September 14 (SeeNews) - Standard & Poor's (S&P) said it has affirmed the BBB- long-term issuer credit rating of the Bulgarian city of Stara Zagora with a stable outlook.
"We expect subdued activity as a consequence of the novel coronavirus disease (COVID-19) pandemic to weigh on Stara Zagora's revenue in 2020. However, we believe a gradual recovery from 2021 will help contain deficits after capital accounts in 2021-2022," the ratings agency said in a statement on Friday.
According to Standard & Poor's, due to Stara Zagora's large share of EU funding, some debt absorption will take the form of temporary bridge financing, allowing debt to remain low in the medium term.
The global ratings agency also said in the statement:
"OUTLOOK
The outlook is stable because we expect Stara Zagora can maintain low debt and sound liquidity, despite lower revenue as a consequence of the COVID-19 pandemic.
Downside scenario
We would consider a negative rating action if Stara Zagora's management was unable to sustain strong financial indicators because of looser financial policy or weaker revenue performance. The latter could happen if, for example, the pandemic-induced recession were to be deeper or longer than in our current base case. This would likely see the city's financial performance worsen and weigh on liquidity, or result in faster debt accumulation.
Upside scenario
We could consider a positive rating action if we observed significant structural improvements in the city's financial policies and planning that mitigated the potential volatility in revenue and structurally improved Stara Zagora's liquidity position.
RATIONALE
The ratings on Stara Zagora are supported by the city's management's commitment to contain costs, which has kept debt low. We anticipate that a gradual recovery in the economic climate and municipal revenue will come in the second half of 2020, allowing the city's budgetary performance to remain solid in the medium term. Stara Zagora's strong financial metrics counterbalance the limited predictability of the institutional framework under which Bulgarian cities operate, which also clouds the transparency of the city's long-term financial policy.
The pandemic and related lock-down measures will burden the local economy
Bulgaria's GDP is lower than international peers' and we forecast that real GDP will contract by 6.2% in 2020 to $8,950 as a consequence of the pandemic. We believe Stara Zagora's economy will mirror the national trend and recover in 2021 with 5% growth.
Stara Zagora is in the center of Bulgaria, near the country's largest power complex. This supports the regional economy, which enjoys a low unemployment rate and high wages. Although we project local unemployment will increase due to national measures to contain the spread of COVID-19, we expect it will remain well below the national average. At the regional level, exposure to coal-power generation might pose a medium-term hurdle for the city's economy in terms of employment and demographics, since the effect of a possible transition to other energy sources is uncertain at present.
The institutional framework under which Bulgarian local and regional governments operate is still evolving. Consequently, Stara Zagora's finances are fairly unpredictable, given the important role the central government plays in the intergovernmental system. We believe there may be some unexpected changes in the distribution of revenue and government-mandated spending, due to the ongoing decentralization process.
Within this framework, we view the city's financial management as adequate in the short term, but lacking in long-term planning, which ultimately weakens the predictability and efficiency of policymaking. As is the case for peers in the region, political considerations could interfere with the city's important financial decisions. Municipal companies' disclosure standards are limited, but we believe monitoring of this small sector is adequate. Positively, the city usually has a relatively smooth budgeting process and an adequate debt policy, with a tendency to secure prefunding for capital projects.
Stara Zagora's revenue and overall financial performance will feel the impact of COVID-19 in 2020
We expect the pandemic-led economic slowdown to weigh on Stara Zagora's revenue and push up expenditure this year. As such, we project the city's operating balance to decline to 1.7% of operating revenue on average over 2020-2022, from 5% in 2019. At the same time, transfers from the central government will continue to constitute a relatively high share of the municipal budget, and are designated for specific expenditure. This leaves limited headroom for the city to modify over half of its budget. The city can, in theory, independently modify some of its own sourced revenue. However, the actual use of this flexibility is subject to management's decisions, and we think it could be hampered by political considerations. We also foresee elevated capital expenditure over 2020-2022, representing a pickup in the EU budget cycle and large ongoing investment projects. This will create a negative balance after capital accounts, although we believe deficits will remain below 5% of total revenue, on average.
The municipal investment program principally focuses on educational infrastructure, street renovations, energy efficiency, and sustainable transportation. The city aims to finance the majority of these projects using EU funds, which should support low, albeit increasing, debt. Positively, EU-funded projects are carried out through off-budget accounts, which reduces pressure on the municipal budget. Nonetheless, we understand this structure will require the city to incur debt to finance the final stages of projects before it receives reimbursement from the EU. We believe part of this municipal debt will likely be temporary and cyclical in nature. However, some will likely be long term, which will see tax-supported debt increase to 17% of consolidated operating revenue by year-end 2022, from about 8.6% in 2019.
The city's dependence on EU project timelines and funding could also expose it to liquidity volatility temporarily weakening the debt-service-coverage ratio. To help mitigate this, the city secured a Bulgarian lev (BGN) 10 million (about €5.1 million) credit line toward year-end 2018 for EU-related projects. However, we expect the city's internal liquidity sources alone will be sufficient to cover more than 100% of uses in the next 12 months.
Although Stara Zagora has a track record of securing external funding when needed, we continue to factor into our liquidity assessment Bulgaria's weak domestic banking sector. In our view, this could hamper the city's access to external liquidity at times."