OREANDA-NEWS. September 28, 2015. Fitch Ratings has affirmed the Autonomous Region of Sardinia's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'A-' and its Short-term foreign currency IDR at 'F2'. The Outlooks on the Long-term IDRs are Stable.

The affirmation reflects Fitch's expectation that the region's stable operating performance will fully cover debt service requirements over the medium term, and allow a reduction of direct debt while maintaining a satisfactory liquidity position. The ratings also take into consideration the region's revenue resilience, and the administration's initiatives to guide the local economy out of stagnation, supported by the region's legislative and financial autonomy stemming from its autonomous institutional status.

KEY RATING DRIVERS

Stable Fiscal Performance: Fitch expects the region to record a EUR400m operating balance over the medium term, with a stable operating margin at an average 6% - in line with 2014, which will cover debt service requirements almost 2x.

The region also recorded a positive EUR39m fund balance in 2014 (EUR1.2bn deficit in 2011), alongside an overall budget surplus, following active management of EU funds for capital spending. Capital spending will continue to be mostly tailored to non-debt resources and average EUR850m per year over 2015-2017, allowing the region to achieve its debt reduction.

Decreasing Debt, Solid Liquidity: In line with Fitch's central scenario, outstanding debt will decrease, despite additional EUR500m debt in 2015-2017 to partly finance Sardinia's investment plan (20%), due to early redemptions. We forecast debt will fall towards EUR1bn by 2017, from EUR1.35bn at end-2014. Debt sustainability should remain sound over the medium term, with debt servicing requirements (including early repayments) at 4%-5% of the region's current revenue, while debt coverage by the current balance, or debt payback, is forecast by Fitch to stabilise at around three years. Liquidity should remain solid and be around EUR400m-EUR500m, cushioning against unexpected shortfalls.

Rebounding Economy: After a period of recession in 2012-2013 (-3.5% and -2.7% respectively) and stagnation in 2014-2015, Fitch forecast a modest GDP recovery (0.5%) in 2016, supported by the administration's series of measures. These include a permanent 25% cut to business tax - IRAP - for corporations, while exempting newly established enterprises from tax for five years.

Sound and Active Management: Apart from reviving local SMEs, the administration aims at stabilising the employment rate towards 50% - notably in traditional sectors such as oil refinery, green energy, construction and tourism - and containing the unemployment rate towards 15% (Italy: 13%). It also aims to support local consumption and tax generation capacity, to counteract then impact of a demographic outflow.

Rating Above Sovereign: Sardinia's ratings are above Italy's sovereign ratings (BBB+/Stable), as its financial and fiscal autonomy, protected by The Italian Constitution, entitles it to receive fixed shares of major national taxes, ranging from 90% of VAT to 70% of personal income tax (PIT). This revenue structure supports the region's tax resilience. Protection granted by its special autonomous status protects the region from the risk of unilateral interference from the state, including risks of annual budgetary appropriations.

Nevertheless, due to the stressed sovereign finances, similarly to all other regions, Sardinia contributes to Italy's consolidation efforts, somewhat reducing the predictability of intergovernmental relations.

RATING SENSITIVITIES
An upgrade would be contingent on an operating margin above 6% on a sustained basis, coupled with an improvement in socio-economic indicators towards the EU average, supporting budget flexibility.

A downgrade could stem from a prolonged economic downturn or economic shock with unemployment rate rising above 20%, jeopardising tax revenue generation. A structural deterioration of the operating margin significantly to below 6% over the medium term, with debt rising above Fitch's projections could also lead to a downgrade.