OREANDA-NEWS. Fitch Ratings says in a new report that the rating outlook for Russian local and regional governments (LRGs) in 2016 is negative as LRGs remain exposed to high budgetary pressures.

The ratings of Russian LRGs will remain under pressure in 2016 in view of negative debt metrics dynamics and decelerated fiscal performance. Fitch projects aggregated direct risk to reach 35% of total revenue in end-2016 (from 29% at end-2014), while revenue growth will slow in 2016.

Fitch downgraded Russia's Long-term foreign and local currency Issuer Default Ratings (IDR) to 'BBB-' from 'BBB' in January 2015 with Negative Outlook. As a consequence, Fitch downgraded five Russian LRGs and placed another four on Negative Outlook, which were equalised with the sovereign. Another 14 LRGs have been downgraded during 2015 or placed on Negative Outlook, which means 21 Russian LRGs (out of 44 rated by Fitch) have a Negative Outlook by end-2015 compared with 13 at end-2014.

Negative rating actions will likely continue in 2016, before reaching lower equilibrium ratings. However the Outlooks on some LRGs that are committed to narrowing their budget deficits, maintain reasonable debt levels and reduce refinancing risk could be revised to Stable despite deterioration of their budgetary performance and debt metrics during 2014-2015.

The credit quality of Russian LRGs with 'BB+'/'BBB-' ratings is still supported by their moderate debt burden and still sound, albeit declining, operating performance. Debt management remains prudent with low FX exposure and an absence of floating rates or derivatives. Strong regions are still resilient due to their well-developed tax bases and wealth from mineral resource extraction, benefiting from the weak national currency.

Weaker regions with ratings in the low 'BB'/'B' categories are challenged by increasing debt burdens coupled with refinancing pressure and low budget flexibility. The average operating margin for these LRGs is likely to stabilise in the low positive range, which remains insufficient to cover annual interest payments for most Russian LRGs.

Fitch expects operating revenue to grow by 4%-6% in nominal terms in 2016 (2015: expected 3%), on the back of continuing inflation and a stagnant economy (Fitch projects 9% CPI and 0.5% GDP growth for Russia). Opex will grow in line with or slightly below operating revenue growth, while capital expenditure will decline moderately and be driven mostly by earmarked loans or capital grants from the federal budget.

Russian LRGs will continue to deal with a structural deficit, at RUB230bn-RUB250bn in 2016, slightly down from an expected RUB270bn for 2015 (2014: RUB393bn). Therefore, most Russian LRGs have achieved a 50% reduction in their deficits since the exceptional fiscal imbalance in 2013, when the aggregate deficit soared to RUB600bn. Fitch believes that further significant deficit reduction will be challenged by the stagnating economy.

Fitch projects aggregate direct risk will reach RUB2,300bn at end-2015 (2014: RUB1,970bn), and its growth will slow to 12% in 2016, from 17% expected for 2015 (2014: 22%). In 2015, 80% of direct risk was represented by bank loans and subsidised loans from the federal budget. This makes regions dependent on the decisions of federal authorities and market conditions, exposing them to ongoing refinancing pressure.

Positively, market interest rates have demonstrated a decline to 12%-14% by end-2015 from above 20% at end-2014 and Fitch expects further reduction to 10% during 2016. In 2015 the federal government has provided some relief through alternative sources of funding. These have included medium-term budget loans at subsidised rates in replacement of market funding and extensions of the maturity of existing budget loans. Ministry of Finance will likely continue this practice in 2016. Although these measures will not reverse debt growth, Fitch expects them to offset the increasing cost of market funding and to contain the deterioration of subnationals' debt metrics.