Fitch: Structural Fiscal Imbalance Key Risk for Russian Sub nationals

Fitch Ratings says in a new report that the ratings of Russian local and regional governments (LRGs) remain under pressure from structural fiscal imbalances.

For 2015, the credit quality of Russian subnationals is challenged by a sluggish national economy, which is compressing tax proceeds, by accelerating inflation which increases budget spending and by higher cost of borrowing due to a depressed national debt capital market.

The LRGs' revenue-generating abilities lag behind growing operating expenditure fuelled by the decisions of the federal government implemented in late 2012 and 2013. This has led to structural budget deficits in most regions, and raised the number of Russian regions recording a deficit to 90% in 2013 and 2014 from 68% in 2009, when Russia was last in economic recession.

Fitch forecasts that the regions' direct risk will grow 16% in 2015 (2014: 22%), in the form of short-term bank and budget loans. The extended reliance on short-term bank loans places a strain on most Russian LRGs as refinancing needs increase. Average market interest rates could double in 2015, making new debt more expensive. Weak access to long-term financing and a low self-financing capacity have forced regions to postpone investment programmes and reduce capital expenditure needed to replace a deteriorating infrastructure.

In mitigation, Fitch believes state support, including the provision of subsidised federal budget loans and extending the maturity of outstanding budget loans, could ease refinancing risk in 2015 and reduce LRGs' interest expenses. However, over the longer term, the measures will not be sufficient to reverse the deterioration in the sector's debt metrics. Improvement will only be achievable through the elimination of the structural imbalance between spending obligations and revenue sources of LRGs that arose in 2013-2014.

The credit quality of Russian LRGs with 'BB+' and low investment-grade ratings is supported by their moderate debt burden and still sound, though declining, operating margins. They have continuously recorded a resilient performance with strong double-digit operating margins and low debt below 15% of current revenue. The ratings for a number of LRGs are constrained by the sovereign ratings of 'BBB-'/Negative.