Overview

• We anticipate that Ukraine's capital city of Kyiv will completely offset its intergovernmental debt with the Ministry of Finance once its infrastructure projects are completed in 2020. This would reduce the city's direct debt by 50% by 2021.
• We believe that uncertainties regarding the potential dismissal of the mayor as the head of the city's state administration and the date of the next municipal election in 2020 will not affect the city's ability to honor its debt obligations.
• We are therefore raising our rating on Kyiv to 'B' from 'B-'.
• The outlook is stable.

Rating Action

On Nov. 15, 2019, S&P Global Ratings raised its long-term issuer credit rating on the Ukrainian City of Kyiv to 'B' from 'B-'. The outlook is stable.

Outlook

The stable outlook reflects our expectations that Kyiv will preserve its sound operating surpluses, supported by the solid economic recovery. The outlook also factors in our assumption that the city will borrow moderately in the medium term.

Downside scenario

We might lower the rating if we were to lower our sovereign ratings on Ukraine. We might also consider a negative rating action if the intergovernmental agreement on debt reduction is derailed.

Upside scenario

We could raise our rating on Kyiv if we observed an improvement in its debt and liquidity practices or a strengthening of capital markets and banking system in the country. An upgrade would also be contingent on a similar rating action on Ukraine.

Rationale

The upgrade reflects our view that, by year-end 2020, Kyiv's direct debt will be reduced by the remaining amount of its loan from the Ministry of Finance. Kyiv has successfully completed similar agreements with the central government over 2016-2019, allowing the city to write off the major part of its intergovernmental debt.

Our rating on Kyiv is supported by solid budgetary performance, fueled by a strong economic recovery in Ukraine, and its moderate debt burden. At the same time, our assessment remains constrained by the very volatile and centralized Ukrainian institutional setting for local and regional governments (LRGs). Kyiv's weak payment culture, with a track record of defaults, also continues to weigh on the rating.

A volatile framework, low wealth levels, and weak financial management remain the main constraints on Kyiv's credit quality

The city operates in a very volatile institutional framework. Kyiv's budgetary performance is significantly affected by the central government's decisions regarding key taxes, transfers, and expenditure responsibilities. Frequent changes in revenue sources and spending mandates undermine reliable long-term planning at the municipal level. Most taxes are regulated by the central government and a high share of social expenditures continues to restrict its spending flexibility. At the same time, the central government increased its attention to the city's debt, by writing off its intergovernmental liability and encouraging the city to use these funds for capital investment.

Kyiv's debt and liquidity management has improved in the past few years thanks to a reduction in debt stock and restructuring of the remaining unsettled market liability. At the same time, the unreliable medium-term financial planning, frequent deviations from legislated budgets, and a track record of a weak payment culture constrain our assessment.

Political instability could increase due to the potential dismissal of the mayor, Vitali Klitschko, as the head of the city's state administration, with the date of the next municipal election in 2020 still uncertain. Nevertheless, in our view the financial impact of this uncertainty will be limited and won't lead to disruptions in the debt write-off, as the intergovernmental agreements are fixed in the budget law and according decrees.

While Kyiv's GDP remains relatively low compared with peers, the city's economy has been rebounding strongly since 2015. As the capital city, Kyiv remains the Ukraine's most prosperous and diversified region. The city contributes more than 20% of the national GDP and benefits from a strong labor market, with the lowest unemployment rate in Ukraine. Moreover, despite the overall declining national trend, the city continues to attract migrants from all over the country. We believe that the city's growth will mirror the national economic recovery and expand at 3.1% on average annually over 2019-2021. We expect its GDP per capita to reach US$13,400 by 2022.

Sound budgetary performance will persist, and the debt burden will remain low

We believe that Kyiv's operating budgetary performance will remain solid over the coming three years, supported by the economic recovery. Central government grants (mostly earmarked public wage-related transfers), which contribute up to one-quarter of operating revenues, will continue to support the city's finances.

