Fitch affirms Ukrainian city of Lviv at 'B-', outlook stable
Fitch Ratings has affirmed the Ukrainian city of Lviv's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B-', the outlooks are stable, the rating agency has reported on its website.
"Fitch has also assigned the city a National Long-Term Rating of 'AA-(ukr)' with stable outlook," it says.
"The affirmation reflects Fitch's unchanged view that the city's rating is constrained by the Ukraine sovereign rating (B-/Stable). Fitch also assesses the city's Standalone Credit Profile (SCP) at 'bb-', based on the combination of Lviv's vulnerable risk profile and debt sustainability assessment at 'aaa'," Fitch said.
"The affirmation also reflects Fitch's expectations that the city's sound operating results will be maintained over the medium term, as well as sound debt metrics. This is despite the projected moderate growth of the city's net adjusted debt following the implementation of an ambitious capex program by its municipal companies, which is financed from debt incurred from international financial institutions and guaranteed by the city," Fitch experts stated.
"The city's revenue framework is unstable amid continuous shaping of tax and budgetary regulation. Lviv's operating revenue is dominated by taxes, which are all collected by the national tax office, and represented over 50% in the last four years (57% in 2018). Transfers from the central government accounted for about 30% of the city's revenue. The city's operating margin has historically been sound, at over 20% in 2015-2018. However, the ongoing amendments to national fiscal regulations and the dependence on a weak counterparty for a material portion of the city's revenue drive the Weaker assessment of the robustness of Lviv's revenue framework," according to the document.
"We assess Lviv's ability to generate additional revenue in response to possible economic downturns as limited, similar to other Fitch-rated Ukrainian cities. Although the city has rate-setting power over a number of local taxes, which accounted for 21% of the city's operating revenue in 2018, the real ability to generate additional revenue is limited. Any potential increase in local tax rates is constrained by both legally set ceilings and the relatively low income of the city's residents," the experts added.
"Fitch assesses the city's ability to reduce spending in response to shrinking revenue as weak, similar to other Fitch-rated Ukrainian cities. This is evidenced by a material proportion of inflexible items in the city's operating expenditure and overall low per capita spending compared with international peers. Although the city's capital expenditure averaged 25% of total spending in 2015-2018, it does not provide the city with much expenditure flexibility in light of the city's high overall infrastructure needs amid serious infrastructure underfinancing during a prolonged period of time," the agency said.
"Ukraine's framework for debt and liquidity management is weak. The national capital market is underdeveloped, while the unfavorable credit history of the sovereign, including Ukraine's default in 2015, exerts further downward pressure. The 2015 sovereign default impaired Ukrainian local and regional governments' (LRG) access to debt capital markets. This is why like many other national peers, Lviv did not borrow from the market and maintained a debt-free status in 2014-2017. Lviv resumed borrowing in 2018 following Ukraine's return to the capital market. In June 2018, Lviv issued bonds of UAH 440 million with three-year maturity. Ukraine's key policy rate was reduced to 17.5% at end-April 2019 from 18% set on December 1, 2018," it stated.
"The total value of the guarantees issued by the city reached about UAH 5 billion at the end-2018, but the actual debt withdrawn by the municipal companies was lower, at UAH 1.2 billion (i.e. 12% of the city's operating revenue). Under Fitch's rating case we expect the latter to rise to UAH 2 billion in 2020 and UAH 3 billion in 2023, but the actuals may deviate from those assumptions, depending on the pace of projects' implementation," the report says.
Fitch's key assumptions within our rating case for 2019-2023 include:
- Nominal growth of operating revenue close to expected inflation, with income tax and single tax revenue rising well above inflation and compensating the projected decline of current transfers from the state budget;
- Nominal growth of operating expenditure by about 2pp. above inflation;
- Capex exceeding 20% of the city's total expenditure, in line with the four-year historical average.