Fitch Affirms Autonomous Region of Sardinia at 'A-'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the Autonomous Region of Sardinia's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'A-' with Stable Outlooks and its Short-term foreign currency IDR at 'F2'.
The affirmation reflects Fitch's expectation that the region's debt will continue declining, with the stable operating performance fully covering debt service requirements in the medium term, while maintaining a satisfactory liquidity position. The ratings also take into account the expected mild recovery in the local economy, also supported by the administration's initiatives favoured by the region's autonomous institutional status.
KEY RATING DRIVERS
Rating Above the Sovereign
Sardinia's ratings are above Italy's sovereign ratings (BBB+/Stable), as its financial and fiscal autonomy, protected by the Italian Constitution, entitles it to receive fixed shares of major national taxes, ranging from 90% of VAT to 70% of personal income tax (PIT). This revenue structure supports the region's tax resilience. The protection granted by its special autonomous status protects the region from the risk of unilateral interference from the state, including risks of annual budgetary appropriations.
Nevertheless, due to the stressed sovereign finances, similarly to all other regions, Sardinia contributes to Italy's consolidation efforts, somewhat reducing the predictability of intergovernmental relations.
Healthy Performance to Continue
According to Fitch's baseline scenario, the region is expected to continue recording an operating balance of approximately EUR400m over the medium term, in line with preliminary 2015 figures (net of about EUR490m on-off items due to the extraordinary revision of accruals), with a stable operating margin at an average 6%, allowing debt service requirement coverage of almost 2x. The region also recorded a positive approximately EUR250m fund balance in 2015 (EUR1.2bn deficit in 2011), alongside an overall budget surplus, following active management of EU funds for capital spending. In order to pursue the challenging debt reduction policy, Fitch believes that capital spending will continue to be mostly commensurate with non-debt resources.
Declining Debt, Healthy Liquidity
Despite increased activity from the regional development agency, SFIRS (not translating into higher overall liabilities), the region intends to draw down additional EUR500m debt in the medium term to possibly complement capex funding. Nevertheless, Fitch believes that outstanding debt will decrease towards EUR1bn by 2017 (or 15% of total revenue), from EUR1.35bn at end-2014. Debt metrics will remain sound, with debt servicing requirements (including early repayments) at 4%-5% of current revenue and payback (debt coverage by the current balance) stable at around three years. Liquidity should remain solid and be around EUR350m-EUR400m, cushioning against unexpected shortfalls.
Recovering Economy
According to Fitch, weak recovery signals that materialised in 2015 (+0.6%) will progressively strengthen throughout 2016 and 2017, also thanks to the positive effects of the measures adopted by the administration, including the reduction of the tax burden through a 25% cut to business tax - IRAP - for corporations, while exempting newly established enterprises from tax for five years.
Sound and Active Management
Although young population's unemployment remains an issue the administration continues to address, the employment rate is growing towards 50% - with 31,000 newly employed. Use of the national income assisted fund in traditional sectors such as oil refinery, green energy, construction and tourism decreasing by 40% has also contained the unemployment rate at 15% (Italy: 13%). Fitch believes these trends will be beneficial to local consumption and tax generation capacity in the medium term, which we expect to grow to EUR6.6bn by 2017 (EUR5.7bn in 2014).
RATING SENSITIVITIES
An upgrade would be contingent on an operating margin consistently above 6%, coupled with an improvement in socio-economic indicators towards the EU averages conducive to higher budget flexibility.
A downgrade of Italy, a prolonged economic downturn or economic shock with unemployment rate rising above 20%, jeopardising tax revenue generation could result in a downgrade of Sardinia. A structural deterioration of the operating margin significantly to below 6% over the medium term, with debt rising above Fitch's projections could also lead to a downgrade.
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