The Big Idea
Costa Rica | Opportunistic issuance
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 a strategy of minimizing high debt service costs and maximizing investor demand, Costa Rica’s financing program should remain opportunistic. Although the legislature approved shelf registration for $5 billion in Eurobonds, the country along with almost all other emerging markets issuers faces a new reality of higher US dollar borrowing costs. Finance Minister Acosta also has pointed to Eurobond issuance only in March next year after getting encouragement from the rating agencies. There are limited risks of disruptive issuance. Costa Rica has broad financing options, good core investor demand as an infrequent issuer and improving fundamentals.
Fitch Ratings weighed in first on the approval of a $5 billion shelf Eurobond issuance. The summary report highlighted not only the financing flexibility but also the much better than expected fiscal consolidation:
Fitch expects a downward debt trajectory over the coming five years, reflecting a better primary balance and significantly improved real interest rate-to-growth differential.
Minister Acosta now prefers to wait for a positive outlook from rating agencies ahead of the Eurobond launch. This should coincide with full-year fiscal performance released in February or March showing consecutive years of fiscal outperformance beyond IMF program targets. The fiscal turnaround has been remarkable, especially on a relative basis, as many countries struggle against pro-cyclical adjustment in the aftermath of Covid-related social and political pressures. The structural fiscal deficit shifted from a primary deficit of 2.0% of GDP in October 2018 to a surplus of 2.3% of GDP in October 2022. The two consecutive years of positive surprise on fiscal performance should motivate all the rating agencies to shift towards a positive outlook on the ‘B2/B’ ratings early next year. The positive rating action is unique in a region that has suffered a trend of net rating downgrades since 2014.
Costa Rica should soon join ‘BB’ rated credits like Guatemala and Paraguay that have also benefited recently from positive rating actions. There has been some criticism that valuations are too tight for still a ‘B’ rated credit that trades at near convergence to ‘BB’ rated credits. However, the markets typically trade ahead of rating agencies more slowly to lower execution risks. Although it may take years to adjust towards the ‘BB’ rating category, the trajectory seems firm under the rigidity of the fiscal rule and the public employment reform. The fiscal rule has already been stress-tested through the Covid shock and through the political transition. Although there have been a few attempts to weaken the fiscal rule, the conservative legislature has pushed back. This reaffirms a society consensus for fiscal discipline that again in unique for the spreading populism across the region.
The financing flexibility is also ideal, with no urgency to saturate Eurobond markets or double their debt stock. The lobbying on the legislature impressed urgency for approval but in reality, there are backup sources of funding for the January $1 billion payment including $400 million in treasury deposits or access to local funding markets. The true intentions were to maximize financing flexibility with the optionality but not the necessity of Eurobond issuance. Costa Rica was probably the first country to strengthen IMF relations and divert towards cheaper multilateral funding through the surge in USD borrowing costs. Costa Rica was also the first to access the RST lending facility while benefiting from the broader benefits of a successful IMF program. The ideal moment for Eurobond issuance was through the cheap borrowing costs of zero interest rates that defined record emerging markets issuance from 2017 through 2021. This has since shifted with a sharp deceleration in 2022 and a regional shift towards either cheaper ESG-related issuance or multilateral loans.
The multi-year Eurobond issuance should be opportunistic with no near-term incremental supply considering the $1 billion January amortization and shorter tenors to minimize funding costs on the steep Eurobond curve. The additional gradual issuance should capture stronger demand from higher credit ratings through 2025. The fiscal accounts are already in autopilot to reduce the debt ratios after having already reached a 2% of GDP trend primary fiscal surplus. The strong fiscal rule and additional Eurobond conditionalities (pre-requisite for fiscal discipline) should reaffirm the trajectory towards debt sustainability. The impressive consecutive years of relative outperformance may slow the pace of additional gains; however, strong fundamentals and illiquidity should reaffirm the low beta status to maximize high carry returns.
Santander Investment Securities
1 (212) 692-2539
U.S. Fixed Income Trading Commentary Disclaimer
This commentary has been prepared by the U.S. fixed income trading desk of Santander Investment Securities Inc. (together with its affiliates, “Santander”) for its institutional investor clients only, and may under no circumstances be redistributed beyond the recipient in whole or in part. The recipient is an “institutional account” as defined in FINRA Rule 4512(c) that (i) is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies and (ii) will exercise independent judgment in evaluating any potential investments and any recommendations of any broker-dealers. For the avoidance of doubt, this commentary is not suitable for or intended for retail investors.
This commentary has not been produced or reviewed by, and does not otherwise reflect the views or input of, the Research Department of Santander (“Santander Research”). This commentary may conflict with the views of Santander Research, is not subject to all of the independence and disclosure standards applicable to research reports prepared for retail investors and is not independent from the interests of Santander. Santander may have positions (long or short) in, effect transactions in or make markets in the subject securities (or related derivatives) mentioned in this commentary, and such positions or trading may be inconsistent with this commentary. However, Santander is under no obligation to make a market in or otherwise provide liquidity in any security discussed herein. This material may have been previously communicated to Santander’s trading desk. Santander may have in the past or may in the future provide investment banking services (including underwriting activity and loans) or other services for the companies mentioned in this commentary.
This commentary has been provided for informational purposes only and is not a recommendation, offer or solicitation for the purchase or sale of any security or related instrument. This communication is intended to be short term and brief in nature, and therefore does not provide a full analysis of any issuer or security or a sufficient basis upon which to base an investment decision. The individual circumstances of the recipient’s investment objectives and needs have not been considered in this commentary, and nothing in this commentary constitutes investment, legal, accounting or tax advice or a representation that any investment strategy or service is suitable or appropriate to the recipient’s individual circumstances. Information contained herein has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made as to its accuracy or completeness. The recipient should not rely on this commentary for any investment decision or other action, and Santander expressly disclaims any liability for any losses arising from any reliance on or otherwise related to this commentary. This commentary reflects the personal views of the individual sender of such commentary, and no part of his or her individual compensation was, is or will be directly or indirectly related to its content. This commentary is provided as of the date and time thereof, and Santander does not undertake any responsibility to update or revise any of the information contained herein, which may change without notice. Past performance is not indicative of future results.
Fixed income securities, including those described herein, are subject to many risks, including, but not limited to, interest rate risk, the credit risk of the issuer, inflation risk, liquidity risk and risk of a downgrade by rating agencies. Emerging markets investments are additionally subject to political, economic, legal, regulatory, market, settlement, execution, currency and other risks. Fixed income, and specifically emerging markets, investments are not suitable for all investors.
Santander Investment Securities Inc. is an SEC registered broker-dealer, FINRA member and SIPC member. Santander Investment Securities Inc. is a direct, wholly-owned subsidiary of Santander Holdings USA Inc., which is a direct, wholly-owned subsidiary of Banco Santander, S.A
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.
Copyright © 2023 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.