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Costa Rica | IMF anchor
admin | August 14, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Distressed LatAm credits have rebounded from the low prices of the spring, but blowout fiscal deficits and debt ratios leave solvency concerns lingering. ‘B’ credits such as Costa Rica and El Salvador have benefited from their high yield, with the market assuming liquidity risks have probably been resolved six months after the initial shocks. That makes for good carry, but debt solvency with ratios closer to 50% of GDP than 70% of GDP requires commitment to an International Monetary Fund program. Early IMF talks have offered somewhat of an anchor to bond prices with a significant rally since the initial headlines and a normalization of the curve. The sooner an IMF program goes in place, the better.
An IMF program will be critical to reaffirm credible policy management and commitment to fiscal discipline. Costa Rica is now at a crossroads, with the IMF negotiations critical for sustaining the recent gains and anchoring bond prices on what could be an ambitious program with high execution risk next year that will likely require Eurobond issuance.
Headlines have come out for weeks about an IMF program. The latest guidance was that the legislative approval for the RFI loan was a pre-requisite to jumpstart formal negotiations. The Rapid Financing Instrument was approved at the committee level and now should be submitted for a floor vote. These delays forebode a more difficult process on legislative approval for a formal IMF program. The official timeframe outlines broader consensus building since April among different sectors of society with proposals requested between August 9 and August 20, discussions between August 24 and August 28 and a public presentation of the IMF agreement next month. This is the first critical test.
The IMF agreement is controversial for a country reluctant to subordinate its economic management and complacent about the severity of its financing and structural fiscal problems. The IMF program will focus on “four key challenges: revenues, public spending, tax evasion and state assets. The goal is to reduce, in a sustainable manner, the fiscal deficit in 2021.” The public awareness campaign has been necessary to build solidarity and consensus for approval of the IMF program and the austerity measures. There has been clear pushback against any tax hikes while revenues are quite low at 14% to 15% of GDP and VAT at 13%, low against the 16% LatAm average rate.
The IMF program and its successful execution will be critical to reduce financing risks. The IMF program looks likely to require access to voluntary capital market funding and cooperation from the legislature to approve Eurobond issuance next year. The official assumptions about domestic funding of 11.2% of GDP seems high.
Exhibit 1: Highlights of Costa Rica’s balance sheet
Source: https://www.presidencia.go.cr/comunicados/2020/07/gobierno-solicita-a-la-asamblea-legislativa-aprobar-en-julio-el-credito-con-el-fmi/, Ministerio de Hacienda
The question is whether the legislature will agree to the measures necessary for the IMF program and the large estimated funding program of 15% of GDP. These negotiations should also coincide with the budget. The initial guidance from the IMF staff notes suggests a primary deficit of 1.4% of GDP in 2021 against the 2.5% of GDP initial official forecast. This seems challenging with the upwardly revised primary deficit of 4.5% of GDP this year, but maybe not yet ambitious enough for an IMF program.
The markets have been complacent about the IMF anchor with headlines suggesting little to no deal risk as 2045 yields rally from 9% to 8%. The stakes are high with the first litmus test being the consultation period over the next few weeks to build consensus for formal IMF negotiations in September. This near-term event risk merits close monitoring and perhaps more conservative positioning on the lower cash price bonds on the long end of the curve. The delays on approval of the RFI do not show much urgency. If there is not consensus through this consultation period, then markets may be vulnerable to disappointment on what looks like indecision and high rollover and financing risks next year.
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