- We assume that Russian local and regional governments could face their highest budget deficits since the turn of the century.
- In our view, recession and low commodity prices will substantially reduce Russian regions' tax revenue in 2020-2021.
- The federal government is providing substantial liquidity support to Russian regions, but it will fall short of fully compensating lower revenue.
- As a result, the deleveraging trend of recent years will reverse this year and regions' debt burdens could climb to 30% of operating revenue by the end of 2022.
Russian regions' budgets are coming under great pressure from the recession provoked by lower oil prices and the social distancing measures to slow the spread of COVID-19. S&P Global Ratings is projecting steep shortfalls in revenue that will push Russian LRGs to their highest budget deficit in the 21st century, reaching 6%-9% of their total revenue. The magnitude will depend on the exact amounts of tax revenue decline, possible expenditure cuts, and potential federal support.
In response, the central government has introduced a package of supportive measures to fortify regional budgets:
- Structural means, such as additional federal grants and temporary removal of legal limits on budget deficits and debt burdens.
- Liquidity support mechanisms, such as deferral of budget loan payments, extending the short-term treasury facility, and the right to provide budget loans between regions from 2021.
We believe that these measures will certainly alleviate the immediate pressure on the liquidity position of local and regional governments (LRGs). Their structural budgetary performance will suffer regardless, however. Supplementary central government transfers and restructured loans will fill as little as 20% of their total 2020 financing needs or less than half of the increased needs (financing needs include the overall projected deficit and debt service, but exclude supporting measures). As a result, we project LRGs' debt burdens will climb to 30% of operating revenue by 2022 after years of continuous decline.
S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
Budgetary performance is set to weaken
We believe that LRGs' fiscal performance will weaken as we approach the end of the second half of 2020, unless additional revenue from the federal level supports regional balances. As a consequence of the tax-revenue decline and assuming moderate cuts in capital expenditure, we project that the overall Russian LRG sector deficit in 2020 will be pushed to 6%-9% of total revenue, versus the small 2% we expected previously (see chart 1). We note the high uncertainty regarding the exact amounts of tax revenue decline, possible expenditure cuts, and potential federal support. Therefore, our forecast assumes a few financial scenarios. We believe, however, that in 2020, LRGs will likely report the weakest results since the turn of the century, with the margin to decline in the range between our scenario 1 and scenario 2.
The recession, lower commodity prices, additional state-mandated paid nonworking days, and business support programs will reduce regions' tax revenue in 2020. We anticipate that LRGs' three main tax sources of income--corporate profit tax, personal income tax, and property tax--will be crucially restricted. At the same time, we believe that operating spending will continue growing, while LRGs could moderately cut some capital expenditure. They will have to make challenging political decisions on prioritizing spending. The implementation of federally mandated national projects, combined with the already high level of inflexible social expenditure, now has the extra spending related to COVID-19 added to it.
We believe that the commodity-dependent regions will face the largest revenue loss this year. Nevertheless, their accumulated cash cushions and large borrowing capacity will allow them to absorb temporary elevated deficits without a substantial impact on their creditworthiness. But the magnitude of the financial damage will depend on the depth and duration of the revenue shortfall.
Additional support from the federal government can help ease liquidity pressure, but will likely fall short of addressing the structural imbalance
The Russian government is providing minor additional grants to the regions in 2020. We think this support will not be sufficient to meet their potential revenue shortfall resulting from the recession. The federal government plans to transfer Russian ruble (RUB) 200 billion (about US$2.7 billion on May 6) in supplementary balancing grants to compensate for lost tax revenue, and an additional RUB80 billion for medical equipment. Although it will help the regions in the short term, we estimate it will cover only around one-third of the projected deficit this year.
At the same time, some of the liquidity support measures the federal government has proposed could ease pressure on regions' creditworthiness in the short term. These include temporary removal of the legal limits imposed by the budget loan restructuring agreement on the budget deficit and debt burden.
Previously, if a region exceeded any of the limits of a budget loan, it would have had to repay the full principal within one year. We believe that LRGs will benefit from this measure, because if they break the agreement they will not have to issue expensive market debt to repay the budget loans. Nevertheless, according to the statement by the Ministry of Finance, the removal of the limits is temporary and regions are allowed to exceed the limits only in the amount of funds they spend on supporting the economy and eliminating COVID-19 countermeasures and associated revenue shortfalls. The lack of detailed explanations and precise criteria allowing the federal government to define the particular expenditure lines creates ambiguity in LRGs' decision-making process. This might, in turn, lead to material widening of deficits and hikes in debt burdens, which the federal authorities have been trying hard to curb over the last two years, and undermine all the previous consolidation efforts.
As we had expected, the central government has deferred budget loan payments, extending the maturity by 10 years (we do not consider it a default when a local government fails to honor intergovernmental debt, see "Credit FAQ: What Does S&P Global Ratings Consider A Default For Sovereign And Non-U.S. Local And Regional Governments?," published April 13, 2017). However, although the federal government is the largest creditor to LRGs, budget loans do not weigh materially on regional redemptions. They constitute only 16% of planned annual debt repayments due in 2020, which are dominated by capital market debt.
The duration of short-term loans from the Federal Treasury has been extended to 180 days from 90. Short-term loans have proven a successful means of reducing liquidity risks and lowering the cost of debt for Russian LRGs. At the same time, there is a lack of clarity as to whether this instrument could be contracted in December, which could trigger the accumulation of market borrowing toward the year-end.
The federal government also proposed to allow cross-regional budget loans; however, the effectiveness of such loans has not been tested. We believe that LRGs will not only lack sufficient funds to lend to peers, but will need to attract financing themselves. Additionally, any remaining reserves will be assumed as spent in the next budget cycle. We believe that this mechanism will be rather beneficial for neighboring regions that are jointly involved in infrastructure projects. But we estimate the scope of the funding through horizontal loans will be minor and will not transform into a comprehensive liquidity instrument for regional governments.
In 2020, we expect to see a reversal of Russian LRGs' recent deleveraging trend
We project that expanding deficits will reverse the deleveraging trend that Russian LRGs demonstrated in 2017-2019, and likely boost their direct debt to 30% of consolidated operating revenue by the end of 2022 (see chart 2). LRGs that regularly issue bonds enjoy good access to the market and will increase their placements this year, which could cover as much as 30% of their 2020 borrowing needs. The regions with smaller effective deficits, however, will likely rely on bank loans. At the same time, we believe that some of the weakest LRGs might experience difficulty attracting market financing and securing bank loans, and therefore have to seek federal support through transfers or budget loans.
We anticipate that the pace of LRGs' total debt accumulation will be affected by the borrowing plans of Moscow and the large oil- and gas-producing regions. These regions will likely have to spend the more than RUB1.0 trillion they have accumulated in cash before they return to the capital markets for funding. Therefore, the major part of reserves on regional accounts will likely be consumed by 2021 and LRGs that have depleted their accumulated funds will likely then turn to the capital markets.
This report does not constitute a rating action.
|Primary Credit Analysts:||Natalia Legeeva, Moscow (7) 495-783-40-98;|
|Felix Ejgel, London (44) 20-7176-6780;|
|Additional Contacts:||Victor Nikolskiy, Moscow (7) 495-783-40-10;|
|Sabine Daehn, Frankfurt (49) 69-33-999-244;|
|Boris Kopeykin, Moscow (7) 495-783-40-62;|
|EMEA Sovereign and IPF;|
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