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RA Fitch Affirms Ukrainian City of Kharkov at 'CCC'

May 23, 2016 | Cbonds

Fitch Ratings has affirmed the Ukrainian City of Kharkov's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'CCC', and Short-Term Foreign Currency IDR at 'C'. Fitch has also affirmed the city's National Long-Term rating at 'A+(ukr)' with a Negative Outlook.


The ratings are constrained by the ratings of Ukraine (CCC) and a weak institutional framework. The ratings also reflect Fitch's unchanged base case scenario regarding the city's satisfactory budgetary performance and low debt over the medium term.

The Negative Outlook on the National Rating reflects a volatile macro-economic environment in Ukraine and weak prospects of an economic recovery over the medium term.

KEY RATING DRIVERS
The weak institutional framework governing Ukrainian local and regional governments remains a constraint on the city's ratings. The framework is characterised by frequent changes to the allocation of revenue and expenditures and by a lack of clarity, hindering the long-term development and budget planning of local and regional governments in Ukraine.

The City of Kharkov is currently free from external debt obligations. In 2015, the city repaid its outstanding bank loan of UAH294m and has no plans to raise new debt over the medium term. Weak national debt capital markets also limit access to funding, indirectly allowing the city to maintain a balanced budget.

Our base case scenario is for the city's budgetary performance to remain satisfactory over the medium term with an operating balance at above 15% of operating revenue. A mild budget deficit will be funded by the city's accumulated liquidity (2015: UAH752m). Downside risks stem from unpredictable fiscal changes, the overall weakness of sovereign public finances and a volatile economic environment in Ukraine. Fitch projects the Ukrainian economy will grow 1%-2% in 2016-2017 after contracting 11.6% in 2015 and 6.8% in 2014, indicating a slow recovery of the city's economy.

In 2015, Kharkov recorded an operating balance of 25% (2014: 10%) of operating revenue and a surplus of 7% of total revenue (2014: deficit 4%). The central government made significant amendments to Ukraine's budget and tax codes, leading to a sharp increase in operating revenue for the city in 2015. The growth was driven by a 22% increase in tax revenue resulting from new taxes, higher tax rates and high national inflation (2015: 48%), and an increase in current transfers from the central government to finance the city's new social responsibilities.

Kharkov's exposure to contingent risk has increased as public sector debt doubled during 2011-2015 to UAH565m. The debt stock increase is mainly attributable to some utilities companies and the city's park, with some exposure to forex risk. Most of the city's public sector entities (PSEs) are loss-making and depend on subsidies to sustain operations. In 2015, compensating subsidies and capital injections granted to PSEs totalled about UAH400m, or 5% of the city's operating revenue. It should be noted that disclosure of PSE's performance in 2015 is limited to the largest 15 PSEs out of 72 PSEs in the city.

RATING SENSITIVITIES
A downgrade of the sovereign's IDRs would lead to a corresponding action on the city's IDRs. In the absence of a sovereign downgrade, significant deterioration of Kharkov's credit profile could also lead to a negative rating action.

A sovereign upgrade would be reflected in the City of Kharkov's ratings. However, the ratings will likely remain low, given significant country risks and Ukraine's 'CCC' Country Ceiling.

Company: Kharkov City

Full company nameKharkov City Council
Country of riskUkraine
Country of registrationUkraine

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