The Big Idea

Costa Rica | Smooth political transition

Siobhan Morden | April 1, 2022

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.

Election cycles across Latin America are a source of concern for all except Costa Rica with a runoff round on the first Sunday of April between two market-friendly candidates and the International Monetary Fund program already back on track. The IMF board already completed the first and second program reviews and disbursed the latest $284 million loan tranche despite uncertainty on the final election outcome with polls showing a technical tie. Costa Rica has been the stealth outperformer last year and this year with relatively low volatility and good carry.

Under the current circumstance, boring is good. Costa Rica’s approval of the public employment reform reestablished the IMF as an anchor. The final stage of approval was surprisingly quick and the timing opportune. It reaffirmed broad political support for fiscal discipline through an election cycle. It’s not obvious what if any tweaks the winning candidate will make to the IMF program since there are no obvious hurdles remaining. There are several tax proposals that are not technically part of the IMF program for hitting structural benchmarks. The extra revenue would help offset low tax collection and buffer against external shocks. However, the savings from public employment reform should allow the fiscal accounts to exceed original forecasts with a primary surplus of 1.3% of GDP in 2023.

The IMF cites potential savings of 0.5% to 0.8% of GDP over a five-year horizon. The IMF also states that revenues should be strong even adjusting for one-offs and cyclical factors with targets “comfortably within reach” even without approval of the revenue measures. There has been no support among the political establishment to push through the tax hikes and predictably not much if any support from either of the presidential candidates. The debate may instead shift to whether the program should be rolled over when it expires in July 2024. The renewal of the IMF program and broader access to multilateral funding would provide low-cost fund for debt service that otherwise cannibalizes the budget.

IMF relations should evolve after the runoff round this weekend. The latest polls all reaffirm a technical tie with UCR showing a slight advantage at 41.4% for former World Bank economist and former Finance Minister Chaves against 38% for former President Figueres. There is still a high undecided 18.1% with high rejection rates that only confirms a highly uncertain outcome. The policy management should remain consistent under either candidate as the IMF program provides a coherent framework and stability under fiscal rule and public employment reform.

The amended IMF program does include a new structural benchmark for legislative approval of amendments to the BCCR law to strengthen the autonomy and governance framework. The legislature is typically unreliable so this new benchmark may prove challenging from a logistical standpoint. There also hasn’t been much if any socialization on this topic with the burden on the next administration to prioritize central bank reform on the political agenda.

The low execution risk for the IMF after strong fiscal performance should continue to anchor credit spreads. Costa Rica also benefits from supportive technicals with a low beta status an advantage under the highly volatile external markets. The supply and demand dynamics have been quite favorable with inferior liquidity that deters against active trading and light overall positions. This offers relative advantages against benchmark liquid credits like DomRep that have near five times more bonds outstanding and heavy long positions. The relative spread differential has converged across the curve with the COSTAR’25 trading inside the DomRep curve. Costar should trade at a lower and tighter range relative to DomRep shifting from 80 bp to 150 bp on COSTAR’45-DOMREP’49 differential to now flat to +50 bp. This does not reflect the current mismatch on ‘B/BB’ credit ratings. However, it seem fair to assume a lagged response with all the rating agencies having recently shifted from negative to neutral in February and March. The path towards ‘BB’ ratings may prove gradual and data dependent after fiscal consolidation and after reaching trend target of the 1.3% of GDP primary surplus in 2023.

Siobhan Morden
siobhan.morden@santander.us
1 (212) 692-2539

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.