OREANDA-NEWS. Fitch Ratings has affirmed the Russian Kemerovo Region's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BB-' and its Short-term foreign currency IDR at 'B'. The agency has also affirmed the region's National Long-term rating at 'A+(rus)'. The Outlooks on the Long-term ratings are Stable.

Fitch has also affirmed the region's senior unsecured debt at Long-term local currency 'BB-' and at National Long-term 'A+(rus)'.

The affirmation reflects the recovery of Kemerovo's budgetary performance in 2015 but also the structural weaknesses in terms of tax concentration and volatile revenue.

KEY RATING DRIVERS
The 'BB-' ratings reflect Kemerovo's volatile budgetary performance and high deficit before debt in the previous four years that led to rapid debt increase, albeit from a low base. The ratings also reflect the region's concentrated economy with a developed tax base that is exposed to economic cycles, a weak institutional framework and our expectation of a stagnant local economy as a result of a recessionary environment in Russia.

Fitch expects the region's operating margin to consolidate at 5%-6% during 2016-2018, which is close to 2015's 5.7%. This will be sufficient to cover interest expenses, such that the current margin will remain in small positive territory (2015: 3%). Budgetary performance will be underpinned by strict control on operating expenditure and improved tax proceeds following the earnings recovery at mining and metallurgical companies, which are the region's largest taxpayers. The recovery was driven by the stabilisation of prices of key commodities and the depreciation of the rouble.

A stronger operating balance and a narrowing of the capital account deficit led to the budget deficit shrinking by almost twofold to 5.7% of total revenue in 2015. Fitch expects Kemerovo's deficit before debt to narrow to 3.7% in 2016, due to continuing control on operating expenditure and cuts in capex. This will limit growth of direct risk, which we expect to stabilise at below 65% of current revenue in 2016-2018. The wide deficit before debt during 2012-2015 had resulted in a rapid rise in direct risk to RUB58bn (61.2% of current revenue) at end-2015, from a low RUB19bn (21%) in 2011.

Immediate refinancing risk is moderate. As at 1 April 2016 the region's debt comprised RUB29.6bn subsidised loans from the federal budget (47% of direct risk), which are likely to be rolled over by the federal government. Another RUB23.7bn (38%) is bank loans with maturities between 2017 and 2019, with moderate concentration in 2018. The remaining direct risk is represented by RUB1bn of domestic bonds (2%) and a RUB8.3bn long-term bank loan from Vnesheconombank (VEB: BBB-/Negative/F3).

Initially in US dollars, the VEB loan was re-denominated in roubles at a favourable exchange rate of RUB/USD 33.62 in 2015 (current official exchange rate is RUB/USD 66.22), eliminating foreign-currency risk. The loan also bears low annual interest rates (1%) and has a long maturity till 1 January 2035, which mitigates pressure on the region's debt servicing needs.

The region has a concentrated economy weighted towards coal mining and ferrous metallurgy. This provides an extensive tax base for the region's budget at 80% of operating revenue. However, this also means a large portion of the region's tax revenues depends on companies' profits, resulting in high revenue volatility through the economic cycle.

Kemerovo saw marginal real GRP growth in 2015, outperforming the 3.7% contraction of national GDP. Fitch expects the local economy to stagnate in the medium term.

Russia's institutional framework for subnationals is a constraining factor on the region's ratings. Frequent changes in the allocation of revenue sources and the assignment of expenditure responsibilities between the tiers of government limit Kemerovo's forecasting ability and negatively affect the region's fiscal capacity and financial flexibility.

RATING SENSITIVITIES
An improvement in the operating balance to 6%-8% of operating revenue and maintaining a debt payback ratio (direct risk-to-current balance) at below 10 years (2015: 20.7 years) on a sustained base could lead to an upgrade.

An inability to maintain a positive operating balance on a sustained basis along with an increase in direct risk above 90% of current revenue could lead to a downgrade.