OREANDA-NEWS. Fitch Ratings has affirmed Volgograd Region's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'B+', Short-Term Foreign Currency IDR at 'B' and National Long-Term rating at 'A(rus)'. The Outlooks on the Long-Term ratings are Stable. The region's outstanding senior unsecured domestic bond issues have been affirmed at 'B+' and 'A(rus)'.

The affirmation reflects the region's budgetary performance and debt metric being in line with Fitch's base case 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 historically weak budgetary performance and high direct risk due to a persistent budget deficit in the past. In 2011-2015, the region's average operating balance was about zero and the average deficit before debt variation 12% of total revenue, which resulted in sharp growth of direct risk to 64% of current revenue by end-2015 from 16% at end-2010.

Fitch projects a moderate improvement of the operating performance over the medium term and forecasts current balance at about 3% of current revenue and budget deficit narrowing to 3%-5% in 2016-2018. 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.

In 2015, the region narrowed the budget deficit to 8.4% from 10.6% in 2014 and intends to record a budget surplus in 2016-2018. Fitch has a more conservative view and projects a gradual reduction of the deficit. We consider the region has limited headroom to sharply reverse the five-year weak performance 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 as a result of the expected reduction of the budget deficit. In 5M2016, the direct risk remained almost unchanged, although its structure improved towards budget loans. Volgograd contracted RUB6.3bn low-cost budget loans and refinanced maturing bonds and bank loans. As a result, the subsidised funding composed 49% of direct risk at June 2016, up from 36% at end-2015. Fitch views this positively as the budget loans are almost 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. In its debt policy, Volgograd relies on bonds, which comprise 32% of its debt stock, and three-year banks loans (19%). About 80% of maturities are spread between 2017 and 2019; by end-2016 Volgograd needs to repay RUB5.6bn, or 12% of its direct risk. The administration plans to fund 2016 refinancing needs with bank loans and budget loans. The region does not plan to issue new bonds in 2016.

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 1% in 2015, which is better than the 3.7% national. It expects a 1%-3% restoration in 2016-2018 supported by development of local industries.

Russia's institutional framework for sub-nationals is a constraining factor on the region's ratings. Frequent changes in the allocation of revenue sources and in the assignment of expenditure responsibilities between the tiers of government hampers the forecasting ability of local and regional governments in Russia.

RATING SENSITIVITIES

Stabilisation of direct risk at below 70% of current balance and sustainable 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.