OREANDA-NEWS. Still well above historic levels--due to delays of investments and constraints in capacity. Our updated forecast now includes a deficit after capital accounts averaging about 1.3% of operating revenues over 2016-2018.

In our view, Vastra Gotaland has average budgetary flexibility, supported by ahigh share of modifiable revenues but offset by a fairly rigid expenditure structure. We note that the region implemented a tax increase of SEK0.25 per SEK100 at the start of 2013 and another SEK0.30 per SEK100 in 2015. Even if local tax rates (combined municipal and regional tax rate) in the region are slightly higher than the national average, we expect that Vastra Gotaland's management would, if needed, continue to use its budgetary flexibility (both on the revenue and expenditure side) to preserve sound operating balances and contain deficits after capital accounts at modest levels.

In its planning period through 2018, Vastra Gotaland will likely fund investment needs with its operating cash flows and liquidity reserves. As such, in our base-case scenario, we expect that the region will maintain high cash reserves and, except for SEK1 billion of an earmarked loan to finance a new administration building (which the city estimates will be finalized in 2019), refrain from external borrowing.

As a result, we think Vastra Gotaland's debt burden will remain low, and we forecast virtually no direct debt and minimal tax-supported debt at year-end 2018. However, the region's gross pension liabilities, which we treat as debt, comprise about 70% of operating revenues and weigh on our analysis of the region's overall debt position.

Although the 2013 revision to Sweden's equalization system for LRGs slightly hindered Vastra Gotaland's revenues, we classify the institutional framework for Sweden's LRGs as extremely predictable and supportive and consider it a key component in our ratings on Vastra Gotaland. In our view, the equalizationsystem and widespread taxing autonomy--on which LRGs' revenue and expenditure management is based--provides a high degree of institutional stability.

Since Vastra Gotaland became the full owner of Vasttrafik in 2012, we have assessed the region's financials on a consolidated basis, including Vasttrafik. We consider Vastra Gotaland's co-ownership of rolling stock leasing company AB Transitio and the related guarantee arrangements in our assessment of the region's contingent liabilities. However, we assess the ultimate recapitalization risk linked to this company to be limited for VastraGotaland. As a result, we assess the region's contingent liabilities as very low.

LIQUIDITY

The short-term rating is 'A-1+'. We assess Vastra Gotaland's liquidity as exceptional. The region has no debt repayments in the short term and it has substantial liquidity reserves, leading to excellent debt service coverage. Asof Sept. 22, 2016, Vastra Gotaland's cash and liquid investments (netted for haircuts) totaled SEK7.8 billion. Prudent investment guidelines are in place, and we are not aware of any material risk exposure in the region's investment portfolios. When assessing Vastra Gotaland's liquidity, we view positively theregion's strong access to the capital markets.

Additional liquidity is available through a SEK750 million checking account and SEK2 billion in syndicated committed bank facilities, which the region uses as liquidity backup for its SEK3 billion commercial paper program. Also, Vastra Gotaland has a €70 million loan agreement with the European Investment Bank, earmarked for investments in Vasttrafik's infrastructure and rolling stock.

Still, we understand that Vastra Gotaland will draw on its liquidity reserves to finance its capital expenditures within the planning period through 2018. However, given our forecast of small deficits compared with the ample supply of liquidity, we expect the region's liquidity to remain a supportive rating factor over our 2016-2018 outlook horizon.

OUTLOOK

The stable outlook reflects our expectation that, over the next 24 months, Vastra Gotaland's efforts to contain operating expenditures, together with recovering revenues, will enable the region to sustain strong budgetary performance. As such, we expect the region will maintain minimal tax-supporteddebt and exceptional liquidity over the same period.

We could take a negative rating action on Vastra Gotaland within the next 24 months if we observed widening deficits after capital accounts approaching 5% of operating revenues, together with a view of further structural deterioration in its budgetary performance. In this downside scenario, if Vastra Gotaland's management did not use its budgetary flexibility to counteract the region's deteriorating performance and financial position, we could revise down our assessment of financial management to satisfactory and lower the long-term rating.