Costa Rica | No jitters yet
admin | October 30, 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.
With Costa Rica facing a sizable amount of maturing debt, the spotlight falls on local investors’ willingness to continue funding and whether there is another accident similar to late 2018. Eurobond holders have to worry about contagion. There are prospects of a disorderly funding crisis, a distressed domestic debt restructuring or both. Another concern is the gradual saturation of domestic funding markets after consecutive years of high structural fiscal deficits amid restricted access to external credit. Costa Rica is not Argentina, but Argentina showed that gross financing needs are important that and it is not just the domestic lending capacity but also the willingness to lend through increasingly high debt ratios.
The highly democratic society in Costa Rica suggests that domestic investors are not forced funding partners as they seemed in the last episode of stress in the fourth quarter of 2018 after the government tapped the emergency funding facility at the central bank. The gross financing needs are also relevant because of an inflexible budget with a structurally high fiscal deficit in base year 2019. There is potentially some breathing room. Costa Rica can carry over multilateral loans and has recently run successful Treasury auctions; however, no viable near-term resolution of a fiscal adjustment program suggests still high rollover and liquidity risks and latent contagion to Eurobonds.
The analysis and inquiries continue into how Costa Rica manages through the uncertainty of solvency and liquidity risks. The International Monetary Fund program represents a commitment to a medium-term adjustment plan that would stabilize debt dynamics. It is a necessary framework after the country lost credibility on fiscal management through 2019. The recent social unrest and political stalemate following the latest proposal of tax hikes and spending cutbacks may complicate access to domestic financing. The timing is clearly inopportune with a stagnant economic recovery following the Covid shock. The monthly economic activity shows no recovery through August while tax collection declined 12% year-over-year in August. The question then shifts on how long Costa Rica can rely on domestic funding without facing rollover stress or domestic debt repayment stress.
There is some breathing room near-term for a backlog of $1.1 billion in multilateral disbursements pending legislative approval as well as another $550 million to finalize with multilaterals for funds of 2.9% of GDP. The participation from the central bank in secondary treasury markets may alleviate some stress, with the first intervention this past week. However, the central bank has made it clear it would only participate in the secondary markets to reduce volatility; it is reluctant to provide direct emergency funding. The domestic funding market is critical as the backbone of the funding program at 11% of GDP out of the total 15% of GDP for 2021. The ability to access external credit will depend on the ability to negotiate an IMF program. How long domestic investors will continue to fund the government will remain a function of progress towards an IMF program and whether investors are responsive or unresponsive to solvency risks.
There has not been any obvious sudden stop or shock to domestic investor sentiment after the suspension of IMF talks, with perhaps local investors more reactive than external investors. The recent treasury auctions on October 12 and 26 show continuing commitment from domestic investors on size, tenor and amounts. There has been a pickup in foreign exchange intervention and reserve loss of $407 million month-to-date coincident to foreign exchange weakness. The trend yet is not disruptive and certainly not comparable to late 2018; however, foreign exchange weakness merits close monitoring for the high dollarization and subsequent mismatch of private sector assets and liabilities. It should still be important to monitor domestic sentiment for the heavy domestic debt amortizations in November and December and the heavy reliance on domestic investors for the majority of a large funding program. If society cannot agree to pro-cyclical and controversial fiscal austerity, then the debate may shift to domestic debt relief and the disproportionate high burden of debt service on the budget and rigidity elsewhere for constitutionally mandated spending and low tax burden.