(The following statement was released by the rating agency)
Dec 12 -
Summary analysis -- Chelyabinsk Oblast ---------------------------- 12-Dec-2012
CREDIT RATING: BB+/Stable/-- Country: Russia
Primary SIC: Legislative
Credit Rating History:
Local currency Foreign currency
13-Dec-2010 BB+/-- BB+/--
The ratings on Chelyabinsk Oblast reflect Standard & Poor’s Ratings Services’ view of its low budgetary flexibility and predictability under Russia’s developing and unbalanced system of interbudgetary relations. Economic concentration on metallurgy and exposure to a single taxpayer, which leads to revenue volatility, and a lack of reliable medium-term financial and capital planning, which is common for most Russian peers, also constrain the ratings. The oblast’s sound budgetary performance, low debt burden, and a positive liquidity position support the ratings.
Chelyabinsk Oblast’s economy is concentrated on the cyclical metallurgy industry. We estimate that ferrous metallurgy, including the oblast’s largest taxpayer, OAO Magnitogorsk Metallurgical Kombinat (MMK; not rated), accounts for about 17% of the oblast’s gross regional product (GRP) and will provide about 10% of tax revenues over the next three years. This share has been gradually decreasing in recent years, but in our view it will likely continue to expose the oblast’s budget revenues to volatility and constrain its financial predictability over the medium term. In 2012, tax revenues will likely be weaker than we expected in our previous forecast, due to a more pronounced deterioration in the performance of steel and pipe producers and the consequent tax paybacks claimed by the oblast’s largest taxpayers.
The oblast’s budgetary flexibility and predictability is also constrained by dependence on federal decisions regarding intergovernmental relations, tax regimes, and spending responsibilities. The oblast has very little control over its budget revenues, about 95% of which will likely come from state-regulated taxes and transfers from the federal government in 2013-2015.
Chelyabinsk Oblast has little leeway in terms of managing its operating spending, and the federally driven increases in public sector salaries will likely further limit the oblast’s flexibility and pressure its budgetary performance in the next three years. Nevertheless, we believe the oblast has some flexibility to curtail its budgeted expenditures, especially in its sizable capital program that will likely make up about 18% of total expenditures in 2013-2015 and could be at least partly cut if the oblast faced weaker revenues.
We expect that over the next three years the oblast’s management will revert to tight control over spending growth in order to maintain sound budgetary performance. We expect that an average 3.5% annual gross regional product (GRP) growth and sluggish performance of the metals industry will lead to an only modest rebound in tax revenues over the medium term. At the same time, we estimate that the federal initiatives to increase public sector salaries, which only modestly affected the oblast’s finances in 2012, might cost the oblast about 8% of additional operating spending in 2013. We expect that, in line with its conservative policies, the oblast’s management will limit the growth of non-personnel-related spending in order to keep deficits and borrowing needs low. Our base-case scenario therefore assumes relatively high operating margins of about 9% of operating revenues in 2013-2015 and modest deficits after capital accounts below 5% of total revenues.
Chelyabinsk Oblast’s total tax-supported debt will likely increase only gradually and will stay at an average of 27% of consolidated operating revenues in 2013-2015. We expect that the oblast will continue modest accumulation of direct debt, and the amount of new guarantees provided to support regional investment projects and agricultural producers will decrease in the next three years compared with 2011-2012.
We view Chelyabinsk Oblast’s liquidity position as “positive”, because we expect it to maintain average cash exceeding its very low debt service falling due in 2013-2015. At the same time, we view the oblast’s access to external liquidity as limited, as it is for most Russian local and regional governments (LRGs), given the weaknesses of the domestic capital market, to which we assign a Banking Industry Country Risk Assessment score of ‘7’, with ‘1’ being the lowest risk and ‘10’ being the highest. (For more details see “Banking Industry Country Risk Assessment: Russia,” published March 19, 2012, on RatingsDirect on the Global Credit Portal).
We expect the oblast to maintain low debt service of about 2%-3% of operating revenues in the next three years, because it will likely continue its conservative approach to borrowing. In our base-case scenario we assume that the oblast will attract only a limited amount of medium-term bank loans that will mature in two to three years.
In 2012 the oblast borrowed commercial debt for the first time in several years in order to refinance maturing budget loans, and it will start repaying the RUB1.7 billion bank loan in small installments already in December 2012. We expect that the oblast will withdraw another RUB2 billion in late 2012 or early 2013 for liquidity purposes from a RUB7 billion bank line that was organized in September 2012 and matures in 2015, and will organize new committed credit facilities in 2013.
At the same time we expect that throughout 2013, the oblast’s average cash reserves will equal about RUB4.5 billion, which will exceed its low debt service by more than 100%.
The stable outlook reflects our view that Chelyabinsk Oblast’s modest revenue growth and the need to increase operating spending in 2013-2015 will be mitigated by management’s conservative financial policies and will result in a continuously sound budgetary performance, low debt, and a positive liquidity position.
We could take a negative rating action within the next 12 months if weaker-than-forecast tax revenues and loosened control over operating expenditures--in line with our downside scenario--lead to a deterioration of the oblast’s budgetary performance. Our downside scenario assumes deficits after capital accounts of about 7% of total revenues and increasing borrowing needs that could push tax-supported debt above 30% of consolidated operating revenues in 2013-2015.
We could take a positive rating action if higher-than-forecast revenues and the management’s adherence to strict fiscal discipline resulted in consistently sound budgetary performance and led to a structural consolidation of the oblast’s liquidity position, with the view to reducing the oblast’s exposure to financial and cash volatility in line with our upside scenario. However, ratings upside is unlikely for the next 12 months, in our view.
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