On March 13, 2015, Standard & Poor's Ratings Services revised its outlook on the Russian City of Ufa to negative from stable. At the same time we affirmed our 'BB-' long-term issuer credit rating and 'ruAA-' Russia national scale rating on the city.
We have revised the outlook to negative from stable because we believe there is an increasing risk of Ufa being unable to maintain its current debt-service coverage ratio of 70%, due to currently difficult market conditions and high interest rates.
The ratings on Ufa, the administrative and economic center of the Republic of Bashkortostan, reflect our view of Russia's volatile and unbalanced institutional framework, which results in Ufa's very weak budgetary flexibility. Due to these system constraints, and a lack of reliable long-term financial planning compared with international peers', we view Ufa's financial management as weak in an international context, as we do for most Russian local and regional governments (LRGs). The city's weak economy, weak budgetary performance, and less than adequate liquidity also constrain the ratings.
Our view of Ufa's low debt and low contingent liabilities supports the ratings. The issuer credit rating on the city is equal to its stand-alone credit profile, which we assess at 'bb-'.
Ufa's wealth level is low, although it exceeds neighboring territories'. Ufa's gross regional product per capita was about $14,000 in 2014, which is in line with the national average. We expect that Ufa's wealth will likely increase in line with the national rate. Also, we believe that Ufa's economy still depends on the oil-refining and chemical industries.
In our view, Ufa's budgetary flexibility is very weak, due to its exposure to federal and regional government decisions regarding tax shares, allocation of transfers, and redistribution of spending responsibilities. We estimate that, in 2015-2017, transfers from higher-tier budgets and personal income tax, which are regulated by the federal and the regional governments, will provide almost 70% of the city's revenues.
On the positive side, in recent years the city has benefited from increasing operating and capital support from Bashkortostan, and we expect this trend to continue in the medium term.
In our base-case scenario for 2015-2017, we expect Ufa's budgetary performance to be weak, given a one-time financial deterioration in 2014 as the city increased spending to prepare for the Shanghai Cooperation Organization and BRICS summits that the city will host this year. Ufa provided about 5% of the total amount spent, while most funds came from Bashkortostan and private investors. In our view, these investments might meet some of the city's infrastructure needs and reduce future spending pressure. Our base-case forecast is that, after a sharp decline in 2014, the city will post a very modest operating deficit of about 1.5% on average in 2015-2017, compared with a 3% deficit in 2014 and a surplus of 1% on average in 2011-2013.
Under our base-case scenario, we assume that capital grants from Bashkortostan will alleviate pressure on the city's budget over the medium term. This co-financing should allow Ufa to maintain its capital expenditure program at about 20% of total expenditure in 2015-2017, while its deficits after capital accounts will likely stay at a modest 4%-5% of total revenues on average, almost the same as the average level in 2012-2014.
Consequently, we expect Ufa's direct debt to increase only gradually and tax-supported debt to remain low compared with that of international peers. We forecast in our base-case scenario that Ufa's tax-supported debt won't exceed 60% of consolidated operating revenues through to the end of 2017. Tax-supported debt includes the city's direct debt, budget guarantees issued to support infrastructure investment projects, and debt of non-self-supporting government-related entities.
We consider Ufa's contingent liabilities to be low because we already include city-owned companies' debt in our tax-supported debt calculation. Still, utility networks, transport, and water companies might require some financial support from the city. Last year, the city, together with cofinancing from Bashkortostan, provided support to the utility networks company.
We view Ufa's financial management as weak in an international comparison, as we do that of most Russian LRGs, mainly due to the lack of reliable budgeting and long-term financial planning. Furthermore, we consider the city's policy for its government-related entities to be unclear.
We have revised our view of Ufa's liquidity to less than adequate from adequate, as our criteria define the terms. We now forecast that the city's average cash reserves, together with credit facilities from banks, will cover less than 80% of debt service falling due within the next 12 months. That said, we continue to view the city's access to external liquidity as limited, given the weaknesses of the domestic capital market. We have revised our Banking Industry Country Risk Assessment for Russia to group '8' from group '7', where group '1' indicates the lowest- risk system and '10' the highest risk (see "Banking Industry Country Risk Assessment Update: March 2015," published March 6, 2015, on RatingsDirect. At the same time, we consider that Ufa has strong access to budget loans provided by Bashkortostan.
In our base-case scenario, we forecast that over the next 12 months, Ufa's cash reserves, together with credit facilities, net of the deficit after capital accounts, will total about Russian ruble (RUB) 950 million (about $15.5 million at the time of publication) on average. This amount covers 70% of Ufa's debt service falling due in the next 12 months. We expect that, in 2015-2016, the city will continue to rely on medium-term credit facilities for refinancing and liquidity purposes, which it usually organizes during the budget year ahead of debt maturity dates. However, we note that, since late 2014, financial markets have offered higher interest rates and shorter-term maturities, which might require a stronger effort from Ufa to stick to its existing debt and liquidity policies.
On the other hand, Ufa has good access to low-interest-rate budget loans from Bashkortostan and we think the city is likely to receive about RUB750 million annually in 2015-2017.
The negative outlook reflects our view that currently turbulent conditions in the Russian financial markets might constrain the city's existing refinancing plans, leading to weaker liquidity.
We could take a negative rating action in the next 12 months if, as envisaged in our downside scenario, the following factors combine:
The city is unable to secure adequate credit facilities, resulting in its debt-service coverage ratio sliding below 40%;
Our assessment of banking industry and country risks in Russia weakens further;
Access to budget loans is reduced or limited; and
The city's interest payments exceed 5% of operating revenues on average in 2015-2017 as a result of the higher cost of debt.
We might revise the outlook back to stable if the city manages to stick to its existing debt and liquidity policies despite weakening market conditions.