(The following statement was released by the rating agency)
Dec 12 -
-- The Latvian economy is recovering faster than we previously expected, with average GDP growth forecast at about 4% in 2012-2015.
-- Along with economic recovery, Latvia's capital city, Riga, has benefited from conservative financial planning, and we expect its budgetary performance to improve in 2012-2015 compared with our previous assumptions.
-- We are therefore raising our long- and short-term issuer credit ratings on Riga to 'BBB/A-2' from 'BB+/B'.
-- The positive outlook reflects our view that Latvia's good economic growth will persist in 2013 and may raise Riga's revenues. Combined with tight spending policies, this may further strengthen the city's budgetary performance and lower its debt burden.
On Dec. 12, 2012, Standard & Poor's Ratings Services raised its long- and short-term foreign and local currency issuer credit ratings on the City of Riga to 'BBB/A-2' from 'BB+/B'. The outlook remains positive.
The ratings on the Latvian capital city of Riga are supported by a relatively wealthy and growing economic base, the city management's track record of structural budgetary consolidation and prudent debt management, as well as strong budgetary performance and positive liquidity position. The ratings are constrained, in our view, by the consolidating but uneven Latvian institutional framework, which limits the city's budgetary flexibility and predictability, and its high debt burden.
Riga's wealth is average when compared internationally, but strong regionally, in our view. We estimate that its GDP per capita exceeds the country average by about 80% and reached about $23,000 in 2011. According to our base-case scenario, Latvia's economy is set to grow by 4% on average in 2012-2015. We expect Riga to benefit from this economic recovery given its status as the country's economic engine. It generates an estimated 58% of the national GDP and has 32% of Latvia's population.
Riga's financial management team has proven capable and willing to swiftly and significantly adjust its budget in case of adverse economic conditions and strong revenue decline, as observed in 2009 and 2010. The city's financial performance was therefore strong in 2009-2011, with an average operating surplus of 10% of operating revenues, and a minor surplus after capital accounts.
Thanks to rising revenues fuelled by economic recovery we assume only a moderate weakening of the city's budgetary performance in 2012-2015, despite gradually catching up spending and increasing interest payments, in our base-case scenario. During this period, in our view, Riga's average operating balance will remain at a sound 8.6% of operating revenues, while the average balance after capital accounts will slightly reduce to a modest 2.8% of total revenues.
The ratings on Riga factor in its very limited revenue flexibility. Under the Latvian intergovernmental system, the city has no influence over 90% of revenues. We also consider that Riga's ability to further cut its expenditures is very limited at present, following heavy cuts in 2009 and 2010.
Riga's financial-policy predictability is also constrained by the ongoing reforms to the shared personal income tax, which accounts for about 65% of the city's operating revenues. About 80% of this tax is allocated to local budgets, but the exact quotas are defined annually. The central government has initiated a gradual reduction of the rate from 25% in 2012 to 20% in 2015. In 2013, Riga will receive almost no compensation for the reduction of the PIT rate, while the compensation the central government could provide to local governments beyond 2014 is still being negotiated. In our base case we expect that after 2014 the loss will be adequately covered by the expanding tax base, and either by additional transfers from the central government budget or additional flexibility in managing property taxes.
Riga has sizable investment requirements, but national restrictions on borrowing considerably constrain its debt-raising capacity. As a consequence, Riga has previously raised debt through off-balance-sheet financing schemes. In this way, it funded the multistage Southern Bridge construction and, less so, housing construction and public transport fleet renewal. We include this debt in our calculation of tax-supported debt under our methodology. Our base-case scenario anticipates that tax-supported debt will reach a high 123% of consolidated operating revenues in 2012, and will remain broadly flat in 2013-2015 due to expected borrowings at company level.
We expect Riga's interest payments to rise significantly because in 2010 it started making payments on its amortizing obligations related to the Southern Bridge project. As a consequence, our base-case scenario anticipates interest payments rising to about 6% of operating revenues in 2013, from a low 2% in 2010. Although we expect interest payments to decline again after peaking in 2013-2014, we anticipate that they will remain at about 5% of operating revenues in the medium-to-long-term.
Under our criteria, we view Riga's liquidity as 'positive,' based on its high cash holdings and what we view as limited access to external liquidity.
At the end of November 2012, we estimated the city's consolidated available cash had averaged about Latvian lats (LTL) 97 million over the past 12 months. This excludes the city's deposits in Latvijas Krajbanka (not rated) because we understand this amount is currently frozen after the bank started bankruptcy proceedings in February 2012. In our base-case scenario we expect the city's average cash holdings to decrease slightly in 2013 by about LTL10 million, but remain well in excess of its debt service falling due in the next 12 months, which we assess at about LTL46 million. This amount includes the redemption of principal and interest payments on the multistage financing of the Southern Bridge.
Riga limits its counterparty risk through its cash management policy, and holds more than 80% of its cash at Nordea Bank AB (AA-/Negative/A-1+).
Although we note that the city can take loans at favorable conditions from the state treasury to cofinance its investment projects, we view Riga's access to external liquidity as limited, according to our criteria. We consider the domestic banking sector to be exposed to high levels of risk, which are reflected in our Banking Industry Country Risk Assessment (BICRA) score of '8' ('1' being the lowest risk and '10' being the highest; for further details see 'BICRA On Latvia Maintained At Group '8',' published on Nov. 9, 2011).
The positive outlook reflects our view that Latvia's good economic growth will persist through 2012-2013 and will raise Riga's revenues. Combined with tight spending policies, this may further strengthen the city's budgetary performance and lower its debt burden.
We could consider an upgrade within the next 24 months if we raise the sovereign credit rating on Latvia and if, in line with our upside scenario, Riga's revenues grow faster than envisaged in our base-case scenario. This would likely lead to budgetary performance improving to a positive balance after capital accounts over 2012-2015, on average. As a consequence, the city's interest payments could then slip below 5% of operating revenues and tax-supported debt may decrease to below 100% of consolidated operating revenues, which would alleviate the debt burden on the city.
We may revise the outlook back to stable within t
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