The oblast’s fiscal flexibility is weak as it is highly dependent on the federal government, which controls its revenue sources and spending mandates, including increases in public-sector salaries, as was the case before the elections in 2011. Despite federal support and some cost-containment measures, the oblast’s budgetary performance weakened substantially and it reported material operating and after-capital-accounts deficits in 2009-2011.
In April 2012, Vologda’s newly appointed governor announced an ambitious deficit-reduction program, which implies spending cuts of at least Russian ruble (RUB) 3.7 billion (about $120 million) this year and a conservative budget plan for 2013. The implementation of this agenda could lead to a recovery of the oblast’s financial performance after a poor 2011. Our revised base-case scenario factors in the new management’s plan, and we now assume an operating surplus of 1%-2% of operating revenues and deficits after capital accounts of 4% in 2012-2014 on average. This scenario is based on two assumptions, however:
-- The ability and willingness of Vologda’s new management to stick to its announced cost-containment policies, both in terms of operating and capital spending; and
-- Additional support from the federal budget through larger operating and capital grants, which would make up for a slow revenue recovery. This is because the federal government displayed its support of underperforming regions during the 2009 downturn. We regard Vologda as one of the key targets for additional state support in 2012-2013 because it is one the most indebted and weakest performers across Russia’s local and regional governments.
Due to weak financials, Vologda’s tax-supported debt is likely to peak to about 70% of consolidated operating revenues in 2012, which we still consider moderate by international standards, yet material in the Russian context. The oblast’s debt will consist of direct debt (at present, 70% of the total) and guarantees and minor debt of its government-related entities (GREs). Budget consolidation will likely cause Vologda’s debt to decrease and stabilize at about 60% of consolidated operating revenues.
Given the oblast’s modest involvement in the local economy, we regard the size of its contingent liabilities, comprising GREs’ and local governments’ payables, as low.
We regard Vologda Oblast’s liquidity as “very negative,” as defined in our criteria. Its liquidity position was volatile throughout 2011 and early 2012, with cash as of early April 2012 accounting for slightly more than 40% of debt service over the next 12 months.
Notwithstanding the new management’s efforts to extend the oblast’s debt profile, Vologda Oblast remains exposed to significant refinancing risks because of its sizable debt. The need to repay budget loans, obtained in 2009-2010, as well as a concentration of bank loans maturing in 2014, will translate into persistently high debt service in the medium term.
Assuming that the federal government would refinance at least 50% of Vologda’s budget loans, as a means of support, and that Vologda would stick to at least medium-term borrowings, we estimate its debt service at 12% of operating revenues on average in 2012-2014 under our base-case scenario.
Despite relatively good access to bank lending, according to our methodology, we qualify Vologda’s access to financial markets as “limited” by international standards. This is because of what we see as a weak domestic bank system and the limited development of Russia’s capital market.
Vologda Oblast’s senior unsecured debt is rated ‘B’ and ‘ruA’. The ‘3’ recovery rating on this debt indicates our expectation of “meaningful” recovery (50%-70%) in the event of a payment default.
The stable outlook reflects our view that additional support from the federal government and the oblast’s new management’s cost-containment agenda for 2012 will counterbalance what we believe will be an only modest recovery of Vologda’s tax and nontax revenues in the medium term. We anticipate that the increased state support could stem from stronger grants and the extension of budget loans. This would result in Vologda delivering operating surpluses of 1%-2% and deficits after capital accounts of about 4% of revenues on average in 2012-2014. We also anticipate the oblast’s debt stabilizing at about 60% of consolidated operating revenues in the medium term.
Our downside scenario implies the absence of additional support from the federal government and/or management’s inability to implement its cost-containment agenda in 2012. We believe this would result in continually weak budgetary performance, mounting debt, and--without a material improvement of the debt profile--higher refinancing risks.
We could take a positive rating action if Vologda’s budgetary performance in 2012-2013 were structurally stronger than we assume for our base case, leading to lower debt (less than 60% of consolidated operating revenues) and improved liquidity. This could be due to management’s extraordinary austerity policies compared with existing plans and/or stronger-than-expected financial support from the federal government.
Related Criteria And Research
-- Methodology For Rating International Local And Regional Governments, Sept. 20, 2010