OREANDA-NEWS. Fitch Ratings has affirmed Russian Republic of Udmurtia's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BB-', Short-term foreign currency IDR at 'B' and National Long-term rating at 'A+(rus)'. The Outlooks on the Long-term IDRs and the National Long-term rating are Negative.

The republic's outstanding senior unsecured domestic bonds have been affirmed at 'BB-' and 'A+(rus)'.

The affirmation and Negative Outlook reflect Fitch's unchanged baseline scenario regarding the region's rapidly growing direct risk and its inability to restore its current balance to positive territory over the medium-term.

KEY RATING DRIVERS

The ratings reflect Udmurtia's weak operating performance, rapid growth of direct risk and high interest expenses. The ratings also take into account the fall in oil prices and slowdown of the national economy, which place a strain on the republic's tax base.

Fitch expects Udmurtia's operating margin will remain weak at near zero in 2015-2016 (2014: negative 3.7%), reflecting the contraction of the regional economy and rigid operating spending. During 8M15 corporate income tax proceeds decreased 7.5% yoy, mainly due to a muted performance of the oil extraction sector. Fitch expects tax revenue in Udmurtia to increase only 1% yoy in 2015, which is lower than the republic's estimations.

Fitch expects the republic will narrow its budget deficit to 10%-12% of total revenue over the medium-term, from a peak of 21% in 2014. The deficit shrinkage will be supported by limiting both capex and operating expenditure. However, the budget deficit will continue to result in direct risk growth.

We forecast Udmurtia's direct risk to approach 100% of current revenue by end-2017. In 2014 direct risk increased to 75.4% of current revenue, from 63.1% in 2013. Interest expenses are expected to grow further to 7% of operating revenue in 2015 from 4% in 2014 and will remain under pressure in 2016-2017. This will keep current margin weak at a negative 6%-7% over the medium-term (2014: negative 8%).

Udmurtia is exposed to refinancing pressure as 63% of total direct risk matures in 2015-2017. In 4Q15 the republic faces RUB3.7bn of repayments (9% of direct risk as of 1 October 2015). Immediate maturities are expected to be covered by a combination of bond issuance, bank credit facilities and budget loans.

In September 2015 the republic issued a new RUB3bn bond, which has an amortising repayment structure with maturity in 2020. The regional administration will also receive RUB1.2bn of additional budget loans in 4Q15, which usually have three-year maturity and bear a negligible 0.1% interest rate. Currently Udmurtia does not have any open credit lines, but plans to contract them in October-December 2015 to cover the budget deficit.

The republic has a diversified industrial economy, which is dominated by the oil extraction, metallurgy, machine building and military sectors. This helps to smooth business cycles and keeps Udmurtia's wealth metrics in line with the national median. In 2014 the republic's GRP contracted 0.2%, weaker than the national average growth of 0.6%. Fitch expects national GDP to shrink 4% yoy in 2015, eroding the republic's tax proceeds.

RATING SENSITIVITIES
An inability to restore the current balance to positive territory and to ease high refinancing pressure could lead to a downgrade.