(The following statement was released by the rating agency)
Nov 05 -
-- The Russian region Sverdlovsk Oblast has reported a moderate financial performance, modest debt, and strong liquidity, in line with our base-case scenario.
-- From our reading of the region’s 2013-2015 draft budget, the new management’s financial policies appear cautious.
-- We are affirming our ‘BB+’ rating on the oblast.
-- The stable outlook reflects the balance between the volatility of the oblast’s budget revenues and material operating and capital spending needs, and the continuation of cautious spending policies.
On Nov. 5, 2012, Standard & Poor’s Ratings Services affirmed its ‘BB+’ long-term issuer credit rating on the Russian region Sverdlovsk Oblast, located in the Urals Federal District of the Russian Federation. The outlook is stable.
The ratings reflect Sverdlovsk Oblast’s limited budget predictability and flexibility, volatile budget revenues, and material spending pressures. The oblast’s creditworthiness benefits from low debt, strong liquidity, and a moderate budgetary performance.
Like that of many other Russian regions, the oblast’s financial policy lacks predictability and stability due to the weak institutional system. In addition to its low flexibility, the oblast’s budget revenues are volatile due to its dependence on metallurgy and pipe production, which are driven by global commodity markets and economic cycles and together contribute about 25% of the oblast’s tax revenues.
In view of slowing economic growth and higher operating spending related to federally mandated increases in public-sector salaries, we anticipate Sverdlovsk Oblast’s operating budgetary performance weakening in the medium term. However, the oblast’s cautious approach to spending will likely support still-strong operating surpluses of about 5% of operating revenues on average in 2013-2015, in our view after, 9% on average in 2010-2011. Importantly, continued prudent spending allocation, as shown by the management’s 2013-2015 budget draft in October 2012, is an important assumption in our base-case scenario.
In September 2012, the oblast’s capital city, Yekaterinburg, was named one of the hosts for the International Federation of Football Associations (FIFA) World Cup in 2018. This puts significant pressure on the oblast, owing to the need for material investments in transport, utilities, and sports facilities to meet FIFA’s requirements. The cost of the preparations is not yet clear, but according to the oblast’s initial estimates it could amount to as much as Russian ruble (RUB) 100 billion ($3.2 billion). Considering the regulations of the federal authorities, we assume that at least half of the required spending will be cofinanced by the federal budget. Under this scenario, Sverdlovsk Oblast’s deficits after capital accounts are unlikely to exceed 5%-6% of revenues on average in 2013-2015, with capital spending accounting for about 15% of total expenditures in the medium term.
We believe the region’s strong self-financing capacity will result in only moderate debt expansion in the medium term. The currently low tax-supported debt of 17%-18% of consolidated operating revenues, which also includes guarantees and debt of non-self-supporting government-related entities, is not likely to exceed 30% by 2015, according to our base-case scenario.
We regard Sverdlovsk Oblast’s liquidity position as “positive”, as defined in our criteria. Our base-case scenario assumes that the oblast’s free cash will exceed annual debt service in the medium term.
After a historical peak in August 2012, when Sverdlovsk Oblast’s cash position stood at a solid RUB22 billion (about $710 million), we anticipate that the oblast’s cash reserves will likely decrease somewhat, due to the expected moderate weakening of budgetary performance in 2013-2015. However, cash levels are likely to stay relatively strong, exceeding payments on debt interest and principal.
In view of Sverdlovsk Oblast’s established track record, our base-case scenario factors in a smooth debt repayment profile in the medium term, which could translate into debt service of a modest 5%-6% of operating revenues. The oblast’s debt burden will mostly consist of direct obligations, including medium-term bonds and bank and budget loans.
In 2013-2015 the oblast is planning to set aside RUB2 billion in a contingency fund to tackle the volatility of its revenues. The rules for fund allocation have been legislated. This could be an important step in combating concentration risks in the long term, although the allocation criteria are still to be tested.
However, the Russian capital market remains volatile. Consequently, we regard all Russian local and regional governments, like Sverdlovsk Oblast, as having “limited” access to external liquidity. The weaknesses of the domestic banking sector are reflected in our Banking Industry Country Risk Assessment (BICRA) score of ‘7’ for Russia (‘1’ being the lowest risk and ‘10’ being the highest). For more details see “BICRA On Russia Revised To Group ‘7’ From Group ‘8’,” published on Nov. 9, 2011, on RatingsDirect on the Global Credit Portal.
The stable outlook reflects our view that the volatility of Sverdlovsk Oblast’s revenues and material operating and capital spending needs will likely be counterbalanced by the new management’s continuation of cautious spending policies. We believe this will translate into a strong liquidity position and only modest debt.
Positive rating actions would hinge on the oblast’s ability to improve its medium-term financial planning and institutionalize reserve and liquidity policies, which would help offset revenue volatility and cover future debt service. Sverdlovsk Oblast’s maintenance of a budgetary performance similar to those in 2010 and 2011 could also lead to positive actions.
Negative rating actions would result if difficulties in addressing existing expenditure pressure, in particular related to the salary hikes or investments related to the World Cup preparations, led to a significant increase in operating and capital spending from 2013. If this were to occur, the oblast’s budgetary performance would structurally deteriorate in line with our downside scenario, eroding its liquidity position, in particular through a rapid decline of accumulated cash reserves.
Related Criteria And Research
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-- 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
Issuer Credit Rating BB+/Stable/--