Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has affirmed the Uzbek City of Tashkent’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘BB-’ with Stable Outlooks.

The affirmation reflects the city’s ‘Weaker’ risk profile that is counterbalanced by a ‘aa’ debt sustainability assessment under Fitch’s rating case. The IDRs are notched down once from our assessment of the city’s Standalone Credit Profile (SCP) of ‘bb’ due to weak reporting and transparency practices that lag behind international standards. This lead to Tashkent’s IDRs being in line with the Uzbek sovereign IDRs (BB-/Stable).

Fitch assesses Tashkent’s risk profile as ‘Weaker’. This reflects a ‘Weaker’ assessment for all six key risk factors of the city.

Uzbek subnationals’ revenue sources are unstable following an extensive tax and budgetary reform in the republic for the past four years. The composition of taxes collected by the city and their allocation between tiers of government are subject to constant change. Taxes are the important source of the city budget and on average contributed 63% of total revenue in 2015-2018, before falling to 42% in 2019. On the contrary transfers from the central budget have gradually increased to 45% of total revenue in 2019 from 12% in 2014.

Ongoing changes to national fiscal regulation resulting in low revenue predictability and high dependence on a weak central government for a material portion of city’s revenue drive the ‘Weaker’ revenue robustness assessment.

Fitch assesses Tashkent’s ability to generate additional revenue in response to possible economic downturns as limited due to a highly centralised budgetary system in the country, despite it being under reform. Fiscal autonomy is controlled by the central government, which sets all tax rates and determines the amount of tax revenue allocated between government tiers. Tashkent’s revenue structure is dominated by the city’s allocated share of national taxes and inter-governmental transfers that together accounted for 95% in 2019.

Affordability for additional taxation is also limited by the low disposable income of the population (average monthly salary in Tashkent was about USD370 in 2018). Fitch views inter-governmental transfers as largely discretionary since the national budgetary framework does not yet have an established revenue equalisation system. This results in the ‘Weaker’ assessment of revenue adjustability.

Expenditure sustainability is fragile due to the city’s evolving mandates and expenditure composition, limiting expenditure predictability. Spending over the last five years had been volatile, due to high inflation and reallocation of spending responsibilities. Expenditure in real terms has varied from declines of 7%-8% in 2016-2017 to increases of 25% in 2015 and 20% in 2019. In general, spending dynamics follow that of revenue as local government budgets must be balanced and deficit is not allowed under national regulation.

Tashkent’s ability to curb spending in response to shrinking revenue is low as most of the city’s spending responsibilities are mandatory. Consequently, the structure of the city’s budget is dominated by inflexible spending items that accounted for a material 80% of total expenditure in 2019. About 40% of spending is salaries and wages, which are the most rigid items and subject to indexation to inflation. Capex (20% of total expenditure in 2019) is under the strict control of the central government. The city’s capex for construction of social infrastructure is subject to approval by the government and usually requires co-financing from the republic’s budget, limiting the city’s fiscal flexibility.

This assessment reflects an overall weak national framework for debt and liquidity management and under-developed capital markets in Uzbekistan. Uzbek subnationals are not allowed to incur debt, except inter-governmental budget loans and to issue guarantees. While Tashkent has no direct debt the city attracts borrowings through its government-related entities (GREs) to finance investment projects and supports these entities in debt servicing. A material part of the debt is denominated in foreign currencies, exposing the city to significant FX risk, given a volatile local currency.

Liquidity available to Tashkent is limited to its cash balance, which is low (end-2019: UZS247.3 billion, equivalent to 3.7% of total spending in 2019), as the city’s access to debt market is restricted by national regulation. At the same time Tashkent is supported by a liquidity mechanism provided by the central government in the form of short-term budget loans to cover intra-year cash gaps. These budget loans have zero interest rate and up-to-nine-month maturity with a requirement to repay by year-end. The ‘BB-’ rating of the sovereign as a provider of additional liquidity in case of need underpins the ‘Weaker’ liquidity flexibility assessment.

Fitch classifies the City of Tashkent as a Type B local and regional government (LRG), as it covers debt service from cash flow on an annual basis. The ‘aa’ assessment is driven by a sound debt payback ratio (adjusted net debt/operating balance), which is the primary metric of debt sustainability for Type B LRGs. According to Fitch’s rating case, which envisages some stress to both revenue and expenditure to capture historical volatility, the debt payback ratio will remain sustainably below 9x over a projected five-year period.

For the secondary metrics, Fitch’s rating case forecasts a fiscal debt burden at 60% in 2024, and the actual debt service coverage ratio (ADSCR: operating balance-to-debt service, including short-term debt maturities) at 1.4x in 2024.

Fitch assesses Tashkent’s SCP at ‘bb’, which reflects a combination of a ‘Weaker’ risk profile (a result of six ‘Weaker’ key risk factors) and ‘aa’ debt sustainability. The SCP also factors in a comparison with international peers. Fitch applies a single-notch downward adjustment for the city’s weak reporting and transparency practices that lag behind international standards. As a result, the city’s IDRs are ‘BB-’.