Fitch Ratings-London/Moscow-7 October 2008: Fitch Ratings has today changed the Outlooks on Republic of Karelia’s (Karelia) International and National Long-term ratings to Positive from Stable. Its International Long- and Short-term ratings are affirmed at 'BB-' (BB minus) and 'B', respectively. The National Long-term rating is affirmed at 'A+(rus)'.

The Positive Outlook reflects Fitch's expectations that continued prudent fiscal discipline and economic development will support revenue growth, allowing the region to overcome operating expenditure pressures and improve budget performance in near future. An upgrade could be triggered by a consolidation of its strong budgetary performance, with operating and current margins above 10% over the next two years, and continued debt restraint.

The republic maintained its sound budget performance in 2007, underpinned by high-quality management and continuous economic growth. The republic overcame the adverse effect of lower corporate profits in 2006 and successfully controlled expenditure pressures stemming from the public employee wage increase for 2007-2008. Its operating performance improved considerably in H108. Fitch expects 2008 operating margin to exceed 10%, up from 8.7% a year earlier.

Karelia’s administration has demonstrated sound debt management. The republic has a moderate debt burden, with long-term issued debt representing the dominant direct risk. Its payback ratio is relatively stable and strong, with a debt/current balance of 2.6 years at end-2007. The administration has developed a sophisticated debt management system, which includes control over the republic’s contingent liabilities and a total debt limit of 50% of own revenue (national legislation permits 100%). Liquidity is adequate and there is no immediate refinancing risk.

The regional budget is characterised by high expenditure rigidity. Social expenditure pressures have increased as Karelia has acquired new responsibilities for financing social allowances and other social spending. In absolute terms socially orientated expenditure tripled over 2004-2007. The federal government’s initiatives to raise wages in the public sector will further increase pressure on socially orientated spending.

The regional economy has a strong industrial presence, which provides a broad tax base for the region. However, bias towards the primary industry resulted in high tax concentration; the 10 largest taxpayers contributed about 35% of Karelia’s total budget in 2007. This exposes its budgetary performance to corporate profit fluctuation.

The Republic of Karelia is located northwest of the Russian Federation and accounts for 0.4% of Russia's GDP and around 0.5% of its population.