OREANDA-NEWS. Fitch Ratings says that budget deficits and rising inflation may require the Russian government to become more prudent with the spending of state-owned utilities & transport companies, which could result in lower subsidies and tariffs. While this is likely to prompt the companies to further substantially cut capex, we believe capex adjustments cannot be used as a long-term sustainable measure.

Consistently high inflation compared with previous years may result in the government deciding to reduce or freeze some of the natural monopolies' tariffs, as was the case in 2014-2015. Fitch expects CPI to increase to 11.2% in 2015, which is substantially higher than 2012-2014, when it was below 8%. Utilities and transport tariff growth contribute a substantial part of inflation in Russia and tariff freezes could be used to contain CPI at acceptable levels.

We expect the impact on thermal generators to be limited, as the pricing parameters for capacity supply agreements, which in most cases provide the largest share of the companies' EBITDA, have not been changed. However, the credit metrics of network utilities and JSC Russian Railways (RZD; BBB-/Negative) may come under pressure if the companies fail to implement rigorous cost containment and cut capex.

Many Russian utilities and transport companies cut their capex in 2014. Open Joint Stock Company Federal Grid Company of Unified Energy System (BBB-/Negative) plans to cut its capex by as much as 30% (RUB163bn) in 2015-2019, while OJSC Moscow United Electric Grid Company (BB+/Stable) is planning to cut its capital expenditures by approximately 17% in 2015. We believe that RZD may postpone some of its capex projects although part of its spending programme is dictated by the needs of the state. Therefore we anticipate state support to be available to the company to fund large-scale projects and loss-making passenger transportation, as was the case in the past. However, we believe that intensifying challenging market conditions may limit the scale of state support, increasing the importance of implementing efficiency measures.

We believe the Russian utilities still have some headroom to further cut or delay expansionary capex in the short term, especially in light of Russia's economic downturn when electricity consumption is much lower than previously expected. The level of maintenance capex is estimated by the companies at a range of 20%-40% from total capex programmes, while the remaining portion is expansion and/or modernisation capex. However, in the medium term, Russian utilities will need to continue investing to replace and modernise what are in many cases highly depreciated assets, which needs to be covered by either adequate tariffs or attractive funding from the market.

We also consider there is significant potential for improving operational efficiencies at all of the Russian state-owned utilities and transport companies. The current state of the Russian economy may make it a focus for the government and the management of companies, which would be positive for credit profiles.

Our ratings on state-owned utilities and transport companies incorporate state support. If the tangible state support, including subsidies, equity injections and a favourable tariff policy, is substantially reduced and the state-owned companies cannot exercise enough flexibility to adjust their capex plans imposed by the state, we may reconsider our rating approach with regard to state support.