OREANDA-NEWS. Fitch Ratings has affirmed Russian Penza Region's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BB' with Stable Outlooks, Short-term foreign currency IDR at 'B' and its National Long-term rating at 'AA-(rus)' with a Stable Outlook.

The affirmation reflects Fitch's expectation that the region will maintain a sustainably positive current balance and moderate direct risk, whose growth will be limited by a narrowing fiscal deficit.

KEY RATING DRIVERS
The 'BB' rating reflects the region's moderate direct risk with limited exposure to immediate refinancing risk and satisfactory fiscal performance with a sufficient operating balance to cover interest payments. The ratings also factor in the modest size of the region's economy and budget, a weak institutional framework for local and regional governments (LRGs) in Russia and a deteriorating macroeconomic environment.

Fitch expects the operating balance to be at 7%-8% of operating revenue in 2016-2018, which is below our previous expectations of 8%-10%, but still in line with the ratings. Current margin will remain positive at 5%-6%. Penza's operating performance deteriorated in 2015 with an operating margin of 6%, down from sound 11.3% one year earlier. This was due to a sharp decline of 23% in corporate income tax (CIT) proceeds, which was not compensated by increases in current transfers or cuts to operating expenditure.

The CIT decline reflected the weakening financial results of local companies due to a sluggish national economy in 2015 and a one-off return of CIT overpaid by taxpayers in late-2014. Fitch does not expect such tax refunds to repeat in 2016. On the contrary, we project a moderate recovery of CIT proceeds leading to the region's overall tax revenue growth of 8% in 2016 (2015: -1.4%), close to our projections of an annual inflation of 9.5%.

Fitch assumes the deficit before debt will be moderate over the medium-term at no more than average 2% of total revenue in 2016-2018 (2015: 3.6%). This will be supported by the region's intent to limit operating expenditure growth below inflation and cut capital spending. Fitch expects capital expenditure will decline to an average 10% of total spending annually in 2016-2018, from an average of 16% in 2013-2014.

Fitch expects direct risk will remain moderate at below 55% of current revenue in 2016-2018 (2015: 54%). As of 1 January 2016 the region's direct risk composed of bank loans and federal budget loans amounting to RUB21.2bn, little changed since the beginning of 2015. Penza's deficit of RUB1.5bn in 2015 was almost fully covered by outstanding cash, so the region contracted new debt only for refinancing maturing debt in that year. Subsidised budget loans constitute around 45% of total direct risk, and their 0.1% annual interest rates allow the region to save on interest payments.

Fitch views positively the smooth amortisation profile of the region's direct risk until 2019. This puts Penza in a more favourable position than national peers in terms of refinancing pressure. However, as with most Russian regions, the debt maturity profile of Penza is shorter than international peers'.

As of 1 January 2016 Penza had to repay RUB1.2bn of bank loans and RUB2.9bn of budget loans for this year. The budget loans should be refinanced by the RUB2.5bn new budget loans that Penza is due to receive from the federal government in 2016 and Fitch expects Penza will roll over the maturing bank loans.

The region's credit profile remains constrained by the weak institutional framework for Russian LRGs, which has a shorter record of stable development than many of its international peers. The predictability of Russian LRGs' budgetary policy is hampered by frequent reallocation of revenue and expenditure responsibilities between tiers of government.

Penza's economy is historically weaker than the average Russian region with a GRP per capita at 75% of the national median in 2013. This has led to a weaker tax capacity than its regional peers. Federal transfers constitute a significant proportion of finances, averaging 40% of operating revenue annually in 2011-2015, which limits the region's revenue flexibility. Fitch views the federal government's ability to provide additional support in the form of transfers to compensate for tax revenue decline as limited, due to the current negative financial and economic environment. Fitch expects national GDP to decline 1.5% in 2016 following a 3.7% decline in 2015.

RATING SENSITIVITIES
Sharp deterioration of budgetary performance leading to an operating margin below 5%, coupled with an increase in direct risk to above 60% of current revenue, could lead to a downgrade.

A sustainable operating balance at 15% of operating revenue and stabilisation of direct risk at around 50% of current revenue accompanied by a Russian economic recovery could lead to an upgrade.