Bangkok--6 Jun--Standard & Poor's
On June 6, 2014, Standard & Poor's Ratings Services lowered its long-termissuer credit rating on Krasnoyarsk Krai, a region in Eastern Siberia inRussia, to 'BB-' from 'BB'. The outlook is negative.
At the same time, we lowered the Russia national scale rating on KrasnoyarskKrai to 'ruAA-' from 'ruAA'.
RATIONALE
We lowered our ratings on Krasnoyarsk Krai because we revised our assessmentof its liquidity to "negative" from "neutral," owing to less free cash on thekrai's accounts and a weaker debt service coverage ratio than we previouslyforecast. We now also expect a slower recovery of tax revenues than in ourprevious base-case scenario, given the lower economic growth rates that weforecast for Russia. The negative outlook reflects that there is at least aone-in-three probability that the krai will be unable to implement sufficientbudget consolidation measures during the next 12 months. If that happened,
budgetary performance would likely remain persistently weak, and the krai'sliquidity position could deteriorate further.
The ratings on Krasnoyarsk Krai reflect our view of Russia's "developing andunbalanced" institutional framework, the region's limited budgetaryflexibility and concentrated economy, weak budgetary performance, ourassessment of financial management as "negative" in an international context,and the krai's "negative" liquidity. The ratings are supported by our view ofthe krai's low contingent liabilities and modest, albeit increasing, debtburden.
We expect Krasnoyarsk Krai's resource-oriented economy to continue growinggradually in 2014-2016, but we don't expect a rapid rebound in tax revenues.Although the region's economic wealth levels are above the average for Russianregions, we estimate that gross regional product will remain below US$15,000until 2015, which is modest in an international comparison. Significantconcentration on metals and mining group Norilsk Nickel and oil companyRosneft exposes the krai's budget revenues to the volatility of worldcommodity prices and to changes to the national tax regime. The companies arethe two largest taxpayers in the krai. Both companies operate in cyclicalindustries, and we estimate that they provided about 20% of the krai's taxrevenues in 2013.
Under Russia's "developing and unbalanced" institutional framework, thefederal government regulates most regional budget revenues, including maintaxes and transfers. We estimated that, in 2013, the krai lost more than 10%of its operating revenues after changes in the national tax legislationallowed its largest taxpayers to create consolidated taxpayer groups andsignificantly decrease corporate profit tax payments.
The federal government also defines regional expenditure responsibilities andleaves little flexibility for the krai's management to offset the volatilityof the tax base. Since 2012, the federal government has imposed a significantincrease in social spending on regional budgets, and provided only partialcofinancing with transfers. In our view, these additional mandates were theykey reason for systemwide worsening of financial results for Russian local andregional governments in 2012-2013. Recently the president announced additionalfinancial support for the regions, including potential softening of targetparameters of the decrees, higher transfers, and more low-interest-rate budgetloans to be provided. Still, in our view, the measures announced will besufficient only to temporarily support the weakest entities, and it isuncertain whether Krasnoyarsk Krai will be among the key recipients.
We therefore expect that, over the next three years, the krai's budgetaryperformance will remain under pressure, but it might gradually improve if themanagement successfully implements austerity measures. It is currently workingon amendments to the 2014 budget that assume optimization of costs andredistribution of funds in favor of salaries and other areas related to thepresidential decrees. We also understand that fiscal consolidation is amongthe newly appointed acting governor's key priorities, so we expect furtherbudget revisions in the second half of 2014 and a more conservative approach
to the 2015-2017 budget.
In our base-case scenario, we forecast the operating balance will remainnegative in 2014, as it was in 2013, and will gradually improve to about 2% ofoperating revenues in 2015-2016, thanks to cost-reduction measures and modesttax revenue growth on the back of increasing salaries, recovering metalsprices, and potential positive effects from inflation and ruble devaluation onthe export-oriented taxpayers' profits. Deficits after capital accounts in2014-2016 will likely narrow to about 6.5% of total revenues from a high 20%in 2012-2013 following the completion of several investment projects in Lower
Priangariye, and because we expect new capital expenditures to be partly cutor postponed. However, these measures might appear painful, given the existinginfrastructure development needs. If the krai proves unable to adjust budgetexpenditures, budgetary performance might remain persistently weak withdeficits after capital accounts at about 10% of total revenues on average, inline with our downside scenario.
