OREANDA-NEWS. Fitch Ratings has affirmed the Polish Municipality of Ostrow Wielkopolski's National Long-Term rating at 'A(pol)'. The Outlook is Stable.

The affirmation reflects the city's sound operating performance, which we expect to be maintained over the medium term, together with its prudent financial management. The rating also factors in the small size of the city's budget, which makes it more vulnerable to negative changes in economic trends.

KEY RATING DRIVERS

For 2016-2018 Fitch expects Ostrow to continue to report a good operating performance, with an estimated operating margin of 15%, or an operating balance around at PLN30m, comfortably covering Fitch-estimated debt service requirements of PLN13m per year. In 2015, the city's operating balance was PLN33m, or 16% of operating revenue (2014: PLN31m and 15.4%), covering debt service by 3x.

Fitch expects that capital expenditure will stay around PLN30m annually in the medium term. The main area of investments will be local infrastructure, including roads and transport (bus fleet), municipal housing and kindergartens. The city will apply for EU funds available under 2014-2020 perspective for co-financing capex. Implementation of new co-financed investments is expected after 2017.

The limited financing requirements and the city's self-financing capacity mean we expect that Ostrow's direct debt will gradually decline to around PLN52m or around 20% of current revenue in 2018 (2015: 32%). The debt payback ratio is expected to be around two years over the medium term, which is the lowest level among the city's peers.

The city administration's policy to steadily increase tax rates and its control of the tax base and operating spending have increased the self-financing capacity, meaning there is little pressure to materially increase debt. The small size of the city's budget makes it more exposed to adverse changes in the local economy or institutional framework. However, the city's management have recognised these risks and may counteract them by the prudent approach to budgeting or maintaining a cash cushion for unexpected expenses. It also creates a good environment for business activities and good living conditions for its citizens to counteract out-flows of people from the city.

The debt of municipal companies (PSE) grew to PLN58m in 2015 from PLN38.5m at end-2014 following their debt-financed investments but it is expected to decline in line with redemption schedules in medium term. The majority of the PSEs' debt was related to the investments of two companies: RZZO which constructed a solid waste treatment plan, the project in large part financed from EU grants; and OTBS, which is responsible for the construction of municipal buildings. In Fitch's view, indirect risk does not constitute a major risk for the city's budget as these companies are self-supported and repay their debt from their revenues.

Ostrow is a small-sized city (72,900 inhabitants) but is located close to the capitals of three Polish regions. This makes the city an attractive place to live. Unemployment in the city in May 2016 (5.2%) was below the national average (9.1%) and has been decreasing since 2010. However, Ostrow's wealth indicators are weaker than the national average. Gross regional product per capita in the Kaliski subregion, where Ostrow is located, was 15.5% below the national average in 2013 (last available data).

In 2016, the National Parliament introduced the '500+ programme', a cash benefit of PLN500 per month per child for families with more than one child. This will be a new central delegated task. The central government will provide transfers that will go through the local government's (LG) budget. This programme will be neutral for the city's operating balance because it will influence both revenue and expenditure but will inflate the operating margin and debt/current revenue ratio from 2016.

The regulatory regime for Polish LGs is relatively stable. Their activities and financial statements are closely monitored and reviewed by the central administration. There is good disclosure in the LGs' accounts. The main revenue sources, such as income tax revenue, transfers and subsidies from the central government are centrally distributed according to a legally defined formula, which limits the central government's scope for discretion. Additionally, local tax rates such as real estate tax, which some LGs are entitled to collect, are capped by the state. This makes LGs somewhat reliant on decisions made by the central government and limits their revenue-raising flexibility.

RATING SENSITIVITIES

The rating could be upgraded if operating performance further improves as reflected by an operating margin of 17%-18%, and direct risk below 35% of current revenue on a sustained basis.

The rating could be downgraded if operating performance deteriorates, coupled with direct debt materially above 35% of current revenue and a debt coverage ratio above 10 years.