Fitch Affirms Russia's Volgograd Region at 'B '; Outlook Stable
The region's outstanding senior unsecured domestic bond issues have been affirmed at 'B+' and 'A(rus)'.
The affirmation reflects that the region's pre-closing 2015 annual budgetary performance was in line with Fitch's baseline scenario. The Stable Outlook reflects the agency's expectation that the region's direct risk will stabilise over the medium term.
KEY RATING DRIVERS
The 'B+' rating reflects Volgograd's weak operating balance, which is insufficient to cover interest payments, and high direct risk due to persistent budget deficit in the past.
The region's operating performance was weak in 2015. Its preliminary estimated operating balance was about 1% of operating revenue (2014: 1.1%) and the current balance remained negative at 2.7% of current revenue in 2015 (2014: 3.2%). Volgograd moderately narrowed its budget deficit to 8.4% of total revenue from 10.6% in 2014. The improvement was driven by shifting part of capex to later periods and a substantial 20% (RUB640m) reduction of interest payments due to increased reliance on subsidised funding provided by the state.
Fitch projects a moderate restoration of the operating performance over the medium term, with a marginally positive current balance. We also expect the region's budget deficit to narrow to 3%-5% from an average high 12% in 2013-2015. Since 2015, the region's administration has been implementing extensive cost-cutting measures in operating and capital expenditure. Volgograd is optimising the list of social aid recipients, freezing wages indexation for administration staff, implementing centralised state procurement and optimising the network of budgetary institutions as the region intends to record a budget surplus in 2016-2018 to reduce debt burden.
Fitch has a more conservative view and projects a gradual reduction of the deficit. We consider the region has limited headroom for manoeuvre to sharply reverse the five-year weak performance with a deficit of 8%-16% towards surplus given stagnating tax revenues and the rigidity of most budget expenditure.
Fitch forecasts Volgograd's direct risk growth to slow in 2016-2018. Risk will stabilise at about 70% of current revenue (2015: 63%) as a result of the expected reduction of the budget deficit. In 2015, direct risk further increased to RUB47bn from RUB41bn at end-2014. Positively, the region contracted RUB6bn budget loans to refinance part of the maturing bank loans in 2015. The budget loans were almost interest free (0.1% annual interest rate), which helped the region save on interest payments.
The region's refinancing risk is lower than its 'B' category peers. The debt portfolio is diversified and almost equally split between bank loans (27%), bond issues (36%) and budget loans (36%). About 90% of maturities are smoothly spread between 2016 and 2018. In 2016, Volgograd needs to repay RUB11.1bn, or 24% of its direct risk at end-2015. The administration plans to fund 2016 refinancing needs with RUB4bn bonds issue, RUB6.2bn budget loans and the remainder with bank loans.
Volgograd region has an industrialised economy with a concentrated tax base. The top 10 taxpayers are subsidiaries of large national companies operating in oil & gas, power generation, transportation and financial sectors. They contributed about 40% of total tax revenue in 2015, which makes the region's revenue vulnerable to economic cycles. The region's administration preliminarily estimated that GRP declined 2.8% in 2015, which is in line with the national trend. It expects a 2%-3% restoration in 2016-2018 supported by development of local industries.
RATING SENSITIVITIES
Additional support from the federal government leading to a stabilisation of indebtedness and improvement of the operating balance sufficient to cover interest payments could lead to an upgrade.
The region's inability to curb continuous growth of total indebtedness, accompanied by an increase of the region's refinancing pressure and a negative operating balance, would lead to a downgrade.
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