Fitch rates city of Tashkent ‘BB-’; outlook stable

Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has assigned Uzbek City of Tashkent Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) of ‘BB-’ with Stable Outlook and a Short-Term Foreign-Currency IDR of ‘B’.

Tashkent’s IDRs are equalised with the Uzbek sovereign IDRs (BB-/Stable). This reflects a combination of the city’s low leverage, resulting in a ‘aa’ debt sustainability assessment according to Fitch’s rating case, and a ‘Weaker’ risk profile. The IDRs also factor in downward adjustment to our assessment for the city’s weak reporting and transparency practices that lag behind international standards.

Tashkent is a capital of Republic of Uzbekistan, and its political and financial centre. Tashkent is the largest city of the country with a population of more than 2.5 million residents. The city’s revenue is dominated by taxes, including allocated national taxes, and inter-governmental transfers. Main spending responsibilities cover education, healthcare and social benefits. According to budgetary regulation Uzbek subnationals are not allowed to borrow on the domestic market and externally. However, in accordance with the presidential decree, Tashkent has an exclusive right to issue domestic bonds, but is currently free from direct debt. Budget accounts are presented on a cash basis and the budget horizon was extended to three years from one year in 2018.

The rating reflects the following rating drivers and their relative weights:

High

Revenue Robustness Assessed as Weaker

Uzbek subnationals’ revenue sources are unstable following an extensive tax and budgetary reform in the republic. The composition of taxes collected by the city as well as their allocation between tiers of government is subject to constant change. Taxes are the main revenue source of the city and on average contributed 65% of total revenue in 2014-2018. Transfers from the central budget (BB-/Stable) had been material over the last five years and increased to 38% of total revenue in 2018 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.

Revenue Adjustability Assessed as Weaker

We assess 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 81%. The proportion of local taxes was low at 14% in 2018.

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 Assessed as Weaker

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 a decline of 7%-8% in 2016-2017 to increases of 25% in 2015 and 22% in 2018. In general, spending dynamics follow that of revenue as local government budgets must be balanced and deficit is not allowed under national regulation.

Expenditure Adjustability Assessed as Weaker

Tashkent’s ability to curb spending in response to shrinking revenue is low as most of its spending responsibilities are mandatory. Consequently, the structure of the city’s budget is dominated by inflexible spending items that accounted for a material 76% of total expenditure in 2018. About 40% of spending is salaries and wages, which are the most rigid items and subject to indexation to inflation. Capex (21% of total expenditure in 2018) 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.

Liabilities and Liquidity Robustness Assessed as Weaker

This assessment reflects an overall weak national framework for debt and liquidity management and under-developed local capital markets in Uzbekistan. Uzbek subnationals are not allowed to incur debt, except for 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. At end-2018, Tashkent had serviced five GRE loans and the city’s administration esimates that another 10 loans could crystallise into the city’s debt. Therefore, Fitch has included those 15 loans in its adjusted debt calculation, which it estimates at UZS1.4 trillion (equivalent to USD170 million) at end-2018. A material part of the debt is denominated in foreign currencies, exposing the city to significant FX risk, given a volatile local currency (depreciated 3.4x over 2014-2018).

Liabilities and Liquidity Flexibility Assessed as Weaker

Liquidity available to Tashkent is limited to its cash balance, which is low (end-2018: UZS118.5 billion, equivalent to 2.6% of total spending in 2018), 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.

Debt Sustainability Assessment: ‘aa’

Fitch classifies the City of Tashkent as a Type B local and regional government (LRG), which is required to cover 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 on 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 shows that the fiscal debt burden will be under 60% in 2019-2023, while the actual debt service coverage ratio (ADSCR: operating balance-to-debt service, including short-term debt maturities) will be 1.7x in 2023.

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

Improvements to budgetary practices and a debt payback of about 6x on a sustained basis under Fitch’s rating case could lead to a positive rating action, provided the sovereign is also upgraded.

A downgrade of the sovereign or deterioration of the city’s debt payback to beyond nine years under Fitch’s rating case would lead to a downgrade.