The Big Idea
Costa Rica | A comfortable financing program
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.
Persistent global risk aversion and rising US Treasury rates may raise rollover risk across Latin America, but Costa Rica is the exception. This is a sharp reversal from late 2020 when high gross funding needs and restricted market access worried the markets. A virtuous circle has started thanks to captive, deep local markets, strong IMF relations and considerable fiscal adjustment. Declining liquidity and solvency risks validate Costa Rica’s relative outperformance this year. The country now shifts to optimizing its funding strategy or maybe even to liability management on a path to higher credit ratings.
There has been no negative reaction to the announcement of a multi-year funding program of $6 billion from 2022 through 2027. Surprisingly, sovereign credit spreads are actually now even tighter post-announcement on relative terms. Costa Rica still benefits from an illiquid, under-developed bond curve that will only slowly receive maybe $1 billion to $1.5 billion in annual issuance over the next few years. The $5.5 billion stock of Eurobond debt stands in stark contrast to the $26.4 billion in DomRep and probably explains the majority of the relative value dynamics. This disparity on the Eurobond debt stock partly reflects the smaller gross funding needs of a smaller economy in Costa Rica but also the administrative barriers of two-thirds legislative approval necessary for external debt issuance. This alone should weigh against disruptive supply.
Costa Rica would be unique as one of the few ‘B’ credits that could easily access Eurobond markets as an infrequent issuer with positive credit momentum of a successful IMF program with better-than-expected fiscal consolidation. The IMF vote of confidence has served as an anchor through the persistent external risk aversion.
The next question is how best should Costa Rica optimize their financing program? This is a critical question. The country has a high debt stock after years of cumulating structurally high fiscal deficits. The high debt service explains the difference between the nominal fiscal deficit of -5.2% of GDP and a primary deficit of -0.3% of GDP last year. The high debt service cost has been a topic of public policy debate for years where the debt service alone cannibalizes near half of the budget. The funding strategy should shift away from the local markets and instead target cheaper multilateral loans (1.217% IMF lending rates as of 2/24/2022) or the still cheaper and longer tenors of the Eurobond markets (35% to 45% domestic debt issuance are 1- to 5-year tenors). The medium-term financing program hopes to reduce the debt service from 5.1% of GDP in 2022 to 4.3% of GDP in 2027.
The medium-term financing program from 2022 through 2027 shows a marked reduction in the gross financing needs as well as a shift towards external credit. There is still optionality for $1 billion in Eurobond issuance this year, but it depends on legislative approval against a purely opportunistic funding strategy. The Finance Ministry has already identified and developed an external funding program that fully relies on multilateral credit at $2.4 billion for 2022 without the need to access Eurobond markets. The official target is to shift external credit towards 30% to 53% of the gross financing program. This virtuous circle depends upon still progress on fiscal consolidation under the binding constraints of the fiscal rule, the savings of the public employment reform and the pushback to social and political pressures under the global inflationary stress from the commodity shock. The initial rhetoric from the Chaves administration suggests a conservative approach on fiscal management for further fiscal consolidation. Despite tight relative valuations with COSTAR’45 trading around 40 bp inside DOMREP’49, positive credit momentum may continue to reinforce and validate outperformance.
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