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Fitch Affirms Russian Republic of Karelia at 'B+'; Outlook Stable
October 14, 2016 / 8:21 PM / 10 months ago

Fitch Affirms Russian Republic of Karelia at 'B+'; Outlook Stable

(The following statement was released by the rating agency) MOSCOW, October 14 (Fitch) Fitch Ratings has affirmed the Russian Republic of Karelia's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'B+' and National Long-Term Rating at 'A(rus)'. The agency has also affirmed the republic's Short-Term Foreign Currency IDR at 'B'. The Outlook on the Long-Term IDRs and National Long-Term Rating is Stable. Karelia's senior debt ratings have also been affirmed at 'B+' and 'A(rus)'. The affirmation reflects Karelia's weak fiscal performance, which we expect to continue over the medium term, along with the republic's stabilised credit metrics that are commensurate with the ratings. KEY RATING DRIVERS The 'B+' rating reflects Karelia's weak fiscal performance, material direct risk, and stabilised liquidity amid a prolonged difficult economic environment in Russia. The ratings also factor in our expectations of fragile operating performance in 2016-2018 and a consistently negative current balance. We expect the republic's direct risk to edge higher to 80%-85% of current revenue over the medium term (2015: 79.9%). We expect continued weakness in the republic's 2016 fiscal performance, with an operating margin close to 1%. Thereafter we expect slow improvement in fiscal performance in 2017-2018, driven by a recovery of tax revenues, additional support from the federal government and operating expenditure restraint. Otherwise, Karelia would continue posting negative margins (operating and current), reflecting prolonged structural imbalances of its budget, which could be negative for ratings. Fitch expects Karelia to gradually narrow its deficit before debt variation to about 10% of total revenue in 2016, and further to 6%-8% in 2017-2018. The republic's interim deficit before debt was 11% of total revenue at end-8M16. This compares with 11.5% in 2015 and 12% in 2014. Fitch expects the trend of shrinking deficit in 2017-2018 to be driven by the recovering profits of the republic's key industrial tax payers. The republic's expenditure remains rigid, with the share of inflexible current transfers exceeding 80% of operating expenditure in 2013-2015. The region's financial flexibility is also limited, as the scope for capex reduction is almost exhausted, with capital outlays decreasing to below 10% of total spending in 2014-2015 (2011-2013: average 15%). We expect capex to remain at this level in 2016-2018, unless Karelia receives additional capital transfers from the federal government. The republic's interim direct debt (bonds and bank loans) decreased in absolute terms to RUB9.4bn by end-August 2016, from RUB12bn in 2015. This is due to greater use of low-cost budget loans, which by end-August 2016 rose to 11.7bn (2015: RUB9bn). Those loans are low in interest cost and have extended maturities stretching up to 2034. As a result the republic's interim direct risk and liquidity position stabilised at RUB21.1bn (2015:21bn) and RUB1.1bn as of end-August 2016 (2015: RUB1bn), respectively. Karelia's tax base has historically been sound, supporting above-national median wealth metrics. However, fiscal changes introduced in 2012-2013 by the federal government have had a deeply negative effect on the republic's fiscal capacity. In addition, prospects for a swift recovery of Russia's economy remain weak; in its restated forecast Fitch expects continued, albeit slower, contraction in the national economy of 0.5% in 2016 (2015: -3.7%). Russia's institutional framework for subnationals is a constraint on the republic's ratings. Frequent changes in the allocation of revenue sources and assignment of expenditure responsibilities between the tiers of government limit Karelia's forecasting ability and negatively affect the republic's fiscal capacity and financial flexibility. Fitch expects the region's dependence on financial support from the federal government to increase in 2016-2018. RATING SENSITIVITIES Growth of direct risk above 85% of current revenue, together with a negative operating balance for two years in a row, would lead to a negative rating action. A positive rating action could result from stabilised fiscal performance with operating surpluses leading to sufficient coverage of interest costs. Contact: Primary Analyst Konstantin Anglichanov Director +7 495 956 99 94 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow, 115054 Secondary Analyst Vladimir Redkin Senior Director +7 495 956 99 01 Committee Chairperson Raffaele Carnevale Senior Director +39 02 87 90 87 203 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Fitch has made a number of adjustments to the official accounts to make the local and regional government internationally comparable for analytical purposes. These adjustments include: - Transfers of capital nature received were re-classified from operating revenue to capital revenue; - Transfers of capital nature disbursed were re-classified from operating expenditure to capital expenditure. - Goods and services of capital nature were re-classified from operating expenditure to capital expenditure. 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