OREANDA-NEWS. November 30, 2015.  Fitch Ratings has affirmed the Russian City of Volzhskiy's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'B+' with Stable Outlooks and a Short-term foreign currency IDR at 'B'. The agency also has affirmed the city's National Long-term rating at 'A-(rus)' with Stable Outlook.

The city's outstanding senior unsecured debt has also been affirmed at 'B+'/'A-(rus)'.

The affirmation reflects Fitch's unchanged expectation of the city's weak operating performance in 2015-2017 but stable debt levels.

KEY RATING DRIVERS
The 'B+' rating reflects the small size of Volzhskiy's budget and the city's high dependence on the decisions of the regional and federal authorities, which lead to volatile performance and low shock resilience. The ratings also reflect the city's weak liquidity, short-term direct risk, albeit moderate in absolute terms and the recovery of the city's budgetary performance in 2014 and 2015.

Fitch expects Volzhskiy's operating margin to stabilise at 3%-4% and the current margin to be close to zero in 2015-2017, while the deficit before debt will narrow to RUB115m in 2015 from RUB140.7m a year earlier. The city intends to balance the budget over the medium term and Fitch projects a gradual narrowing of the deficit before debt variation to 0.5%-1% of total revenue in 2016-2017 from an average 2.6% in 2014-2015.

Volzhskiy's operating performance recovered strongly in 2014 with an operating margin of 5.8%, compared with a negative 4% in 2012 and 2013. This was driven by a near doubling of current transfers from Volgograd Region (B+/Stable/B), which compensated for the city's tax revenue decline. Over the last three years, the city has lost 10pp of its personal income tax (PIT) share in return for the transfer of healthcare expenditure and staffing costs for pre-school education to the regional budget.

Fitch expects Volzhskiy's direct risk to represent a moderate 38% of current revenue by end-2015 (end-2014: 36%). We expect the city's absolute direct risk to remain constant or marginally increase in 2016-2017, but to reduce relative to current revenue. Despite its moderate overall debt burden, the city is highly exposed to on-going refinancing pressure given its weak cash position and high proportion of short-term bank loans due within the next 12 months.

The city in early 2015 issued RUB300m domestic 2020 bonds to lengthen its debt maturity profile. The new bonds accounted for 27% of direct risk at 1 November 2015 and partly mitigate refinancing pressure. However, the city faces a repayment of RUB665m of bank loans (60% of direct risk) in 2016 and Fitch will closely monitor its ability to cope with refinancing risk.

With 326,720 inhabitants, Volzhskiy is the second-largest city in the Volgograd region after the regional capital, the City of Volgograd. The city's economy is dominated by processing industries and, together with the City of Volgograd, forms a strong regional industrial agglomeration. In 2014, the region's economy grew only 0.5% in real terms following the deterioration of the domestic economy.

RATING SENSITIVITIES
An improvement in budgetary performance with a sustainable positive current balance, and maintenance of moderate direct risk, could lead to an upgrade.

Significant growth in direct risk above 70% of current revenue with continuing reliance on short-term debt, along with a weak operating balance insufficient to cover interest payments, would lead to a downgrade.