Costa Rica | Slow progress

Siobhan Morden | October 22, 2021

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. This material does not constitute research.

The relative stability in Costa Rica sovereigns suggests all is well with the country’s International Monetary Fund program. Reassurance from IMF staff after the recent mission reaffirms the IMF anchor, thanks mostly to Costa Rica’s outperformance on fiscal targets through September. But it’s still important to monitor progress on the country’s reform agenda. The approaching election cycle could add complications to Costa Rica’s economic program and IMF relations next year. Stay neutral on Costa Rica but closely monitor progress on public employment reform and the political risks of the approaching February 2022 elections.

Discussion of public employment reform has gone quiet through the past few weeks of legislative review of an 800-page revised draft proposal.  There was finally a breakthrough in the last week week with committee approval and submission to the legislative floor for further review. This is not a fast-track process for a democratized country about to enter an election cycle.  There does not seem to be the same momentum on this second round to get legislative approval and address the latest pressures from the IMF.  The public employment reform represents critical savings for a structural fiscal deficit and a structural benchmark of the current IMF program.  Is there enough momentum?  The logistics of the second-round approval process should theoretically be easier.

It is worth remembering that the first-round floor approval in mid-June was not finally reviewed by the constitutional court until mid-September. This was three months on top of many months of preparation and anticipation. It suggested apparently flexible legislative and judiciary deadlines and no respect for the IMF deadline at the end of May. The second round of debate should be easier after making the suggested corrections from the constitutional court; however, the obstructionist opposition from PUSC Pedro Munoz suggests potential glitches and requires a more activist approach from the Alvarado administration. It is also worrisome that the legislature has prioritized vehicle tax cuts as opposed to the revenue-enhancing measures in the IMF program such as luxury home taxes, lottery taxes and so on.  It is unclear whether there is sufficient momentum to get reform into yearend for a first-floor vote followed by constitutional court review then a second floor vote.

The market should remain focused on the undefined IMF negotiations after the virtual first review that ran September 22 to October 6.  The markets focused on the headline IMF endorsement “of significant progress” and shrugged off the note that “discussions will continue in coming weeks“ with no calendar date for the IMF board review. This seems open-ended with IMF board approval likely depending on progress on the public employment reform.

Costa Rica’s fiscal performance should remain the anchor with performance criteria more relevant for the first review and perhaps the structural benchmarks increasingly relevant for the next reviews. The fiscal performance continues to offer a cushion. The country’s outperformance on targets mostly came from one-off accounting benefits including the SOE surpluses. The cumulative primary fiscal surplus of CRC100.5 billion far exceeded the -390 billion deficit performance criteria in July and the cumulative CRC98 billion surplus also far exceeds the September indicative target deficit of -480 billion.

Despite these benefits, the fiscal targets might become increasingly at risk for no progress on the revenue-enhancing measures.  This is where the public employment reform could provide some unexpected savings.  The Planning Ministry assumes 0.9% of GDP in savings in the first year that exceeds the 0.4% in forfeited tax revenues and provides some budgetary flexibility for the fiscal targets next year and the recent slippage on reduction in auto taxes.

Even if there is progress on the public employment bill, Costa Rica is probably entering a more volatile phase of the IMF program ahead of presidential elections next year.  The legislative support for the public employment reform should provide a preview on broader political support for the IMF program through an election cycle.