Aug 1 (The following was released by the rating agency)
Overview -- Local governments in Argentina are experiencing slower economic growth, high inflation, and difficulties financing their 2012 budget deficits.
-- We are downgrading the province of Buenos Aires to 'raA' from 'raAA-', the province of Cordoba to 'raAA-' from 'raAA', the province of Mendoza to 'raA+' from 'raAA', and the province of Neuquen to 'raA+' from 'raAA', and affirming the 'raAA' national scale rating on the city of Buenos Aires.
-- We are also lowering the short-term national scale rating on Neuquen to 'raA-1' from 'raA-1+' and affirming the 'raA-1+' short-term national scale ratings on the city of Buenos Aires and the province of Cordoba.
-- The negative outlook on all entities reflects our belief that provincial finances could continue to deteriorate in the next 12-18 months.
On July 31, 2012, Standard & Poor's Ratings Services lowered its national scale ratings on the province of Buenos Aires to 'raA' from 'raAA-', Cordoba (Province of) to 'raAA-' from 'raAA', Mendoza (Province of) to 'raA+' from 'raAA', and Neuquen (Province of) to 'raA+' from 'raAA'. In addition, we affirmed the 'raAA' national scale rating on the city of Buenos Aires.
At the same time, we lowered the short-term national scale rating on Neuquen to 'raA-1' from 'raA-1+' and affirmed the short-term national scale rating on the city of Buenos Aires at 'raA-1+'. The outlooks on all entities remain negative.
The rating actions reflect the impact of current economic slowdown and high inflation on the provinces' fiscal balances. The provinces' revenues-both their own source revenues and coparticipation transfers--are shrinking. At the same time, high inflation is pressuring the public-sector costs especially amid demands for higher wages which account for more than 50% of the governments' expenses.
As a result, we expect increasing fiscal deficits for most of the provinces in 2012. The central government's discretionary transfers to support the provinces' individual capital programs or its transfers to compensate unfavorable coparticipation distribution have been important funding sources in the past several years. For 2012, we are expecting these transfers to sharply decline, given the central government's own fiscal needs.
Besides the provinces' regular needs to finance their budgets, the uncertainty over these transfers exacerbates the funding gap for most of the provinces and increases pressure to cut their capital expenditures and/or to increasingly rely on short-term bonds to finance operating expenditure. Given that access to international capital markets is mostly closed to Argentine local governments, the provinces are more likely to be dependent on domestic markets, multilateral agencies (such as The World Bank), and domestic financial institutions.
Still, following the passage of the fiscal Responsibility Law in 2004, provinces need an authorization from the central government to issue debt, which constitutes an additional uncertainty factor to our analysis. Provinces have increasingly relied on short-term debt to cover their funding needs, which we believe constitutes an additional risk factor, given the rollover risk of this type of debt as provinces are dependant on local market conditions. We believe that short-term issuances are to be used to cover temporary shortfalls but not to be used as a permanent funding source for operating needs. We believe that the central government's fiscal support for the provinces is important through discretionary transfers, direct financing of projects, and its power to authorize any new debt.
However, we believe that each province faces different fiscal challenges, which leads us to differentiate their credit quality in the national scale rating spectrum. The downgrade of the province of Buenos Aires, which contributes 36% of Argentina's GDP, reflects its increasing fiscal deficits and uncertainty over the central government transfers to cover deficits.
The densely populated suburban areas of Buenos Aires have a significant number of poor residents who pose a constant pressure on the province's spending on social programs. In addition, we expect the province to increase its debt service due to short-term issuance and/or borrowings from local financial institutions to finance its large budget deficit.
The province's debt surpasses that of its national peers--total debt represents about 70% of its operating revenues. As of March 2012, its total debt reached ARP61.1 billion: 54.3% of this debt is denominated in pesos and corresponds to debt with the central government, 0.5% is indexed to inflation, and 45.2% is in foreign currency.
Despite the province's relatively smooth maturity profile for its capital market debt in 2013, the increasing short-term financing needs weaken its financial performance. For fiscal 2012, we estimate that the province is likely to maintain a fiscal deficit of around 10% of operating revenues.
