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Fitch Affirms Russian Republic of Karelia at 'B+'; Outlook Stable
April 7, 2017 / 4:08 PM / 8 months ago

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

(The following statement was released by the rating agency) MOSCOW, April 07 (Fitch) Fitch Ratings has affirmed the Russian Republic of Karelia's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B+'. The agency has also affirmed the republic's Short-Term Foreign-Currency IDR at 'B'. The Outlook on the Long-Term IDRs is Stable. Karelia's senior unsecured debt ratings have also been affirmed at 'B+'. The ratings reflect Karelia's weak debt metrics, a prolonged difficult economic environment in Russia, and a volatile institutional framework for Russian subnationals. The ratings also factor in the gradual improvement of a fragile operating balance, which we expect to continue over the medium term. KEY RATING DRIVERS Karelia demonstrated a slow recovery of its budgetary performance in 2016, but its operating balance remained negative. Thereafter we expect the operating balance to turn to low positive values in 2017-2019, driven by growing tax revenues due to profit recovery of the republic's key industrial tax payers and favourable changes to corporate income tax regulation. Operating performance will be also supported by higher transfers from the federal government, while operating expenditure should remain under control. However, the current balance will continue to be negative, reflecting prolonged structural imbalances of the region's budget. Fitch expects Karelia to gradually narrow its deficit before debt variation to 6%-7% of total revenue in 2017, and further to 5%-6% in 2018-2019. The republic's deficit before debt narrowed to 6.3% in 2016 after double-digit deficits averaging 14.4% in 2013-2015. Fitch expects the shrinkage of deficit in 2017-2018 will be also driven by restrictions on debt stock and budget deficits imposed by the Ministry of Finance in return for financial support. The region's expenditure flexibility is limited, as the scope for capex reduction is almost exhausted, with the share of capital outlays decreasing to about 10% of total spending in 2014-2016 (2011-2013: average 15%). We expect capex to remain at this level in 2017-2019, unless Karelia receives additional capital transfers from the federal government. Karelia intends to implement several measures aimed at current expenditure cut but this could be challenging given inflexible staff cost and current transfers in excess of 90% of operating expenditure in 2016. We expect the republic's direct risk to edge higher to 85% of current revenue over the medium term. It increased in absolute terms to RUB22.2 billion at end-2016, from RUB21 billion in 2015. However, following an almost 10% increase in revenue, debt decreased to 76.6% of current revenue at end-2016 from the peak 80% a year earlier. Further budget loans as a share direct risk increased to 53% at end-2016 from 43% in 2015. Those loans bear almost zero interest rates, hence saving interest expense. Karelia is exposed to material refinancing risk, which stems from the region's high dependence on access to capital market to service its debt. The debt maturity profile is stretched to 2034, but about 96% of the risk is concentrated in 2017-2019. This results in a weighted average maturity of its debt of about two years, which is short in an international context. 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 forecast Fitch expects moderate recovery of the national economy at 1.4% yoy in 2017 (2016: -0.2%) and the local economy will likely follow this mild trend in 2017-2019. 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 2017-2019. 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 Vladimir Redkin Senior Director +7 495 956 24 05 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow, 115054 Secondary Analyst Elena Ozhegova Director +7 495 956 24 06 Committee Chairperson Guido Bach Senior Director +49 69 768076 111 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. 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. 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