OREANDA-NEWS. Fitch Ratings has affirmed the Ukrainian City of Kharkov's Long-term foreign currency Issuer Default Rating (IDR) at 'C', Long-term local current IDR at 'CCC' and Short-term foreign currency IDR at 'C'. Fitch has also affirmed the city's National Long-term rating at 'A+(ukr)' with a Negative Outlook.

The ratings are constrained by the ratings of Ukraine (Restricted Default/CCC) that is in default on its sovereign eurobond obligations (see 'Fitch Downgrades Ukraine's Foreign-Currency IDRs to 'Restricted Default' dated 6 October 2015). .

KEY RATING DRIVERS

In Fitch's assessment the weak institutional framework governing Ukrainian subnationals remains a constraint on the city's ratings. The framework is characterised by frequent changes to allocation of revenue and expenditure assignment and a lack of clarity and sophistication. This hinders the long-term development and budget planning of local and regional governments in Ukraine.

The City of Kharkov is currently free from external debt obligations. In our baseline scenario we project the city's budgetary performance to remain satisfactory in 2015-2017 with an operating balance at 10% of operating revenue (2014: 9.8%) and a close to zero budget deficit (2014: 4.4%). The overall weakness of the national debt capital markets limits the city's access to funding, in turn allowing the city to maintain a balanced budget.

Fiscal performance may be hindered over the medium term by the low predictability of fiscal changes and a volatile economy in Ukraine. In 2015 the central government made significant amendments to the Ukraine's budget and tax codes, which could sharply increase 2015 operating revenue. Fitch also expects the city's tax capacity over the medium term to be negatively affected by Ukraine's recession. Fitch has revised its forecasts for Ukraine to a 9% contraction in 2015 compared with a previously expected 5% decline.

Fitch expects the city's net overall risk to remain low at 10% of current revenue (2014: 12%) in 2015-2017, due to forecasted balanced budgets. In April 2015, Kharkov fully repaid its outstanding debt (2014: UAH294m) and Fitch expects no new borrowings up to year-end. The city's liquidity position improved with accumulated cash balance doubling to UAH1bn at 1 September 2015.

Kharkov's exposure to contingent risk has increased as public sector debt almost doubled during 2011-2014 and peaked at UAH417m by end-2014. Most of the city's public sector entities (PSEs) are loss-making and depend on subsidies to sustain operations. In 2014, compensating subsidies and capital injections granted to PSEs totalled UAH285m, or 6% of the city's operating revenue. It should be noted that disclosure of PSE's performance in 2015 is limited and our assessment is therefore based on historical data.

RATING SENSITIVITIES
The city's ratings are constrained by the sovereign. A downgrade on the sovereign's Long-term local currency IDR would lead to a corresponding action on the city's IDR. In the absence of a sovereign downgrade, significant deterioration of Kharkov's credit profile could also lead to a negative rating action.

A sovereign upgrade would be reflected in the City of Kharkov's ratings. However, the rating will likely remain low, given high country risks and Ukraine's 'CCC' Country Ceiling.