Russian local and regional governments (LRGs) enjoyed increased revenue in 2017 but "their rising fortunes may be about to turn," Standard & Poor's argued in a special report on January 22.

As the federal government outperformed fiscally in 2017, regional fiscal health remains a major concern and an issue of debate. Previously Fitch Ratings expected the regions to come close to balance for the first time in 10 years.

S&P notes that LRGs have been supported by appreciation of the ruble since the beginning of 2016 as well as rising salaries, which boosted Russian regions' tax revenues in real terms in 2017. 

This allowed a few LRGs, especially those that serve as headquarters to exporting producers and their suppliers, to achieve budget surpluses and subside liquidity pressures. 

But the agency warns that these positive developments are likely to be temporary and expects a weakening in LRG fiscal performance due to "still-low economic growth, the largely exhausted boost from ruble appreciation, and rising spending pressure."

In 2017 S&P upgraded Irkutsk Oblast and Krasnoyarsk Krai, and revised our outlooks on Samara, Tomsk, and Magadan Oblast to stable from negative.

Overall Russia's economic growth is expected to "remain subdued over the next three years at about 1.5%-1.6%, on average, due to structural constraints, international sanctions, and weak commodity markets."

This will affect the regions with weaker growth of tax and non-tax revenues, as well as the constrained ability of the federal government's to increase grants. As ruble exchange rate remains stable, no help will come from currency appreciation.

S&P also reminds that LRGs now have little fiscal flexibility, as in 2016 the federal government imposed a fiscal consolidation agenda on the Russian regions. 

LRG's direct debt is expected to increase slightly, and make up 30% of operating revenues by year-end 2020 from 28% in 2016, with the debt dominated by commercial borrowings amid federal government restrictions.

"At the same time, we expect that the LRG bond market will gradually expand over the next three years," the report claims, with new issuers taping the capital market and established players expanding their bond placement programs.

In 2018-2020, the LRG bond market will continue to be driven by borrowing decisions of regions with the largest budgets: Moscow, St. Petersburg, and Moscow Oblast.