OREANDA-NEWS. Fitch Ratings has affirmed the Russian Lipetsk Region's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BB', Short-term foreign currency IDR at 'B' and National Long-term rating at 'AA-(rus)'. The Outlooks on the Long-term ratings are Stable. The region's outstanding senior unsecured domestic bonds have been affirmed at 'BB'/'AA-(rus)'.

The affirmation reflects Lipetsk region's improved fiscal performance, albeit still prone to volatility, and strengthened liquidity driven by higher tax proceeds in 2015. It also reflects the region's moderate debt level.

KEY RATING DRIVERS
The ratings reflect the expected decline in the region's budgetary performance, sound liquidity and increasing direct risk with manageable refinancing risk. They also take into account the high concentration of the regional economy in ferrous metallurgy, which makes Lipetsk region vulnerable to steel market fluctuations, leading to volatile tax revenue.

Fitch projects the region's operating balance will decline to 8%-10% of operating revenue over the medium term but remain in line with the past five years' average margin of 9.7%. The margin peaked at 14%-15% in 2014-2015 boosted by tax proceeds from the steel sector. The region's top taxpayer, export-oriented PJSC Novolipetsk Steel Plant (BBB-/Negative), benefited from rouble depreciation (USD/RUB exchange rate averaged 61.4 in 2015 vs. 38.6 in 2014) and solely contributed to 36% growth of corporate income tax proceeds in 2015.

Fitch considers that the volatility of the region's finances is partly mitigated by the administration's prudent approach, which set aside excess tax proceeds in cash reserves and kept expenses under control. This led to Lipetsk's cash balance growing 5.4 times during 2014-2015 to RUB7.3bn, which covers 37% of its direct risk as of end-2015.

Fitch forecasts the region will demonstrate a moderate budget deficit of about 6% of total revenue in 2016-2018. Part of the deficit will be funded by accumulated cash reserves. In 2015, the region achieved a balanced budget (2014: deficit 0.2%), while in 2011-2013 the deficit averaged 8.5%.

Fitch projects the region's direct risk will increase in 2017-2018 but remain below 50% of current revenue. In 2015, direct risk decreased to 43.2% from 45.9% in 2014 due to higher tax proceeds. Refinancing pressure is moderate as Lipetsk's debt maturity profile is smooth and stretched until 2020. By end-2016, the region has to repay RUB4.3bn of debt, which corresponds to 22% of its direct risk. Half of this amount will be refinanced by a new RUB2.1bn budget loan and the remainder will be funded by the region's cash reserves.

The region's credit profile remains constrained by weak institutional framework for Russian LRGs. The latter 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.

The region's economy is developed and its wealth metrics are in line with the national median. In 2015, gross regional product fell by 0.3%, which is better than the wider Russian economy (3.7% fall) due to the good performance of the steel sector. The ferrous metallurgy sector contributed 58% of the region's industrial output and more than 40% of total tax proceeds in 2015, making its economy vulnerable to fluctuations in the domestic and international steel markets.

RATING SENSITIVITIES
A strong operating balance at about 15% of operating revenue on a sustained basis accompanied by debt coverage (direct risk to current balance) below four years could lead to positive rating action.

Widening deficit before debt variation leading to an increase in direct risk to above 60% of current revenue could lead to negative rating action.