Fitch Ratings on November 18 upgraded the Ukrainian City of Kharkiv's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to 'B-' from 'CCC', and Short-Term Foreign Currency IDR to 'B' from 'C', the rating agency said in a statement.

The outlook on the Long-Term IDRs is stable.

Fitch also revised the outlook on the city's National Long-Term rating to Stable from Negative and affirmed it at 'A+(ukr)'.

Fitch says that the upgrade follows the upgrade of Ukraine's Long-Term Foreign and Local Currency IDRs on November 11, 2016 as the city is rated at the same level as the sovereign.

The revision of the Outlook on the National Long-Term rating reflects Fitch's expectations of stabilization in the national economic environment, with mild restoration of Ukraine's GDP and easing inflation, which should be positive for the city's economy.

According to Fitch, the upgrade of the city of Kharkiv's IDRs and revision of the Outlook on the National Long-Term rating reflect the following key rating drivers and their relative weights: The city's ratings remain constrained by Ukraine's ratings (B-/B) and a weak institutional framework governing Ukrainian local and regional governments. The framework is characterized by political tensions and challenging reform agenda implied by Ukraine's IMF program to secure additional external funding. This has resulted in frequent changes in the allocation of revenue sources and the assignment of expenditure responsibilities, which limits forecasting ability and hinders the strategic planning of local and regional governments in Ukraine.

Fitch says it expects that the improved macroeconomic stability should positively impact the city's economy. Fitch has recently revised its forecast for Ukraine's economy and expects mild GDP growth recovery of 1.1% in 2016 and 2.5%-3% in 2017-2018, following a 9.9% contraction in 2015. The inflation pressure has eased to an expected 10%-15% in 2016-2017 and 8% in 2018 after 48.5% in 2015.

The city of Kharkiv is the capital of the country's fourth-largest region, which contributed 6% of Ukraine's GDP in 2014. Kharkiv region's GRP per capita is close to the national average, although that of the city is likely to be higher as it is the wealthiest municipality in the region. Kharkiv is one of the country's key scientific, industrial and cultural centers. Its economy is diversified across manufacturing and services, and supported by a large number of companies.

The city's IDRs also reflect the following key rating drivers:

Fitch says its base case scenario is that the city's budgetary performance will remain satisfactory over the medium term with an operating balance above 15% of operating revenue (2015: 25%) and deficit before debt variation of 1%-3% of total revenue (2015: surplus 7%). In the nine months of2016, Kharkiv recorded fiscal surplus of UAH 864 million, supported by a good dynamic in tax revenues. However, future growth is uncertain, in Fitch's view, due to unpredictable fiscal changes and the overall weakness of sovereign public finances in Ukraine.

Fitch says it expects the city will remain free from direct debt in 2016-2018 after it repaid its outstanding bank loan in 2015. Kharkiv does not plan to borrow over the medium term and will fund any fiscal deficit from its cash balance. The city's liquidity amounted to UAH 1.6 billion at end-September 2016, which covered two months of its budgeted expenditure for 2016, providing some cushion in case of stress.

Kharkiv's exposure to contingent risk is growing. Its public sector debt doubled during 2011-2015 to UAH 565 million. 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 totaled about UAH 400 million, or 5% of the city's operating revenue. Disclosure of the PSEs' performance in 2015 is limited to the largest 15 of 72 PSEs in the city.

Fitch says that the city's ratings are constrained by the sovereign. Any rating action on Ukraine's sovereign IDRs would lead to a corresponding rating action on the city's ratings.