The Big Idea

Costa Rica | Opportunistic issuance

Siobhan Morden | December 9, 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. This material does not constitute research.

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.

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

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

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