Fitch Affirms Russia's Kaluga Region at 'BB'; Outlook Stable
The affirmation reflects Fitch's unchanged base line scenario regarding the region's sound operating performance and our expectation that the region's direct risk will stabilise in relative terms on the back of a narrowing fiscal deficit and growing operating revenue.
KEY RATING DRIVERS
The 'BB' rating reflects the region's high direct risk, which is mitigated by an increasing proportion of low-cost loans from the federal budget and strong operating performance driven by the administration's proactive management. The ratings also factor in a weak institutional framework for local and regional governments (LRGs) in Russia and a weak macroeconomic environment.
Fitch expects Kaluga to continue to report a solid operating performance, supported by its diversified tax base. The agency expects the operating balance to be close to 14% of operating revenue in 2016-2018, which is a moderate deterioration from a high 16.5% in 2015 but in line with the 2011-2014 average. Kaluga demonstrated a broadly stable budgetary performance during 1H16 in line with our projections, leaving our base case scenario unchanged.
Fitch expects the region's deficit before debt variation to shrink notably to about 5% of total revenue in 2016-2018, from an average 12.3% in 2013-2015. This will be driven by lower capital expenditure and planned cost control measures. Fitch therefore forecasts direct risk growth to slow down in absolute terms, while continued operating revenue growth should allow the overall debt burden to stabilise at close to 90% of current revenue (2015: 89.3%). A strong current surplus also supports adequate interest coverage.
As with most Russian regions, Kaluga is exposed to refinancing pressure over the medium term. It faces repayment of 67% of its outstanding liabilities in 2016-2018. The region has successfully substituted part of its bank loans with new loans from the federal budget (RUB9bn have been received so far in 2016), providing immediate relief to refinancing pressure. However, volatile interest rates in domestic markets could make new debt more expensive and put pressure on the region's current margin.
Kaluga is focused on local economic development and has successfully attracted foreign investments and promoted industrial production. This policy has resulted in the rapid growth of the tax base, but also led to a high debt burden of the region, albeit linked to infrastructure development. As of 1 August 2016, direct risk increased to RUB39.4bn from RUB35.6bn at the beginning of the year. This is however mitigated by new debt being in the form of subsidised loans from the federal budget, limiting interest expenses. Budget loans dominated the region's direct risk (62%) followed by bank loans (17%), while the remaining 21% referred to the liabilities of Development Corporation of Kaluga Region (DCKR).
DCKR was established by the region to finance local investment projects, namely the development of regional industrial zones. The region provides subsidies to cover the principal and interest on DCKR's debt. Consequently, Fitch views DCKR's liabilities as the region's direct risk. As of 1 January 2016, DCKR's liabilities amounted to RUB8.4bn of long-term loans from state development institution Vnesheconombank (BBB-/Negative/F3). Positively, DCKR's liabilities have a smooth maturity profile between 2018 and 2022.
The region's economy has wealth indicators above the national median due to past rapid, industrially-driven economic growth. Industrial output growth decelerated in 2013-2015, following the negative national trend, and the regional administration expects Kaluga's GRP to fall 1.2% in 2016, after a sharp 7.2% contraction in 2015, before growing marginally in 2017-2018.
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 government tiers
Sound operating performance with an operating margin close to 15% stabilisation of direct risk (including DCKR's debt) at the current level (2015: 89.3% of current revenue) and easing refinancing pressure, all on a sustained basis, could lead to an upgrade.
Inability to limit direct risk growth and weakening in budgetary performance leading to permanent deterioration in debt coverage (direct risk-to-current balance) beyond 12 years (2015: 7.4 years) would lead to a downgrade.