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.

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

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