct risk at end-2014, and three-year loans from the federal budget for the remainder. As of 1 April 2015, Murmansk faces repayment of RUB5.7bn bank loans and RUB2.3bn federal budget loans for this year. This, coupled with the weak current balance, results in the region being highly dependent on financial market access and federal budget support for debt refinancing and deficit funding.

Fitch expects the region will roll over maturing budget loans and additionally receive RUB3bn loans from the federal budget to refinance half of its maturing market debt in 2015. The remaining maturing bank loans are likely to be refinanced with the same banks.

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

The regional economy has a strong industrial base as Murmansk is home to several natural resource extracting companies. This provides an extensive tax base for the region's budget, with tax revenue representing 82% of operating revenue in 2014. However, a large portion of tax revenues depends on companies' profits, resulting in high revenue volatility. In 2012 and 2013 corporate income tax proceeds fell sharply due to weak earnings at major local taxpayers following price declines for key commodity exports.

RATING SENSITIVITIES

Improvement in budgetary performance leading to debt coverage ratio (direct risk to current balance) below 10 years on a sustained basis would lead to an upgrade.

Inability to balance the operating budget and an increase in direct risk beyond Fitch expectations would lead to a downgrade.