With diminishing access to capital markets and a growing tension in the relationship between the province of Buenos Aires and the central government, the province's ability to fulfill its financing needs are is becoming difficult in the next 12-18 months. The downgrade of the province of Cordoba reflects the increasing funding needs due to more uncertain central government transfers to cover the province's pension system deficit. We are expecting the province to end the year with a balanced fiscal budget or a small deficit. Given Cordoba's diversified economic structure, its revenues from its sources will increase at least 25% in 2012, although at a slower rate than in previous years.
At the same time, the provincial government has already took measures to contain its operating expenses and cut capital expenditures. Also, as a result of the recent issuance of $105 million in the local capital market, we believe the province has already obtained most of the funds to cover its 2012 operating needs. The main credit risk for the province is the funding of its pension system.
Unlike other provinces in the 1990s, the province of Cordoba did not transfer its pension system to the central government, but agreed to finance the deficit jointly with it. However, in 2011, the central government didn't transfer ARP1.040 billion to cover the pension system deficit.
The province has already initiated legal actions against the central government for its refusal to transfer these funds, along with more than ARP500 million for public works that the central government committed to transfer as well. Overall, Cordoba is claiming that the central government owes it about ARP2.2 billion. The resolution of this claim is uncertain. Although the province expects to cover the pension system deficit with its own revenues in 2012, in the future, this could be more difficult to achieve.
The downgrade of the province of Mendoza reflects the deterioration of its fiscal balance which we believe will deepen in 2012. Mendoza had a small fiscal deficit in 2011 which we expect to increase to about 2% of operating revenues in 2012. We expect the province's funding needs to be about ARP1 billion in 2012, which will force it to look for alternative sources of funding, which will generate a significant challenge. In addition, the province needs the central government authorization to increase its debt.
The province of Neuquen's revenues are equally distributed among its own revenue sources, coparticipation transfers, and royalties. The growth of these revenues slowed in the first half of the year compared to 2011, and prospects for the second half are not better. At the same time, the province is constrained in cutting capital expenditures, as most of the public works projects already have earmarked funds. Overall, we are expecting a fiscal deficit of 7%-8% of total revenues in 2012. The province already issued about ARP400 million in short-term debt in the local market and asked for an additional authorization from the central government to issue short- and medium-term notes for ARP855 million. It's is still uncertain whether the province will be able to issue in the local market the necessary debt to close 2012 fiscal gap or to access alternative funding sources.
We are affirming the national scale rating on the city of Buenos Aires because we believe the city is better positioned to withstand a slowdown and high inflation than other local governments given its high fiscal flexibility both in terms of revenues and expenses and its low debt burden. The city covers 90% of its revenues from its own sources. We expect an operating surplus of about 15% of revenues in 2012 and fiscal deficit would depend on the city's ability to execute capital expenditures which have significantly increased in the past several years. Its capital expenditures accounted for more than 15% of total expenses for the past three years and are expected to remain at those levels in 2012.
Also, at the beginning of the year the city issued $415 million in debt, which will help to cover most of its 2012 funding needs. We believe the city will be able to deal with the potential responsibilities which are currently in discussion with the central government (for example, the subway maintenance) in a manner consistent with its current rating level. Outlook The negative outlooks on the provinces of Cordoba, Mendoza, Neuquen, and Buenos Aires, and the city of Buenos Aires parallel the outlook on the sovereign. The negative outlook on Argentina indicates at least a reasonably high chance of a downgrade this year or next.
A worsening external position, most likely from financial outflows (possibly combined with weakening terms of trade) or additional policy actions that further diminish Argentina's growth prospects could lead to a downgrade. On the other hand, actions that restore investor confidence in medium-term prospects for the economy (monetary or structural), and thus reduce uncertainty over its external liquidity position, could lead us to revise the outlook back to stable. The negative outlooks on these entities reflect our belief that provincial fiscal deficits could continue to widen in a context of deteriorating economic conditions in Argentina.