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 Long-Term Local Currency 'BB' and National Long-Term 'AA-(rus)'.

The affirmation reflects Fitch's expectation that Lipetsk region will maintain a satisfactory fiscal performance, albeit still prone to volatility, and a moderate debt level. It also reflects the region's strengthened liquidity, driven by higher tax proceeds in 2014-2015.

KEY RATING DRIVERS

The ratings reflect the region's moderate direct risk with manageable refinancing risk, satisfactory budgetary performance with a sufficient operating balance to cover interest payments and sound liquidity. 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's 2016 base case remains unchanged. We expect that Lipetsk region will maintain a sound operating balance close to the historical average at about 8%-10% of operating revenue in the medium term, supported by strong tax base and administration's cost-containing approach. In 2015 the operating margin reached a historical high of 15% as taxes grew 16% yoy due to favourable conditions on the metallurgy market.

Fitch projects the region will record a moderate budget deficit in the medium term at about 6% of total revenue, deteriorating compared with deficit free budgets in 2014-2015, when the fiscal performance was boosted by tax proceeds from the steel sector. The region's top taxpayer, export-oriented PJSC Novolipetsk Steel (BBB-/Negative), benefited from rouble depreciation. The positive effect wore off in 1H16. Tax proceeds from the steel sector fell by 14% yoy, leading to a RUB1bn budget deficit during 7M16, which is within our expectations.

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

Fitch projects the region's direct risk will increase in 2017-2018 but stay moderate at below 50% of current revenue. Refinancing pressure remains manageable as Lipetsk's debt maturity profile is relatively smooth, stretching until 2020, and evenly split between bank loans, bond and budget loans. As of 1 August 2016, the region had repaid part of this year's maturities with its cash reserves and has contracted RUB2.1bn long-term budget loan at a subsidised interest rate to refinance the remainder.

The region's economy is developed and its wealth metrics are slightly above the national median. In 2015, gross regional product grew 0.8%, 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.

Russia's institutional framework for sub-nationals is a constraining factor on the region's ratings. It 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 within government tiers.

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.