Costa Rica | Implications of paralysis

Siobhan Morden | November 4, 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.

With no breakthrough yet in government negotiations over debt issuance, Costa Rica’s Eurobond approval is pushed back again. The country still has sufficient access to funds, so policy paralysis may actually strengthen fiscal rule and reinforce its trajectory towards debt sustainability.  In fact, restricted access to Eurobond markets perversely supports favorable technicals and fiscal consolidation and strengthens a positive view of the credit.

The latest headlines may appear worrisome. Finance Minister Nogui Acosta is complaining that there are insufficient funds for year-end salaries. This sounds like a tactic to encourage legislative approval of Eurobond issuance during the current tense phase of negotiations.  First, there is no funding stress for a country that has run chronic fiscal deficits for years with minimal Eurobond access. Second, financing flexibility is now even greater. Costa Rica has broad access to multilateral funds under the successful International Monetary Fund program and newfound access to the IMF’s Resilience and Sustainability Trust, or RST.  The last IMF staff review is just pending IMF board approval over the next few weeks for disbursement of the latest tranche.

There is still the possibility of compromise while the Chaves administration controls the agenda for the extraordinary sessions. There should be unconditional support for a $1.5 billion authorization of Eurobonds if the Chaves administration accepts the minority committee opinion. The logistics suggest a difficult timeframe to launch an offer this year; however, there is financing flexibility to delay into next year.

The rating agencies response to the situation seems flawed. Why are the ‘B/B2’ rating constrained by the need to get Eurobond legislative approval? There are now broader financing alternatives with multilaterals while the country continues to rely on their deep domestic markets.  There are also initiatives to broaden access to the local markets with proposed regulations to encourage foreign participation.

Eurobonds also represent a low 10% of the debt stock with scarcity value and stronger debt repayment capacity of only $5.5 billion bonds outstanding. It’s also not the ideal moment for Eurobond issuance after the run-up in US dollar funding costs that translates into high 8.5% rate on longer maturities. The majority of Latin American issuers are now re-balancing their funding programs for lower cost alternatives that includes either multilateral loans or ESG enhancements. The high debt service in Costa Rica that cannibalizes 47% of the 2023 budget requires a lower cost financing strategy.

There are low rollover risks for the $1 billion January Eurobond amortization. The central bank shows $460mn of USD treasury deposits, imminent IMF disbursements of $264mn of the third review and another $710mn from the RST while the legislature remains cooperative on approving multilateral loans. There is also open access to the local markets for either CRC or USD funding while the bank liquidity in USD remains quite high. If the Finance Ministry doesn’t want to validate the higher CRC local rates, the USD domestic funding rates are similar to offshore rates.  It’s not a question about convertibility risks as FX reserves continue to escalate at recent highs of $7.75 billion end October while the central bank buys USD to prevent excessive FX appreciation. There is no track record of default or payment accidents that would suggest that the January payment is at risk with three months remaining to source the remaining $540mn of USD funds under various funding options.

There is also the perverse benefit of tense legislative relations – with pushback against proposals to weaken the fiscal rule. This should reinforce a difficult rationalization of domestic spending necessary for reaching a fiscal primary surplus. The current policy paralysis would reinforce the strength of the fiscal rule and public employment reform that would reaffirm a trajectory towards a 2% of GDP primary surplus. There has been no recognition from rating agencies of the impressive fiscal performance from 2021 through 1H2022 at a 1.3% of GDP primary surplus. The consolidation of the rigid fiscal rule and public salary constraints should allow for a faster trajectory towards the trend 2% of GDP primary surplus necessary for debt sustainability.

The rules-based culture of a highly democratic country should mitigate liquidity and solvency risks with policy paralysis now a perverse benefit after having already approved two critical economic reforms. The straitjacket of spending restraint pushes things further down a path toward fiscal consolidation, lower debt ratios and credit metrics closer to a ‘BB’ rating category. The near-term event risks remain low. There is sufficient funding, and Costa Rica should maintain its relatively tight differentials to ‘BB’ comps.  The protracted delays on Eurobond approval reinforces favorable supply and demand technicals and the lower beta status versus the liquid benchmarks like the Dominican Republic and Colombia.

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

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