Debt accumulation will continue, although at a slower pace compared with2011-2013, and tax-supported debt will reach about 50% of consolidatedoperating revenues by the end of 2016. Although the debt burden will remainmoderate compared with that of international peers, it will result inrelatively high debt service, given that we currently estimate the averagematurity of outstanding debt at about 3.5 years. Debt service might furtherincrease owing to the worsened borrowing terms in the Russian capital market,with shorter maturities available at higher interest rates.
We believe that contingent liabilities will remain only modest over the nextthree years. The krai-owned government-related entities are unlikely torequire significant extraordinary support, and its municipal sector is alsorelatively healthy financially.
We view Krasnoyarsk Krai's financial management as a "negative" factor for itscreditworthiness in an international context, as we do for most Russian localand regional governments. In our view, the krai lacks reliable long-termfinancial planning and doesn't have sufficient mechanisms to counterbalance
the volatility that stems from the concentrated nature of its economy and taxbase. Also, in our view, in recent years the management loosened controls overspending growth, and, together with federal decisions, this has led to weakerbudgetary performance.
Liquidity
We have revised our view of Krasnoyarsk Krai's liquidity position to"negative" from "neutral" as defined in our criteria. We expect that, in2014-2015, following a depletion of cash reserves in 2013, Krasnoyarsk Krai'saverage free cash net of deficits after capital accounts, together withcommitted credit facilities, will cover about 80%-100% of annual debt service.We also apply a negative adjustment for the krai's "limited" access toexternal liquidity due to the weaknesses of the domestic capital market (see "Banking Industry Country Risk Assessment: Russia," published May 15, 2013, onRatingsDirect).
In 2013, Krasnoyarsk Krai used about Russian ruble (RUB) 13 billion (US$375million) of cash to cover its large deficit after capital accounts. We expectthat, in 2014-2015, average free cash net of the deficit will be lower than wepreviously forecast, owing to continued weak budgetary performance and largedeficits.
It will likely equal only about RUB5 billion-RUB7 billion, coveringonly 20%-30% of the krai's annual debt service. The debt service in 2014 willequal about 9% of operating revenues and will mostly consist of maturingbonds. By the end of 2014, the krai will also have to refinance RUB10 billionin short-term bank lines that it obtained to cover the liquidity gap in thefirst half of the year. We believe it will increasingly rely on committed banklines, budget loans, and cash on accounts of budgetary units, which it can usetemporarily, to cover its refinancing needs. Our base-case scenario assumesthat, within the next 12 months, cash and committed facilities will coverabout 80%-100% of debt service.
In 2015, we estimate debt service will peak at 14% of operating revenues,because, apart from amortizing bonds, the krai will have to repay almost RUB8billion of two-year bank loans that it obtained in 2013. Our base case assumesthat, after 2015, debt service will reduce again, because the krai will
primarily rely on medium-term borrowing and will extend maturities once market
conditions improve.
OUTLOOK
The negative outlook reflects our view that, in 2014-2015, Krasnoyarsk Krai'sconstrained capacity to implement cost-cutting measures might lead toconsistently large deficits after capital accounts of about 10% of totalrevenues, and further weakening of its liquidity position.
We could take a negative rating action within the next 12 months if, in linewith our downside scenario, budgetary performance remains persistently weakand the krai's debt service coverage ratio falls below 80% as a result of cashdepletion or shorter maturities of newly contracted debt, which would lead usto change our assessment of its liquidity to "very negative."
We could revise the outlook to stable within the next 12 months if, in linewith our base-case scenario, Krasnoyarsk Krai's currently weak budgetaryperformance improved gradually in 2014-2016, thanks to a modest recovery intax revenues, lower capital expenditures, and tighter controls over operating
spending growth.