ACRA affirms credit rating of the Kaliningrad Region at BBB-(RU), outlook Stable and affirms bond issue credit rating

The credit rating assigned to the Kaliningrad Region (hereinafter — the Region) is determined by the influence of one procyclical industry on the regional economy, the tightness of the local market, and a heavy reliance of budget indicators on federal transfers.

The credit rating of bond issue of the Kaliningrad Region (RU34001KLN0) has been affirmed and is equivalent to the credit rating of the Kaliningrad Region.

The Kaliningrad Region belongs to Russia’s North-Western Federal District and has no land borders with other RF regions. Its population makes up less than 1% of the country’s total. In 2015, its gross regional product (GRP) amounted to RUB 304 bln (roughly 0.5% of Russia’s aggregate GRP).

Key rating assessment factors

Federal-market-driven economy. Industrial manufacturing forms the foundation of the Region’s federal-market-driven economy (23% of GRP). The industry comprises vehicle manufacturing and food processing (50% and 33%, and 25% and 35% in 2014 and 2015, respectively). Although the regional budget does not rely on one large taxpayer, significant tax risks are brought by the tightness of the local market, the logistical remoteness of local manufacturers from their primary sales markets, and the procyclical nature of vehicle manufacturing.

Federal-transfer-reliant budgeting. On average, own revenues amount to 61% (2014–2016), which signals of a moderate reliance of the regional budget on government financing. At the same time, ACRA notes that the Region’s economy and taxation base are highly dependent on federal support measures, namely on earmarked federal funding provided since 2016 to reimburse the elimination of customs privileges for its SEZ (special economic zone) residents.

Capital expenditures are financed from the federal budget. The building of new infrastructure in 2014–2016 was made possible by earmarked federal programs in the highway construction and housing & utilities sectors. In 2017–2018, the lion share of capital expenditures will be channeled into the new 2018 FIFA World Cup infrastructure, while funding of the housing & utilities sector will be limited to the level required to maintain the current 70% wear and tear level of the existing infrastructure.

Refinancing risk alongside a significant share of long-term loans. According to the Region’s debt strategy, share of fiscal loans shall decline from 53% at year-end 2016 to 33% by year-end 2019, with a pro rata increase of bond share in the debt portfolio. Generally, leverage indicators suggest medium credit risk level; however, additional pressure on the budget is exerted by the debt of public sector enterprises suffering from an unstable financial situation and the debt of municipalities (that has partly decreased in 2016).

Key assumptions

  • Maintaining federal transfer volumes compensating producers’ customs privileges;
  • Prolongation of the state program for development of the Kaliningrad Region
    until 2025;
  • Possibility of debt redemption (support) of municipalities and public sector companies from the regional budget;
  • Longer debt portfolio strategy implementation.

Potential outlook or rating change factors

The Stable outlook assumes that the rating will most likely stay unchanged within the
12 to 18-month horizon.

A positive rating action may be prompted by:

  • Diversification of the industrial output structure in the Region and reduction of its dependence on procyclical production;
  • Engineering infrastructure development aimed at replacement of obsolete fixed assets;
  • A change in debt structure in terms of building up proportion of longer debt;
  • An improvement of municipalities’ and public sector companies’ financial situation;
  • An increase in the budget liquidity level.

A negative rating action may be prompted by:

  • A significant curtailing of federal transfers that compensate for customs privileges granted to local producers;
  • A dramatic decline in the proportion of federal transfers spent on capital expenditures;
  • A debt portfolio growth while maintaining the current redemption schedule.

Issue ratings

The Agency believes that bond issued by the Kaliningrad Region (RegS RU34001KLN0 /
ISIN RU000A0JS29) has a status of senior unsecured debt. Credit rating of this debt instrument corresponds to the credit rating of the Kaliningrad Region.

Key issue properties

The credit ratings of the Kaliningrad Region and bond issued by the Kaliningrad Region have been assigned under the national scale for the Russian Federation based on the Methodology for Credit Ratings Assignment to Regional and Municipal Authorities of the Russian Federation and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities. In the course of assigning a credit rating to the bond issue above, Methodology for Assigning Credit Ratings to Individual Issues of Financial Instruments under the National Scale of the Russian Federation has also been used.

For the first time, a credit rating has been assigned to the Kaliningrad Region on December 20, 2016. The credit rating and its outlook have been revised on June 20, 2017. The next revision of the credit rating and its outlook is expected to occur within 182 days following the rating action date (as per calendar of planned sovereign rating revisions and publications).

For the first time, a credit rating has been assigned to the Kaliningrad Region bond issue on December 23, 2016. The credit rating has been revised on June 20, 2017. The next credit rating revision is expected to occur within 182 days following the rating action date (as per calendar of planned sovereign rating revisions and publications).

The assigned and affirmed credit ratings are based on the data provided by the Kaliningrad Region, information from publicly available sources (the Ministry of Finance, the Federal State Statistics Service, and the Federal Tax Service), as well as ACRA’s own databases. The credit ratings are solicited, and the Kaliningrad Region participated in their assignment and affirmation.

No material discrepancies between the provided data and the data officially disclosed by the Kaliningrad Region in its financial statements have been discovered.

ACRA provided no additional services to the Kaliningrad Region. No conflicts of interest were discovered in the course of credit rating assignment and affirmation.

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