Russian regional governments face an increasing likelihood of defaults, says Standard & Poor's Ratings Services today in a report: Is The Russian State Supportive Enough To Prevent Regional Government Defaults In 2015?.
"This is reflected in our primarily negative rating actions in the last 18 months, resulting from what we regard as weak prospects for economic growth and a slowdown in corporate profits and nominal personal income growth," said Standard & Poor's credit analyst Karen Vartapetov. "This undermines regions' key revenue sources--corporate profit tax and personal income tax
At the same time, the pressure from the federal government to increase inflexible socially-related spending leaves regions with almost no choice but to increase their deficits and debt. This puts regions in the unsustainable position of financing operating expenditures by borrowing, the report says
Although Russian regions' cumulative debt remains low by international standards (direct debt plus guarantees will likely rise to an average of 55%-57% of operating revenues by 2018, from 33% at year-end 2014), the relatively short maturity of the debt exposes regions to constantly increasing refinancing risks.
Russian market participants and public officials increasingly state that defaults of Russia's regional governments are very unlikely, because they say the federal government will provide support. However, Standard & Poor's believes that regional defaults in Russia are not only likely, but have already been taking place according to our definitions, the report says.
Standard & Poor's would assess an entity to be in default if it did not honor its debt obligations in full or on time, or both. Some market participants in Russia, however, may consider a regional government to be in default only if it doesn't meet its public debt obligations, i.e., only on bonds.
"According to information and data collected from sources we consider to be reliable, in the first quarter of 2015, there was at least one case of a non-rated regional government delaying a principal repayment on a bank loan because of the region's lack of access to market refinancing," said Mr. Vartapetov. We are also aware of cases in which banks renewed loans to regional governments at below-market interest rates, as those governments were unable to repay or refinance the loans. Depending on the details of such debt rollovers, Standard & Poor's might classify such cases, as distressed exchange offers, as akin to default. We are also aware of cases in which regions were unwilling to honor budget guarantees or when such guarantees were unilaterally withdrawn by regions before expiry dates.
Despite the material size of transfers and loans from the federal government to the regions (about 3% of GDP on average annually), federal support is not designed to meet debt service needs of the regions, in our view. Even if federal funds are provided to remove the refinancing pressure from a region, this support is often not timely and its allocation criteria is only modestly predictable.