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. Last Updated: 07/27/2016

Ratings Game Gives Regions Confidence

Russian regions that continued to service their debts after the federal government stopped honoring its own in 1998 are being rewarded — major rating agencies are keeping many regional ratings at the sovereign level and hinting that some could go higher.

Sovereign ceilings are not going to be blown off tomorrow, but there's an omen — Russian regional ratings, by every agency's book, have been quick to follow every upgrade of the sovereign ones.

Moody's Investors Service this week upgraded the Komi republic's rating by two notches to Caa1. A few days earlier, Fitch put Moscow and St. Petersburg on review for an upgrade. Standard & Poor's has upgraded Moscow and St. Petersburg to B and Yamal-Nenets autonomous district to CCC+.

Moscow and St. Petersburg should be eager to get international ratings as both are looking to issue new debt to refinance past borrowings. Moscow has to patch a hole left by some $700 million in repayments this year, of which about $150 million is still outstanding. St. Petersburg has just under $200 million of debt outstanding.

But they are not alone. Dozens of regions that seemingly have no reason to pay agencies for a rating still ask for one. Regions, apart from those that need to refinance their existing debt, are not allowed to borrow internationally, according to last year's amendments to the Budget Code. However, Standard & Poor's currently rates seven Russian regions, while Moody's rates 12.

"Regions strive to get the same rating as the country. Whether or not a region can be rated above the country is a common question posed by regions and cities," said Elena Okorotchenko, a regional ratings analyst with Standard & Poor's.

Elizabeth Rudman, a regional ratings analyst with Moody's, can name a few good reasons why the regions are keen to get ratings.

One of the most obvious ones is that the ban on foreign issuances is not going to last forever, and you want to be ready to borrow when the opportunity comes.

Also, the regions need to attract direct foreign investment, and a credit rating — even a low one, which a Russian region can expect — is a big lure for an investor. Thus, the U.S. Export-Import Bank has said it was ready to finance projects in the regions provided they had sufficient credit ratings.

"Regions are not getting ratings for the purpose of borrowing because they don't have an opportunity to borrow at the moment — they are using the ratings as a marketing tool," said Rudman.

"We received our ratings a long time before the ban on hard currency borrowing was introduced," said an official in Samara, one of the top rated regions in the country. "If we give it up now, it will be hard to regain it later, or so the rating agencies tell us. It is prestigious to have one, even if we are talking not about today, but tomorrow," said the official, who declined to be named.

Agencies are far from ready to rate regions higher than the Russian Federation itself, especially concerning hard currency. The main obstacle: No matter how well their economies are doing and how transparent they are willing to be, the federal government still has too much control over them.

"The regions are not sufficiently autonomous or have to operate within a restrictive and centralized intergovernmental system," said Okorotchenko. "Theoretically, a region's local currency rating may go above a country's local currency rating, but this is not the case for Russia."

The most recent demonstration of this was a partial rerouting of tax revenues from the regions to Moscow.

On average, more than 50 percent of all tax revenues collected in the regions are regulated by federal legislation — and this is an important means of control, said Fitch analyst Ilona Dmitriyeva.

"The sovereign can always use its power, such as imposing a debt moratorium," said Rudman. Agencies are more likely to consider assigning higher ratings to other entities within a country that are less dependent on the state — such as dollar-earning oil exporters, she added.

Moody's in June announced a change in its rating strategy, saying that ratings of debt of some sovereign issuers may exceed their country ceilings, and the agency put almost 40 issuers on review for upgrade. But all of them were corporates.

In the area of local currency borrowings, however, some regions may see a breakthrough.

Some regions' own creditworthiness could justify a higher rating, said Okorotchenko. But Standard & Poor's currently has a uniform country rating for issuances in foreign and local currencies for Russia.

This methodology, however, may change — and then the best and most transparent borrowers are likely to have local currency ratings higher than the sovereign's foreign currency rating. This is the case, for example, with the Czech Republic, where Prague's local currency rating is several notches ahead of the country's foreign currency rating.

In Russia, the cities of Moscow and St. Petersburg are most likely to beat the federation if S&P changes its methodology.

Other Russian regions leading rating agencies' list for willingness to cooperate and doing a fairly good job about their economies are Samara, Bashkortostan republic and the Komi republic. This was the latest in a string of several upgrades that agencies say will continue.

A significant part of the improvement was the regions' ability to raise the cash component of their revenues and cut tax arrears, said Rudman. The financially stronger regions have maintained their economies successfully despite the fact that under the new legislation they now receive a smaller chunk of locally collected taxes.

"The overall economic environment outweighs disadvantages in the tax regime," said Rudman. Even in a more difficult economic situation, the regions manage to avoid short-term ruble borrowing, she added.