The Big Idea
Costa Rica | Cost-benefit analysis
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.
Costa Rica could soon follow The Bahamas back into the Eurobond markets. The timing is ideal. The market is offering a bit of a respite from risk aversion, and there is internal demand for US dollars after a loss of $630 million in foreign exchange reserves since March. A return to Eurobonds should prove the first test of governability for the Chaves administration as well as the first test of investor demand after the impressive relative performance in Costa Rica’s sovereigns so far this year.
There has been renewed discussion about seeking legislative approval for $6 billion in multi-year Eurobond debt issuance. The goal is to not only to diversify funding with a structural inflow of US dollars, taking pressure off the CRC and domestic rates. The goal also is to extend Costa Rica’s debt maturity profile and reduce rollover risk since 45% of the debt stock matures through 2026. The timing is also ideal because of the relative stability of US 10-year rates and the relative calm after months of external risk aversion.
Costa Rica has been a stealth outperformer since last year with almost a transformational performance. It has fully converged to ‘BB’ credit comps like the Dominican Republic as one of the few countries on a path toward credit upgrade. Price performance has since shifted toward higher sensitivity to US Treasury risk than to US equity risk, a de facto divergence from the high beta ‘B’ credit pack.
This outperformance also partially reflects the relative illiquidity in Costa Rica’s debt, with $5.5 billion in Eurobonds outstanding for an infrequent issuer like Costa Rica compared to $26.4 billion for the Dominican Republic. In the initial moments of external risk aversion, DomRep gets penalized for its liquidity since investors sell what they can. Interestingly, the tight differentials have persisted for months with Costar’45 still trading inside DomRep’49.
Initial Costa Rica issuance should be quite moderate with no shocks that would saturate the curve. The strategy is to seek approval for multi-year issuance beginning with $1 billion to $1.5 billion a year. This would represent a slow process that would double the Eurobond stock only over four to five years. The investor appetite for this new issuance would require consistent improvement in credit to validate the ‘BB’ current valuations comparison.
The next stage is seeking legislative approval. This should be straightforward since the benefits for debt liability management seem clear. However, the politics of reaching a two-thirds coalition on any legislation is always challenging. This should also represent a test to the Chaves administration on whether he could reach a workable majority on what remains a clearly divided congress and only 18% PSD representation. The timing should prove beneficial for the initial honeymoon period amidst the structural shift towards more market friendly biased legislature.
New issue terms could either seek to extend duration, lower rollover risk or, similar to the prior 10-year issuance, lower debt service costs with shorter maturity bonds. High debt service cannibalizes the budget at 50% of total spending with an increasing cost of funding on higher US Treasury yields.
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