OREANDA-NEWS. November 11, 2015.  Fitch Ratings has upgraded the Metropolitan Municipality of Istanbul's (Istanbul) Long-term local currency Issuer Default Rating (IDR) to ' BBB' from 'BBB-' and National Long-Term Rating to 'AAA(tur)' from 'AA+(tur)'. The Outlooks are Stable. The Long-term foreign currency IDR has been affirmed at 'BBB-'with a Stable Outlook and Short-term foreign currency IDR at 'F3'.

The upgrade reflects Istanbul's continued strong operating performance, wealthy economy and solid fiscal management, which together with high capital revenue, supports a high self-financing capacity for the ongoing large capex investments envisaged for 2015-2019. The upgrade takes into account direct risk to current balance to remain under two years, despite the FX risk the city is exposed to and its large capex investments.

The Stable Outlooks reflects Fitch's expectations that operating performance to remain strong and debt metrics should remain consistent with the current ratings.

KEY RATING DRIVERS
The upgrade reflects the following rating drivers and their relative weights:

HIGH
Fitch projects Istanbul to post strong operating margins above 50% in 2015-2017, supported by its large and well-diversified tax base. This will be supported by the city's sound fiscal discipline track record in keeping operating expenditure under control and the expected improvement in local economic growth in the medium term. In 3Q15, the city's budget has already demonstrated over 80% realisation of the budgeted operating revenue.

In 2014, Istanbul posted a strong operating margin at 65%, supported by the operating expenditure growth, which was substantially below the operating revenue and also reflects its investment driven responsibilities. The local economy was resilient against the adverse sentiment change in the international capital markets in 2014 and 2015. The city's tax revenue grew by 10.3% yoy in 2014, which together with a one-off increase in its account receivables resulted in a higher operating margin on a cash basis.

Fitch expects that Istanbul's strong operating surpluses and asset sale proceeds will cover the bulk of its TRL25bn investment to be implemented in 2015-2017. Istanbul plans to construct additional metro lines of 200km (in total 430 km until 2019) between 2014 and 2019. About 40% of the capital spending will be funded by asset sales and planned privatisation of IGDAS (Natural Gas Distributor), according to the city's estimates, with the remainder coming from budget surplus and borrowings.

According to Istanbul's official announcement of Istanbul on 2 November 2015, privatisation of IGDAS will be in the form of an initial public offering (IPO). At this stage it is not officially stated what percentage of the company shares will be sold through the IPO.

MEDIUM
The city's authorities follow a solid budgetary policy and financial planning, which guarantees sound operating performance, albeit adjustments in the calculation share of the receivables on the balance sheet could be improved. Sound financial planning enables further large financing needs of the capex investments to be covered in a timely and forward-looking manner.

Direct debt was TRY4.6bn at end-2014, down 10% yoy and equal to 41% of current revenue. The debt-to-current balance decreased to below one year for the first time since 2007. However, given the sharp depreciation of the Turkish lira of 20.3% against the US dollar in the year to date, Fitch expects the debt-to-current balance to increase slightly over one year in 2015- 2017, but well below the weighted average maturity of its debt stock of 8.4 years. Istanbul's lender portfolio consists mainly of multilateral banks and also international and domestic commercial banks

Istanbul faces significant foreign exchange risk in times of elevated financial volatility as 94% of its debt was foreign currency-denominated and unhedged at end-2014, up from 93% in 2013. Istanbul has been increasing its FX borrowing due to high domestic interest rates and the short-term maturity profile of its domestic loans. However, Fitch projects the city's debt servicing and debt to current balance will remain sound in 2015-2017. Direct debt servicing will remain below 30% of the operating balance.

Istanbul is Turkey's main economic hub, contributing on average 27.4% of the gross value added in 2004-2011 (last available statistics). Rapid urbanisation and continued immigration flows challenge the province with a continued need for infrastructure investments. In 2014, the population grew 1.5% yoy to 14.4 million.

RATING SENSITIVITIES
A downgrade of Turkey's sovereign ratings (BBB-/BBB/Stable/F3) would prompt a downgrade of Istanbul's ratings. Material deterioration of the debt servicing capacity of the city as a result of persistent financial instability and further depreciation of the Turkish lira or a deterioration of the deficit before financing to more than 10% of total revenues could also prompt a downgrade, although this is not Fitch's base case scenario.

An upgrade of the sovereign ratings could result in a similar action on Istanbul's ratings subject to a reduction of the city's foreign currency exposure to below 35% of its outstanding debt, continued strong budgetary performance and consistent management policies.