The city remains committed to a number of large infrastructure projects (such as the construction of bridges and metro lines). We believe Kyiv will continue to fulfill its investment needs in our forecast period. We also expect that the city will continue its infrastructure development by providing guarantees to its transportation and utility government-related entities (GREs) for loans from the European Bank for Reconstruction and Development and the European Investment Bank. The projects are planned for over a 20-year horizon and include upgrades to transportation facilities, repairs of the city's heating supply, and bridge renovations.

We expect the city will post moderate budget deficits after capital accounts in 2019-2021, not exceeding 5% of revenues.

According to an agreement between the city and the central government, if Kyiv invests in municipal transport infrastructure, the government will write off an equal amount from the city's intergovernmental obligations. The major part of Kyiv's obligations have already been reduced ahead of schedule after it completed some construction projects. We expect the city to have its interbudgetary loan written off completely in 2020, following the successful track record of previous agreements. We therefore project the city will not need to resort to commercial borrowing to refinance or repay these intergovernmental obligations by 2021.

We expect that Kyiv's direct debt will decrease after the settlement is completed and that the stock will remain low through 2022. Besides the intergovernmental liabilities, the city's direct debt consists of a $115.1 million Eurobond placed in 2018, reflecting the restructuring of the 2015 Eurobond. The liability is due in 2021-2022. We believe that, should the need arise, Kyiv could postpone some of its capital expenditure to generate the required funds.

Given that the city's direct debt is denominated in U.S. dollars, we note that Kyiv's debt burden is subject to exchange rate volatility.

In addition to direct debt, our assessment of Kyiv's total debt burden (tax-supported debt) includes liabilities of municipal GREs, which require budget assistance from the city budget. In particular we factor in all debt of GREs explicitly guaranteed by Kyiv (Kyivpastrans, Kyivmetro, GVP Energy Saving Company, Kyivavtodor, and Kyivenergo) and Kyivpastrans (not guaranteed liability), as well as the commercial debt of the water utility, given that repayments of most of these liabilities are made directly from Kyiv's budget. We also include in the tax-supported debt the liabilities that arise from the lawsuit against Kyiv's subway company Kyivmetro, because the city might be required to financially support the entity.

We assume that the city's contingent liabilities are low and include mostly accumulated payables at the city's utility and transportation companies, as we include all municipal companies' debt in the city's tax-supported debt. We also include in the city's contingent liabilities the Ukrainian hryvnia (UAH) 3.7 billion of central government loans received before 2014 to finance mandates set by the central government.

Although the city's cash currently exceeds its debt service over the next 12 months, we see the city's liquidity position as vulnerable. We apply a 50% haircut to the city's cash reserves because the city keeps them in the central treasury and we believe that access to these reserves could be interrupted, given the central government's track record with regard to default. Under our current projections, the coverage ratio will decrease when the city's debt liabilities are due in 2021 and 2022. We also believe that the city's access to external funding is constrained, owing to the weaknesses of the Ukrainian capital market and its banking sector.

Key Statistics

Table 1

Ratings Score Snapshot

Table 2

Key Sovereign Statistics

• Sovereign Risk Indicators, Oct. 10, 2019. An interactive version is also available at http://www.spratings.com/sri

Related Criteria

• Criteria | Governments | International Public Finance: Methodology For Rating Local And Regional Governments Outside Of The U.S., July 15, 2019
• Criteria | Governments | International Public Finance: Methodology: Rating Non-U.S. Local And Regional Governments Higher Than The Sovereign, Dec. 15, 2014
• General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009

Related Research

• Research Update: Ukraine Ratings Raised To 'B' On Improved Macroeconomic Management; Outlook Stable, Sept. 27, 2019
• 2018 Annual International Public Finance Default And Rating Transition Study, Aug. 19, 2019
• Institutional Framework Assessments For International Local And Regional Governments, July 4, 2019
• Local Government Debt 2019: Economic Slowdown Is Set To Spur European LRG Borrowings In 2019-2020, Feb. 25, 2019

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').

Ratings List