TEXT-Fitch rates Russia's Lipetsk Region at 'BB'; outlook stable

Mon Oct 29, 2012 6:13am EDT

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(The following statement was released by the rating agency)

Oct 29 - Fitch Ratings has assigned Russia's Lipetsk Region Long-term foreign and local currency ratings of 'BB', a Short-term foreign currency rating of 'B' and a National Long-term rating of 'AA-(rus)'. The Outlooks for the Long-term ratings are Stable. The rating action also affects the region's outstanding domestic bonds of RUB2.9bn.

The region's ratings reflect its satisfactory, yet improving operating performance, moderate, albeit increasing direct risk, and prudent management. However, the ratings also factor in the volatile budgetary performance due to the regional economy's high concentration and increasing operating expenditure pressure.

Fitch notes that sustaining an operating balance over 12% of operating revenue, and the maintenance of debt coverage (direct risk/current balance) in line with average debt maturity would lead to upgrade. Conversely, the region's continued budget imbalance leading to direct debt increase and deterioration of debt coverage above 10 years would lead to a downgrade.

Fitch forecasts that the region's operating balance will hover around 8%-10% of operating revenue in 2012-2014. In 2011 the region's operating margin accounted for 4.9%, decreasing from 9.1% in 2010. Fitch believes that this was a temporary deterioration caused by one-off current transfers to companies, which facilitated operating expenditure growth.

In 2011 the region recorded a 5% deficit before debt variation, and Fitch expects the widening of the latter to 10.6% of total revenue in 2012. The reason is the increased capex which was postponed from the previous year and the region's planned RUB1bn capital injection to the special economic zone. Fitch believes the region will cope with the pressure over operating expenditure caused by the increase of salaries for public employees and additional responsibilities in the healthcare sector.

2012's deficit will be mostly financed by new borrowing, which will increase the region's direct risk. However Fitch forecasts that the region's direct risk will remain moderate at about 30% of full-year current revenue compared to 23% in 2011. The region has two refinancing peaks in 2013 and 2014 when it needs to repay about one-third of the total risk annually. The region intends to roll-over the debt rather than use accumulated cash reserves for its repayment. The region also plans to substitute most of the bank loans by amortising five-year domestic bonds, which will make the maturity profile smoother.

The region has a strong economy heavily weighted towards ferrous metallurgy. The sector is represented by OJSC Novolipetsk Steel ('BBB-'/Stable/'F3') - one of the largest steel-makers in Russia. This company's tax contribution accounted for 31% of the region's total tax revenue in 2011. This makes the region vulnerable to the fluctuations on the domestic and international steel market.

The administration makes efforts to diversify the economy by developing a network of special economic zones. Fitch believes this will improve the operating performance's predictability, but only over a long-term perspective. The administration's prudent approach to the budget policy resulted in the accumulation of the reserves in the favourable years and its depletion during the negative phases of economic cycles.

Lipetsk Region is located in the centre of the European part of Russia. The region contributed 0.7% of the Russian Federation's GDP in 2010 and accounted for 0.8% of the country's population.

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