OREANDA-NEWS. Fitch Ratings has assigned the Russian Krasnodar Region Long-term foreign and local currency Issuer Default Ratings (IDRs) of 'BB' and a Short-term foreign currency IDR of 'B'. The agency has also assigned the region National Long-term rating at 'AA-(rus)'. The Outlooks on the Long-term ratings are Stable.

The agency has also assigned the region's senior unsecured debt a Long-term local currency rating of 'BB' and a National Long-term rating of 'AA-(rus)'.

KEY RATING DRIVERS
The 'BB' rating reflects high net overall risk resulting from extensive infrastructure investment in the past that is partly mitigated by large exposure to long-term budget loans. The rating also considers Fitch's projection of a sustainably positive current balance for the region, stabilisation of net overall risk over the medium term and a well-diversified economy.

Weak Institutional Framework
Russia's institutional framework for local and regional governments (LRGs) has a shorter record of stable development than many of its international peers. The region's credit profile is therefore constrained by the evolving nature of the framework. The predictability of Russian LRGs' budgetary policy is hampered by frequent reallocation of revenue and expenditure responsibilities between the tiers of government.

High Net Overall Risk
Fitch projects net overall risk to remain high at about 85% (2014: 81%) of current revenue in 2015-2017. Krasnodar incurred significant Olympics-related capex that was not sufficiently compensated by transfers from the federal government. The large amount of capex was financed by long-term subsidised budget loans and debt contracted by NPJSC Centre Omega that was partly guaranteed by Krasnodar region. This led overall risk to almost double and reaches RUB150bn at end-2014 from RUB78bn at end-2012.

At end-November 2015, direct risk amounted to RUB129.5bn and 41% of that was budget loans linked to the Olympics financing. They bear 0.1% interest rate and mature in 2023-2034, which reduces annual debt service and ease refinancing pressure on the budget. The bulk of remaining direct risk is due between 2016 and 2019 when the region has to repay RUB73bn. Fitch expects the region to refinance part of maturing debt with budget loans and to a larger extent with local banks' loans, as is common practice for most Russian sub-nationals.

Fiscal Performance to Improve
Fitch projects the region's budgetary performance will moderately improve in 2015-2017 following the weak performance in 2013-2014. We forecast the operating balance to grow to 5%-7% of operating revenue from 2%-3% in 2013-2014 supported by modest growth of tax revenue and cost cutting measures implemented by the region's administration.

We do not expect operating balance to restore to its sound 10%-15% in 2011-2012 in the context of challenging macroeconomic environment. Maintenance costs for the Olympics infrastructure and new mandates transferred to the region in 2012-2014 will continue to add pressure to the budget.

Fitch forecasts the deficit before debt variation to narrow to 3%-6% of total revenue in 2015-2017 from high 12% in 2014 and 28% in 2013 following the completion of infrastructure projects related to the Olympic Games. Fitch projects capital expenditure to shrink below 10% of total expenditure from high 30%-40% in 2011-2013.

Material Contingent Risk
The region administers an extensive network of public sector entities (PSEs) that includes about 40 public unitary enterprises and about 100 majority-owned shareholdings. The PSEs' debt amounted to material RUB26bn, RUB12bn of which is guaranteed by the region. The guarantee relates to the debt of the Olympics developer NPJSC Centre Omega, 100% owned by Krasnodar region. The region's administration aims to reduce risk stemming from PSEs and plans to fund Omega's debt repayment by selling Olympics property.

Diversified Economy
Krasnodar region's economy is well-diversified, providing a broad tax base. Krasnodar is among the top five Russian regions by gross regional product (GRP) and population, and its GRP per capita is 14% above the national median (2013). Krasnodar's administration estimates the GRP to narrow 1.7% in 2015 following the negative national trend and to moderately grow 1%-3% in 2016-2017.

RATING SENSITIVITIES
A strong operating balance at about 10% of operating revenue on a sustained basis accompanied by reduction of net overall risk towards 60% of current revenue (2014: 81%) could lead to positive rating action.

Consistently weak operating balance insufficient to cover interest expense or inability to maintain the net overall risk to current revenue below 100% would lead to negative rating action.