Training on sovereign risk credit analysis, October 24

Most leveraged regions may struggle to receive public budget loans

Regional leverage analysis

  • Cheap loans from the federal budget will be available only for the regions that control their debt growth and budget deficit. Starting January 1, 2017, a region may be eligible for state support only if its debt-to-fiscal revenues ratio is not growing, while the proportion of commercial debt in its total debt and the level of budget deficit are kept within limits. Regions boasting a broad tax base may count on preferential treatment.
  • Certain regions are running an increased refinancing risk, with six of them suffering from excessive commercial debt. Therefore, their eligibility for public budget loans looks highly questionable and special purpose transfers from the federal budget may be needed to support their financial standing.
  • Regions will inevitably face a further increase in commercial debt, while it already prevails in their liabilities. In 2016, when we expect an increase in the consolidated deficit of the regions to Rub 148 bn, their commercial debt may grow up to Rub 1.54 trillion.

Public budget loans issuance to be subject to firmer budget control and debt discipline

The observed increase in the amount of public budget loans provided to the regions is aimed at stabilizing their debt burden, which started to grow fast in 2013. The increase in debt is mainly due to the federal authorities aiming to raise wages in public sector. Initially, a portion of additional expenditures from the regional budgets was assumed to be covered by the federal budget, while the remainder was left to be financed by the regions on their own.

Despite optimizing some regional budget items and restructuring expenditures to favor the wage fund, many regional governments were still forced to build up commercial debt. In the end, fueled by economic downturn and slower budget revenues growth, the regional debt burden has become excessive running into and at times exceeding 5% of total expenditures of a region. As a result, already in 2014 the Ministry of Finance was forced to double the volume of loans allocated to the regions which nevertheless has not relieved them from the need to keep on taking out bank loans (see Figure 1).

Figure 1. Structure and dynamics of total regional debt, Rub bn

* Forecast
Source: Minfin, ACRA estimates

With an interest rate of 0.1% per annum and maturities of up to three years, public budget loans are the most attractive tools for financing regional budget deficits. The total of these loans to be disbursed in 2016 has so far remained flat at the 2015 level of Rub 310 bn, with regions' eligibility for this financing regulated by the Russian Government Decree N 40 of 27.01.2016.

As in 2015, the ability of a region to access federal financing in order to cover part of its budget deficit is subject to a system of indicators. Loan allocation decisions are based on the following two ratios: budget deficit to fiscal revenues and debt to fiscal revenues (the term 'fiscal revenues refers to budget revenues net of non-repayable receipts). In comparison, last year the regulation called for a reduction of deficit to 10% of fiscal revenues by January 1, 2017, and regions were differentiated by their budget deficit to fiscal revenues ratio. This year, the regulator assumed that the anticipated deficit level has been reached, so the covenants imposed on the regions depend on the local debt to fiscal revenues ratio.

Table 1. Public budget loans issuance rules in 2015 and 2016

*Fiscal revenues.
Source: Russian government

The regions reaching the target deficit level this year may further increase their commercial debt without jeopardizing their eligibility for public budget loans in 2017.

In practice, however, public budget loans will be granted to the regions able to withhold from large bank borrowings or bond issuance for financing budget deficit and at the same time boasting a broad tax base, in order to replenish budgets mainly by taxes and levies. Moreover, such regions are to ensure that their debt burden either declines or at least stays flat.

High commercial leverage of certain regions to require individual solutions

We expect over a half of the Russian regions to be eligible for public budget loans in order to partially finance their budget deficits in 2016.

In 2014, 31 regions were able to keep their fiscal revenues to deficit ratio within 10%, while in 2015 their number increased to 42 (excluding the Crimean Federal District in both cases). However, half of the regions failed to achieve the required ratio and in some of them the situation continues to deteriorate.

On the other hand, the results of budgets execution in 2015 show that six regions – Ivanovo, Kostroma, Omsk region, Republic of Khakassia, Mordovia and Mari El – have a commercial debt exceeding 70% of their fiscal revenues. This perspectively prevents them from qualifying for long-term public budget loans and forces to increase commercial debt, causing additional pressure on their budgets. We expect that of these six regions only Mordovia may attain the required commercial debt-to-fiscal revenues ratio by end 2016.

Figure 2. Highly leveraged regions (debt-to-fiscal revenues ratio as of January 1, 2016)

Source: Federal Treasury, Finance Ministry, ACRA estimates
 

The regions' excessive debt burden issue could be resolved by special purpose transfers from the federal budget. Apparently, in some cases these transfers will be inevitable if the debt-to-fiscal revenues ratio requirement is stiffened by January 1, 2018.

Early in 2016, the regions carried a debt of Rub 2.32 trillion (net of municipal liabilities), which equals more than one third of their total fiscal revenues. This amount includes commercial debt of Rub 1.40 trillion (60% of total fiscal revenues). Although the consolidated figure hardly looks critical it is excessive in terms of individual regions (see Figure 2).

Regions with a high commercial debt are to face an inevitable increase in refinancing risk, as in an adverse market conditions they might fail to meet the federal lending criteria and will be forced to build up bank debt. Those of them that boast a large share of public budget loans will be devoid of this risk, unless failing to comply with the deficit requirement.

Growth in commercial loans appears inevitable

The volume of regions’ bonds to be redeemed in 2016 will run into around Rub 130 bn (Rub 92 bn net of Moscow), while the amount of bank loans to be repaid should exceed by our estimates Rub 950 bn. This leaves over Rub 1 trillion of commercial debt to refinance. Public budget loans allowed to avoid an exponential growth in commercial liabilities in 2014-2015, but in current environment the volume of state support is hardly sufficient to prevent a surge in commercial debt burden.

The sub-federal bond market has shown a slight contraction for the second year in a row, with redemptions exceeding borrowings. The net volume of bank loans received has also shrank, while the amount of public budget loans has increased.

Figure 3. Regional borrowings and redemptions, Rub bn

Source: Finance Ministry, ACRA estimates
 

As we noted in our previous report issued on March 2, 2016, and titled “Regional Budgets to be Saved Again by Public Budget Loans in 2016” we expect regional budgets to further build up deficits coupled with corresponding debt burden growth in 2016, implying the need not only to refinance, but to increase debt. The bond market is highly dependent on the placement conditions, and we do not believe that refinancing volumes will exceed redemptions in 2016 even with Moscow's ambitious borrowing program being taken into account. The most practical way to refinance and build up debt is to tap bank loans and partly public budget loans.

The regions may see their bank debt rising by up to 15% in 2016. As we do not expect the substantial increase of bonds’ share in regional debt portfolios the total amount of commercial debt may run according to our estimates into Rub 1.54 trillion by year end.

Public budget loans are expected to grow 6-8% on average in 2016, with part of them to be spent on refinancing while the other part covering the cash gaps.

By end 2016, regional debt is expected to climb 9% to Rub 2.4 trillion net of state guarantees.

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