TEXT-S&P ups Russian Sakha Republic to 'BB+'; outlook stable
(The following statement was released by the rating agency)
Nov 15 -
-- We expect the economy of Russia's Republic of Sakha to demonstrate solid growth on the back of increasing extraction of natural resources, underpinning budget revenues in the long term.
-- In our view, Sakha will likely maintain its sound budgetary performance, low debt, and positive liquidity over the next three years.
-- We are therefore raising our long-term global rating on Sakha to 'BB+' from 'BB' and our Russia national scale rating to 'ruAA+' from 'ruAA'.
-- The stable outlook reflects our view that Sakha's revenue growth, backed by continued federal support and increasing tax revenues from extraction of natural resources, will likely offset increasing operating spending, resulting in a sound budgetary performance.
On Nov. 15, 2012, Standard & Poor's Ratings Services raised its long-term issuer credit rating on the Republic of Sakha (Yakutia) to 'BB+' from 'BB' and its Russia national scale rating to 'ruAA+' from 'ruAA'. The outlook is stable.
At the same time, we have raised the ratings on Sakha's unsecured debt. The recovery ratings remain at '3', indicating our expectation of meaningful (50%-70%) recovery for creditors in the event of a default.
The upgrade reflects our view that Sakha's economic and revenue growth, along with its prudent financial policies, will result in a consistently sound budgetary performance and positive liquidity.
The ratings are constrained by our view of Sakha's dependence on federal government decisions regarding intergovernmental relations, expenditure responsibilities, and tax regimes. Moreover, Sakha relies heavily on the extraction of natural resources, which is exacerbated by dependence on a single taxpayer. In addition, Sakha's vast territory, remote location, and severe subarctic climate increase costs. They also result in relatively high contingent liabilities, stemming from the need to support numerous government-related entities (GREs) that provide transport, utility, and other public services and to supply goods and fuel across its large territory.
Sakha's economic wealth is relatively high in a national context. Its gross regional product per capita already exceeds the national average and should reach an estimated $17,300 in 2012. We expect that, in 2013-2015, increasing oil and coal extraction will contribute to solid economic growth of about 6.5%. In addition, we anticipate continuous sizable investments in local infrastructure and the mining sector.
However, Sakha's economy will likely remain exposed to the volatility of world commodity markets and the performance of a few large taxpayers. About 30% of Sakha's tax revenues come from the world's largest diamond producer Alrosa OJSC (BB-/Stable/B) and its subsidiaries. We estimate that the second largest industry--oil production and transportation--provides about 20% of tax revenues. The largest taxpayers include pipeline operator OAO AK Transneft (BBB/Stable/--) and oil producer OJSC Surgutneftegas not rated). We believe that over the longer term several large investment projects backed by massive federal and private funding will likely support economic growth.
The flexibility of Sakha's revenues is low, owing to a high share of federal transfers and state taxes, which are likely to equal more than 95% of total revenues in 2012-2015. Nevertheless, in our base-case scenario we expect Sakha to continue to benefit from federal transfers in the medium term because of the strategic importance of large-scale investment projects in the republic.
In our view, Sakha's increasing revenues and demonstrated ability to control expenditure growth should allow it to maintain a sound budgetary performance over the next three years, despite rising public-sector salaries and utility costs. We therefore anticipate only modest weakening of average operating balances, compared with an exceptionally strong performance over the past four years. In our base-case scenario, we expect operating margins of about 5%-6% in 2013-2015. Significant investments in local infrastructure, from the federal budget and Republican Investment Company (RIC) OJSC (B/Stable/--), should enable Sakha to maintain modest deficits after capital accounts of about 2%-3% of total revenues. Consequently, we assume in our base-case scenario that Sakha will maintain low tax-supported debt of less than 30% of consolidated operating revenues in 2012-2015.
We consider Sakha's liquidity position to be positive. Over the past 12 months, Sakha's cash balances have averaged Russian ruble (RUB) 12.8 billion (about $405 million), exceeding its annual debt service and direct debt. Given our assumption of modest deficits after capital accounts and low borrowing needs, we anticipate cash reserves exceeding annual debt service over the next three years. Capital expenditures will have reduced Sakha's cash by year-end 2012, but in line with our base-case scenario we estimate it to be about RUB6.5 billion-RUB7 billion on average throughout 2013.
The republic's debt repayment schedule will likely remain very smooth, in our view, because of prudent debt management that relies on medium-term borrowings, primarily amortizing bonds and budget loans. In line with our base-case scenario, debt service will likely stay at a low 3% of adjusted operating revenues in 2012-2015.
Nevertheless, we view Sakha's access to external liquidity as limited, given the weaknesses of the domestic capital market. This is reflected in our banking industry risk score of '7' for Russia, with '1' being the lowest risk and '10' the highest (see "Banking Industry Country Risk Assessment: Russia," published March 19, 2012, on RatingsDirect on the Global Credit Portal).
We rate Sakha's unsecured debt at 'BB+'. The '3' recovery rating on this debt indicates our expectation of meaningful (50%-70%) recovery for the debtholders in the event of a payment default.
The stable outlook reflects our view that Sakha's revenue growth, backed by continued federal support and increasing tax revenues from the extraction of natural resources, will likely result in a sound budgetary performance, despite the need to increase operating spending. The outlook also takes into account our view that the republic's liquidity position will remain positive, thanks to continued reliance on medium-term borrowings.
We could take a negative rating action within the next year if tax revenues and transfers are lower than forecast and management relaxes control over operating spending, causing Sakha's budgetary performance to weaken, with operating margins of about 0.5%-1% of operating revenues and tax-supported debt exceeding 30% of consolidated operating revenues in line with our downside scenario.
We view positive rating actions over the next 12 months as unlikely. However, we could take a positive rating action if we improved our assessment of the supportiveness and predictability of Russia's system of intergovernmental relations. Over the longer term, if the republic formalized its currently prudent debt and liquidity management practices and improved long-term planning it would also be positive for the ratings.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Public Finance System Overview: Russian System For Regional Governments Is Developing And Unbalanced, Nov. 12, 2012
-- Banking Industry Country Risk Assessment: Russia, March 19, 2012
-- Methodology For Rating International Local And Regional Governments, Sept. 20, 2010
-- Methodology And Assumptions For Analyzing The Liquidity Of Non-U.S. Local And Regional Governments And Related Entities And For Rating Their Commercial Paper Programs, Oct. 15, 2009
-- Methodology And Assumptions: Assigning Recovery Ratings To International Local And Regional Governments' Speculative-Grade Debt, Feb. 3, 2009
Upgraded; CreditWatch/Outlook Action; Ratings Affirmed
Sakha (Republic of)
Issuer Credit Rating BB+/Stable/-- BB/Positive/--
Russia National Scale Rating ruAA+/--/-- ruAA/--/--
Senior Unsecured ruAA+ ruAA
Recovery Rating 3 3