Fitch Revises Karelia's Outlook to Negative; Affirms at 'BB-'

Fri Apr 25, 2014 11:38am EDT

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: Republic of Karelia - Rating Action Report here MOSCOW, April 25 (Fitch) Fitch Ratings has revised the Outlooks on the Russian Republic of Karelia's Long-term Issuer Default Ratings (IDR) and National Long-term rating to Negative from Stable. The agency also affirmed the republic's Long-term foreign and local currency IDRs at 'BB-' and its Short-term foreign currency IDR at 'B'. The National Long-term rating has been affirmed at 'A+(rus)'. Karelia's outstanding senior unsecured domestic bonds of RUB4.75bn have also been affirmed at 'BB-' and 'A+(rus)'. KEY RATING DRIVERS The revision of Outlook to Negative and IDR affirmation reflect the following rating drivers and their relative weights: High: The Outlook reflects sharp deterioration in Karelia's operating performance in 2013: its operating balance turned to a negative 7.5% of operating revenue (2012: 7.7% surplus), while its deficit before debt variation widened to 19.8% of total revenue (2012: 8.1%). This was due to increased operating expenditure and reduced tax proceeds. Restoring the republic's operating surpluses is not likely in 2014-2015, while a small surplus of 1%-2% is expected by 2016. Fitch believes the federal government's election pledges in 2012 to raise public sector salaries will continue to fuel operating expenditure growth over the medium term. New fiscal rules introduced in 2013, comprising the introduction of consolidated groups of taxpayers and advanced deprecation for large corporations, led to a 15% yoy decline in taxes. Russia's institutional framework for subnationals is a constraining factor on the republic's ratings. Frequent changes in allocation of revenue sources and assignment of expenditure responsibilities between the tiers of government limit the republic's forecasting ability and negatively affect its fiscal capacity and financial flexibility. Medium: Fitch updated its base case scenario and now expects a substantially sharper increase in Karelia's direct risk to 65%-70% of current revenue in 2014-2016, compared with 45%-50% previously. The increased debt will be used to fund the republic's budget deficit and refinance maturing debt in 2014-2016. The region's direct risk rose to 60% in 2013 (2012: 42%) and was composed of bank loans (40%), domestic bonds (35%), and loans contracted from the federal government (25%). The republic's cash position weakened during 2013, as Karelia saw its cash reserves fall to RUB182m from RUB1.8bn a year earlier. The region's liquidity is supported by untapped committed credit lines totalling RUB1.2bn as of end-1Q14. The Republic of Karelia's ratings also reflect the following rating drivers: Karelia's contingent risk remains low and is limited to the modest indebtedness of the region's public sector and few issued guarantees. The aggregate debt of the region's public-sector entities for 2013 is not yet available; in 2012 it stood at a low RUB324m. The republic had RUB208m worth of issued guarantees at end-2013. The region's economic profile is dominated by the industrial sector, which contributed 34% of gross regional product in 2012. Local industries were negatively affected by the slowdown of the national economy, leading to a 1% yoy decline in Karelia's GRP in 2013. The republic's government expects the local economy to recover to a 3%-4% growth in 2014-2016. RATING SENSITIVITIES A downgrade could result from continued weak budgetary performance that is insufficient for debt service and from a continued increase of direct risk to above 65%-70% of current revenue in 2014-2015. Contact: Primary Analyst Konstantin Anglichanov Director +7 495 956 99 94 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow, 115054 Secondary Analyst Behruz Ismailov Associate Director +7 495 956 99 80 Committee Chairperson Guido Bach Senior Director +49 69 76 807 6111 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable criteria, 'Tax-Supported Rating Criteria', dated 14 August 2012, and 'International Local and Regional Governments Rating Criteria outside United States', dated 23 April 2014, are available on www.fitchratings.com. Applicable Criteria and Related Research: Tax-Supported Rating Criteria here International Local and Regional Governments Rating Criteria - Effective from 9 April 2013 – 23 April 2014 here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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