On Sept. 11, 2015, Standard & Poor's Ratings Services revised the outlook on the Russian city of Ufa to stable from negative. At the same time, we affirmed our 'BB-' long-term issuer credit rating and 'ruAA-' Russia national scale rating on the city.
We revised the outlook on the ratings to stable from negative, since our previous concerns haven't materialized. Ufa has consolidated its debt and liquidity position by securing credit facilities, and we believe this will allow the city to achieve a debt service coverage ratio above 80% in the next 12 months. Its interest payments have also remained well contained at less than 5%.
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 a global 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 burden and low contingent liabilities supports the ratings. The issuer credit rating on the city is equal to its 'bb-' stand-alone credit profile.
Ufa's wealth level is low in an international context, although it exceeds the republic's average. Ufa's gross regional product per capita was about $11,000 in 2014, which is in line with the national average. We expect that Ufa's wealth will increase in line with the national rate.
In our view, Ufa's budgetary flexibility is very weak, due to its exposure to federal and regional government decisions regarding tax shares, the allocation of transfers, and the redistribution of spending responsibilities. We estimate that, in 2015-2017, transfers from higher government tiers and personal income tax, which are regulated by the federal and 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 will continue in the medium term.
In our base-case scenario for 2015-2017, we expect Ufa's budgetary performance will slightly improve over 2015-2017, but remain weak on a five-year average. This is due to the economic slowdown and a one-time financial deterioration in 2014 when the city increased spending to prepare for the Shanghai Cooperation Organization and BRICS summits, which the city hosted this summer. 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 implies that the city's operating balance will improve and Ufa will post a very modest operating deficit of about 0.6% on average in 2015-2017, compared with a 3% deficit in 2014. However, we note that the economic slowdown has undermined the city's key revenue source, personal income tax, which displayed no growth in the first half of 2015 year on year. Should this trend continue and be accompanied by looser cost control, Ufa's operating deficits might further weaken from the 2014 low, as envisaged in our downside scenario.
Under our base-case scenario, we also assume that capital grants from Bashkortostan will alleviate pressure on the city's budget over the medium term. In our view, this cofinancing should allow Ufa to maintain its capital expenditure program at about 20% of total expenditures, while its deficits after capital accounts will likely stay at a modest 3% of total revenues on average in 2015-2017 compared with almost 8% on average in 2012-2014.
Consequently, we expect Ufa's direct debt will increase only modestly and tax-supported debt will remain low compared with that of international peers. We forecast in our base-case scenario that Ufa's tax-supported debt will remain well contained below 50% of consolidated operating revenues to end-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 (GREs).
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. The city continues to provide ongoing support to its GREs.
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 GREs to be unclear.
We view Ufa's liquidity as less than adequate, as our criteria defines the term. We base our assessment on the city's adequate debt-service coverage and its limited access to external liquidity.
Because the city managed to secure credit facilities worth Russian ruble (RUB)1.3 billion (about $19 million at the time of publication) earlier this year, we expect in our next 12 months base-case scenario that Ufa's free cash reserves, together with available committed credit facilities, net of the deficit after capital accounts, will total about RUB1.3 billion on average. This amount covers 84% of Ufa's debt service falling due in the next 12 months. Our base-case scenario also factors in our expectation that the city will continue to implement its current debt and liquidity policies in 2016-2017, by relying on medium-term credit facilities for refinancing and liquidity purposes (some of which come from the Republic of Bashkortostan). These facilities are put in place during the budget year ahead of debt maturity dates.
At the same time, similar to peers, we view the city's access to external liquidity as limited, given the weaknesses of the domestic capital market (see "Various Rating Actions Taken On Russian Banks Due To Rising Economic Risk," published Feb. 24, 2015, on RatingsDirect).
The stable outlook reflects our expectation that slightly improving--albeit still weak--budgetary performance, notably supported by transfers from higher government tiers, will enable Ufa to maintain a debt service coverage ratio above 80% and a low debt burden in the next 12-24 months.
We could take a negative rating action within the next 12 months if the city were no longer in a position to sustain an 80% debt service coverage ratio, possibly as a result of slower tax revenue growth and/or weaker support from higher government tiers than we currently expect. Such deterioration could possibly cause us to revise downward our assessment of the city's liquidity.
We could raise the ratings within the next 12 months if, in line with our upside scenario, additional budget revenues and a cautious approach to expenditure resulted in positive operating margins and a debt service coverage ratio exceeding 120%. However, we view this scenario as unlikely.