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Fitch Affirms Russia's Tula Region at 'BB'; Outlook Stable

March 13, 2017 | Cbonds

Fitch Ratings has affirmed the Russian Tula Region's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BB' with Stable Outlooks and Short-Term Foreign Currency IDR at 'B'. The region's National Long-Term Rating has been affirmed at 'AA-(rus)' with a Stable Outlook and withdrawn.

The region's senior debt long-term rating has been affirmed at 'BB'. The region's senior debt National long-term rating has been affirmed at 'AA-(rus)' and withdrawn.

The affirmation reflects Fitch's base case scenario regarding Tula Region's stable budgetary performance and moderate direct risk over the medium term.

The National-scale rating is being withdrawn because Fitch has withdrawn its Russian National-scale ratings in response to a new regulatory framework for credit rating agencies in Russia (see "Fitch Withdraws National Scale Ratings in the Russian Federation" dated 23 December 2016).

KEY RATING DRIVERS
The 'BB' ratings reflect the satisfactory operating balance of Tula, which comfortably covers its interest payments, its smaller deficit before debt and moderate direct risk. The ratings also factor in the region's moderate social-economic profile and a weak institutional framework for Russian sub-nationals.

Fitch projects Tula's operating balance to consolidate at about 8% of operating revenue over the medium term, which is below the 10.9% recorded in 2016, but still sufficient to cover interest payments by 4x-5x (2016: 7.7x). In 2016, the operating balance was supported by a 9.2% growth in tax revenue. The latter will likely decelerate in 2017, in Fitch's view, due to revised allocation of excise duty and corporate income tax proceeds although this will be partly offset by higher transfers from the federal government.

We expect Tula will likely post a deficit before debt in 2017-2019, which we project at 3%-4% of total revenue. The region recorded a small surplus in 2016 after four years of deficits. The improvement was driven by a higher operating margin, reduced interest payments and the repayment of RUB1 billion budget loans by municipalities (mostly the City of Tula (BB-/Stable)). Nevertheless, the region's fiscal flexibility remains low, in Fitch's view. Most of its operating expenditure is social-oriented and quite rigid, while capex is already reduced to low levels (2016: 13% of total expenditure).

Fitch forecasts Tula's direct risk to remain moderate at below 35% of current revenue in 2017-2019 (2016: 25.4%). In 2016, direct risk stabilised at RUB15.7 billion, after the region refinanced about RUB5 billion bank loans with federal budget loans. As a result, Tula's debt portfolio is dominated by budget loans (59%), followed by bonds (38%) and bank loans (3%). The budget loans have low 0.1% interest rates, which should help the region to save on interest payments over the medium term.

Despite the moderate debt burden, the region is exposed to refinancing risk as its debt maturity is short in the international context. In 2017, Tula needs to refinance RUB5.5 billion, or 35% of direct risk, which it will fund using bank loans and budget loans; the federal government has approved a RUB1.2 billion budget loan for Tula in 2017. Additional intra-year funding support comes from RUB4 billion short-term treasury loans, allowing Tula to defer more costly bank borrowings to year-end.

The region's economy is moderate in the national context with GRP per capita slightly below the national median. However, it benefits from a well-diversified processing industry and grows faster than the national average. According to the region's estimation, Tula's GRP grew 4.8% yoy in 2015 and 2.5% in 2016, while Russia's GDP contracted. The administration expects growth to continue at 2.5%-3% p.a. in 2017-2018, supported by processing industries and a national economic recovery, which Fitch forecasts at 1.3%-2% for 2017-2018.

The region's credit profile remains constrained by the weak institutional framework for Russian local and regional government (LRGs). It has a short track record of stable development compared with many of its international peers. The frequent reallocation of revenue and expenditure responsibilities within tiers of government reduces the predictability of LRGs' budgetary policies and hampers Tula's forecasting ability.

RATING SENSITIVITIES
Sound budgetary performance with an operating margin above 10% on a sustained basis, accompanied by moderate direct risk below 40% of current revenue, would lead to an upgrade.

Conversely, deteriorated budgetary performance with an operating margin consistently below 5%, accompanied by a weak debt payback exceeding 10 years (2016: 2.7years), could lead to a downgrade.

Company: Tula region

Full company nameTula region Ministry of Finance
Country of riskRussia
Country of registrationRussia

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