Diamond-Capital Smolensk Bond Yields Signal Muni DistressVladimir Kuznetsov
Russia’s regional authorities, lumbered by debt close to the highest level in five years, are facing rising borrowing costs with few prospects of relief from emergency measures being debated in Moscow.
Total regional borrowings rose to 1.7 trillion rubles ($49 billion) in May, near the most since at least 2009, Finance Ministry data show. The premium investors demand to hold Russian municipal bonds over sovereign securities was 37 basis points more than last year’s average on July 14, according to UralSib Capital data.
Standard & Poor’s said the possible resumption of a 3 percent sales tax “fundamentally” won’t solve the problem as Russia’s 85 municipalities struggle to fund social spending programs promised during President Vladimir Putin’s 2012 re-election campaign. Some regions risk bankruptcy if they can’t find enough cash, Finance Minister Anton Siluanov said in an interview with the Vedomosti newspaper on July 14.
The sales tax would be “a drop in the bucket,” Anton Tabakh, senior economist at the Institute of Energy and Finance in Moscow, said by e-mail on July 10. “It will help, but not much.”
The budget shortfall ratio of Russia’s western Smolensk region mushroomed fivefold in 2013 from the year earlier to an “exceptional” 24.7 percent of total revenue, Fitch Ratings said Feb. 21. Spending in the city known for hosting the Kristall factory, the country largest diamond cutter, soared as the regional government poured cash into construction before the city’s 1,150-year anniversary, Fitch said.
The yield on the junk-rated issuer’s 3 billion rubles of bonds due October 2018 climbed eight basis points to 11.29 percent yesterday, compared with 9.2 percent when they were placed in October. Fitch rates Smolensk Region at B+, four steps below investment grade.
That contrasts with the outlook for the oil-rich city of Surgut, which received a BBB- investment-grade rating from S&P on July 9 as Russia’s energy-exporting territories benefit from Brent crude prices above $100 a barrel.
“The credit quality of Russian regions is low due to budgetary problems, and there’s no real improvement on the horizon,” Leonid Ignatyev, head of fixed-income research at BCS Financial Group in Moscow, said by phone yesterday. “The regions will still borrow, probably even more actively than in the last two years. And there is no reason to expect lower yields or narrower spreads.”
As regions boost spending for everything from renovating housing to raising wages, their ability to generate revenue, predominately derived from income taxes, is being hindered by the slowest economic growth since 2009, according to S&P analyst Alexandra Balod.
To help bridge the gap, the government is weighing the re-introduction of a 3 percent sales tax, which regional governments are able to start collecting as soon as next year. It’s also considering raising the personal income tax rate from 13 percent, according to Finance Minister Siluanov.
The sales tax alone could add 200 billion rubles a year to the regions’ revenue, thereby trimming a combined budget deficit that’s set to exceed 640 billion rubles this year, Siluanov said on July 3. Russia won’t let any region fail and the government plans to extend direct loans to replace their bank liabilities, he said.
Tax increases won’t add a “very significant gain” to revenues and “fundamentally, it won’t solve the problem,” Balod of S&P said by phone from Moscow yesterday. The refinancing needs of Russia’s regions will increase 42 percent next year to 910 billion rubles, she said.
Regional issuers have raised 40.6 billion rubles from bond sales this year through July 9, little changed from the same period of 2013, even as offerings by companies slid 49 percent as the crisis in Ukraine drove up borrowing costs, data compiled by Bloomberg show.
The yield on notes due in 2018 of Mordovia, whose capital Saransk is set to be a host city for matches during the 2018 World Cup, has increased 232 basis points since their placement in October to 11.9 percent.
Regions are also struggling in part because the majority of bank loans they take are of short-term duration, according to Balod. “Regions raise 12-month bank loans, sometimes six-month loans,” she said. “It needs to be refinanced fast and often.”