By Marina Neves in Sao Paulo
& Julia L Smith in Buenos Aires
Standard and Poors
BUENOS AIRES - S&P Global Ratings affirmed its 'B-' foreign and local currency ratings on the province of Mendoza. The outlook remains stable.
The ratings on Mendoza reflect Argentina's very volatile and underfunded institutional framework, the province's weak economy with an estimated per capita GDP of $9,884 for 2015, and our view of its financial management as weak, whose debt and liquidity management have deteriorated in 2015 amid the increasing suppliers debt. In addition, Mendoza's creditworthiness suffers from very weak budgetary flexibility due to rigid operating costs and limited leeway to increase revenue. We also view the province's budgetary performance as very weak, given its volatility stemming from high inflation. On the other hand, the province's moderate debt burden and low contingent liabilities support its creditworthiness.
Budgetary performance is likely to remain very weak during 2016, given the subpar fiscal performance in the past year. In 2015, Mendoza's deficit after borrowings widened to 5% of total revenue from 2% in 2014. The province partly financed through ARP5.1 billion in borrowings, most of which was approved in late 2015 to close the fiscal gap and repay debt. In the next two to three years, we expect Mendoza to continue posting high deficits before borrowings, around 14% of total revenue, and to continue to use borrowings to close its fiscal gap. Our base-case scenario for 2016 and 2017 assumes that Mendoza will post surpluses after borrowings of around 3% of total revenue, assuming borrowings of around ARP20 billion. This is due to the recent curing of Argentina's selective default, which improved Argentine local and regional governments' (LRGs') access to international capital markets, and Mendoza's ability to secure funds in the domestic market, particularly from Banco de la Nacion Argentina.
Mendoza's economy is weak, according to our assessment. Double-digit inflation, which is likely to persist for the next two to three years, is taking a toll on the provincial economy. Mendoza's GDP per capita for 2015 was about $9,884, according to our estimates. We expect Mendoza's economy to slightly contract in 2016, in line with the national economy's pace, amid the Macri administration's key economic adjustments to revive the economy and reduce government spending.
In our view, the province's financial management remains weak due to the significant fiscal and political barriers in achieving financial sustainability. Governor Alfredo Cornejo took office in December 2015. Mr. Cornejo is a member of the President Mauricio Macri's Cambiemos political alliance. We expect the province to continue to enjoy a strong relationship with the federal government. Since taking office, governor Cornejo has taken measures to control the provincial spending, in particular public-sector wages by suspending the hiring, encouraging early retirement, and salary negotiations with public-sector unions in early 2016.
Although Mendoza has a moderate debt burden, the province's previous administration had accumulated ARP1 billion in debt to service suppliers. The province issued a bond ("Bono para Provedores") to repay such debt. Banco de la Nacion Argentina is the province's main creditor, with whom Mendoza recently renegotiated a ARP2.2 billion debt, which is expected to be repaid over the next five years.
Mendoza's has moderate debt levels. At the end of fiscal 2015, debt reached ARP14.5 billion. The 57% nominal increase in debt level over 2014 stemmed from the depreciation of the Argentine peso and new borrowings at the end of the year, under the framework of Law 8.816. Our base-case scenario for 2016 assumes that Mendoza's deficit before borrowings will widen, which would require large external financing. Our base-case scenario for 2016 already incorporates borrowings authorized by Law 8.816 and 8.838 amid the continued depreciation of the peso, which increases Mendoza's debt, given that 40% of it is dollar denominated. However, the province's rising revenue, due to double-digit inflation, and debt repayment should partly compensate for higher borrowing. As a result, we expect Mendoza's debt to be 50%-55% of operating revenues for the next two years, which we view as moderate.
Mendoza has very weak budgetary flexibility, in our view, because the provincial payroll and interest payments account for the majority of operating costs (63% in 2015), and due to limited ability to increase revenue. Similar to other LRGs in Argentina, Mendoza is facing ongoing demands for public-sector wage increases. We don't foresee wage pressures abating in the next two years, and they should continue squeezing Mendoza's finances and limit its spending flexibility. According to our base-case scenario for 2016 and 2017, the province will generate about 46% of its total operating revenue, lower than those of the provinces of Buenos Aires and Cordoba. Coparticipation transfers accounted for about 57% of Mendoza's total tax revenue transfers it received from the federal government in 2015. We expect the share of coparticipation transfers to increase between 2016 and 2018, reflecting the recent agreement between the federal government and the provinces to refund the 15% of the coparticipation funds that had been deducted for several years to fund the provincial pension systems.
Mendoza's capex have increased to 8% of total expenditures at the end of 2015 from 6% in 2014, although this increase was due to the renegotiation of existing contracts with suppliers. In our opinion, capex will stay at about 6% of total expenditures for the next three years.
We believe that the province has very weak and volatile budgetary performance due to high inflation, and we expect it to remain so in 2016 and 2017.
Although Mendoza improved its budgetary performance in 2014, the province posted an operating deficit of 7% and a deficit after capex of 13% in 2015.
While the province's revenue grew in line with nominal GDP growth, expenditure accelerated well above inflation level last year. Our base-case scenario assumes operating deficits of around 6% and deficits after capex of around 11% for the next two years.
Mendoza has low contingent liabilities compared with those of its Argentine peers. This is largely because Mendoza has privatized many of its utility companies, and the province is not financially responsible for pension obligations because the central government funds them.Liquidity
Mendoza has weak liquidity with no cash reserves and an estimated debt servicing cost of ARP3.7 billion in 2016. Given that about 40% of the province's debt service is in foreign currency, depreciation of the peso would weaken Mendoza's liquidity further. However, the impact of a weaker peso is tempered by the province's dollar-linked royalty income, which represented 7% of operating revenue in 2015. We expect Mendoza's debt service to reach about 7% of operating revenue in 2016, lower than that in 2015, and to decrease to 5% in 2017 and 2018. We assess Mendoza's access to external liquidity as uncertain largely due to our evaluation of the development of Argentina's domestic capital markets as well as our assessment of the domestic banking system, although the province recently issued a $500 million international bond.OUTLOOK
The stable outlook on the province of Mendoza mirrors the one on the sovereign. The outlook reflects renewed dialogue between LRGs and the federal government about tackling fiscal and economic challenges in the short to medium term. Given that we don't believe that Mendoza could meet the conditions to have a higher rating than the sovereign, we would only consider raising our ratings on the province in the next 12 months if we were to raise Argentina's foreign and local currency ratings and the transfer and convertibility assessment (T&C). In addition, we expect Mendoza's financial management to improve in the form of committed and disciplined fiscal policies, clear budgetary processes, and prudent debt management policy. An upgrade is possible if we expect the province to post operating surpluses and to rein in deficits after capital expenditures. We could lower the ratings on Mendoza during the next 12 to 18 months if Argentina's T&C assessment weakens, if we were to lower the sovereign local or foreign currency ratings, or if we perceive that the province's financial commitments appear to be unsustainable or Mendoza faces a payment crisis within 12 months, which at this point we consider unlikely.