Fitch Affirms Russian City of Kazan at 'BB-'; Outlook Stable.
KEY RATING DRIVERS
The 'BB-' rating reflects the city's high direct risk, low operating balance and a weak institutional framework for Russian sub-nationals. The ratings also factor in Kazan's diversified economy, the long-term repayment schedule of the city's debt, and stable support from the Republic of Tatarstan (BBB-/Positive), of which Kazan is the capital.
Under Fitch's base case scenario, direct risk will remain high at about RUB30 billion in 2017-2019 (2016: RUBB29.8 billion), declining in relative terms to 135% of current revenue in 2019 from 150% in 2016. Around 85% of direct risk comprises RUB25 billion low-cost budget loans from Tatarstan, which were allocated to infrastructure development in preparation for Universiade 2013, hosted by the city.
The high debt levels are mitigated by the budget loans' long-term repayment schedule and low 0.1% annual interest rates. The loans have a grace period until 2023 and the principal amortises in 10 annual instalments to 2032. By end-November 2017, the city's interim direct risk has been reduced to RUB28.1 billion following partial repayment of outstanding bank loans with temporarily available cash to save on interest payments. This would help underpin a sustainable positive current balance over the medium term after volatile performance in 2014-2016. Fitch expects direct risk will return to about RUB30 billion by year-end as the city will need to fund budgeted expenditure.
Kazan's interim fiscal performance was in line with Fitch's expectation. At end-10M17, the city has collected 80% of its full-year budgeted revenue and incurred 74% of its budgeted expenditure, which resulted in a small intra-year surplus of RUB130 billion. Fitch projects that the city will record a deficit before debt variation in 2017-2019 after two years of surpluses in 2015-2016. However, the deficit will likely be small at 1%-2% of total revenue and will be funded by the city's accumulated cash balance (end-2016: RUB1.7 billion).
The city is committed to restricting new market borrowings (bank loans and bonds) until it has fully repaid its outstanding budget loans in 2032, as part of a loan restructuring agreement with Tatarstan in 2013. We therefore project Kazan's direct debt will stabilise at RUB4.8 billion in 2017-2019, equal to 20%-25% of current revenue.
The city's financial flexibility remains weak, in Fitch's view. Fitch forecasts Kazan's operating balance will remain low at 2%-3% of operating revenue (2016: 3.7%) in 2017-2019. This will be supported by the administration's cost control measures and Tatarstan's allocation of additional share of personal income tax collection to the city's budget (0.5ppts in 2017 and 1.7ppts in 2018).
Kazan's budgetary policy is dependent on the decisions of the regional and federal authorities. This result in stable flows of earmarked current transfers received from Tatarstan's budget, which averaged 37% of operating revenue in 2014-2016. Tatarstan also directly finances investment projects in Kazan, which reduces pressure on the city's capital expenditure.
The city's capex declined to 10% of total expenditure in 2014-2016, from an average 34% in 2011-2013, after completion of the Universiade-related projects. Fitch expects Kazan will maintain capex at this level over the medium term, which will support the administration's commitment to restrict new borrowings.
As Tatarstan's capital, the city's economy is boosted by the republic's diversified economic profile with a well-developed industrial sector. The administration estimates the city's economy will return to an average 2% annual growth in 2017-2020 after two years of stagnation. This is likely to be driven by growth of the republic's economy, which the Tatarstan government expects at 2.8% in 2017 and above 3% in 2018-2020, outpacing the Russian GDP growth forecast of 1.8%-2% in 2017-2019.
The city's credit profile remains constrained by the weak institutional framework for Russian local and regional governments (LRGs), which has a shorter record of stable development than many of its international peers. Weak institutions lead to low predictability of Russian LRGs' budgetary policies, which are subject to the federal government's continuous reallocation of revenue and expenditure responsibilities within government tiers.
A material decline of direct risk below 100% of current revenue, accompanied by higher financial flexibility and an operating margin above 5% on sustained basis, could lead to an upgrade.
An increase in direct debt to above 50% of current revenue or a weakening of the operating balance towards zero could lead to a downgrade.