Fitch Downgrades the City of Rio de Janeiro's Ratings to 'BBB-'; Outlook Negative
KEY RATING DRIVERS
The ratings downgrade reflects the downgrade of Brazil. In Fitch's opinion, no subnational in Brazil can be rated higher than the sovereign, given the strong influence the federal government has over states and municipalities in terms of regulation and supervision.
The ratings assigned to the City of Rio de Janeiro factor in the generation of consistent above average operating margins that reached 5.7% in 2014, even in times of weak economic performance. Fitch recognizes this margin will deteriorate at least until 2017.
The ratings also consider that the federal government remains the prevalent creditor, despite a recent increase in the city's financial debt. In Fitch's view, the relevance of the federal debt portion, which corresponds to 46.1% as of June 2015, provides CRio with implicit financial flexibility. Fitch believes this financial flexibility to continue in following two years. The financial debt in foreign currency is subjected to minor devaluation effects. Fitch notes that the Federal Government guarantees the external debt repayment of the city.
Investments in urban infrastructure and transportation have been growing significantly since 2011, reaching BRL3.8 billion in 2014, corresponding to an above average 15.8% of total expenditures, better when compared with local peers but still lower than international 'BBB-' rated entities. CRio expects the current levels to diminish in 2016 given that the most relevant projects should be concluded until then.
Consolidated debt increased in 2014, reaching the equivalent of 61.2% of current revenues, comparing favourably in relation to other subnationals rated in the BBB- category. Fitch expects Rio to incrementally increase its indebtedness in 2016, respecting the fiscal limits imposed by the Fiscal Responsibility Law (FRL). Fitch notes Rio has recently relied on state-owned institutions to finance much-needed investments in infrastructure and transportation.
Pension payments corresponded to approximately 21% of personnel expenditures in 2014. The increases are explained by Rio's decision to partially fund the actuarial pension deficit with additional contributions to Funprevi (Fundo Especial de Previdencia do Municipio do Rio de Janeiro), its proprietary pension system created in 2001 and managed by Previrio. The outstanding assets of Funprevi could be fully depleted by 2019 if no corrective measures are taken, thus requiring additional expenditures.
Upgrade Factors: Fitch does not expect to rate the city above the Brazilian sovereign rating. The adoption of corrective measures to provide long-term sustainability of CRio's proprietary pension system could lead to a positive review of the national scale rating.
Downgrade Factors: Any further negative action affecting the Brazilian sovereign ratings could have a direct corresponding effect on the city's ratings.
The City of Rio de Janeiro is the second most important city in Brazil, generating an equivalent of roughly 5% of Brazilian GDP. The city presents a dynamic economy based on services with a focus on investments primarily in infrastructure and transportation
The ratings and Outlooks are sensitive to these assumptions:
--Fitch assumes a strong level of sovereign support for the City of Rio de Janeiro given that the city's most relevant creditor is the Federal Government. Fitch's base case does not assume a severe change in City of Rio de Janeiro's key structural features.
-- Fitch assumes that Brazilian Subnationals maintain international and domestic market access even if there is return of higher international financial volatility and further domestic confidence shocks.
Fitch takes the following rating actions:
City of Rio de Janeiro
--Foreign and Local Currency Long-Term IDR downgraded to 'BBB-' from 'BBB'; Negative Outlook;
--Foreign and Local Currency Short-Term IDR downgraded to 'F3' from 'F2';
--National Long-term affirmed at 'AA+(bra)'; Stable Outlook;
--National Short-term rating affirmed at 'F1+'(bra)'.