The Big Idea

Costa Rica | Fiscal rule flexibility

| January 5, 2024

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 has been a stellar emerging markets performer for three straight years for good reason. The latest economic data shows a strong combination of high 6% GDP growth, little inflation and a roughly 2% GDP primary fiscal surplus for 2023. It is also one of the only countries in Latin America that is lowering its debt burden. The continuing high 4.4% GDP debt service does remain a burden on the budget and requires continuing commitment to a high primary fiscal surplus. But there are a few institutional checks and balances that should reinforce fiscal discipline through the remainder of the Chaves administration, and Costa Rica should remain on a gradual track for an investment grade rating.

Firstly, fiscal consolidation remains critical. The preview of the 2024 budget reinforces the need to reduce debt payment below 46% of the budget. Debt service at 4.4% of GDP in 2023 remains a rigid component that cannibalizes the majority of the budget. The debt service and public salaries represent the majority of the budget. If there is no popular support for higher taxes, then the budget requires cutbacks across both categories to better allocate spending towards more productive sectors.  There remains broad cultural support for fiscal discipline with no social pushback after near 5% of GDP fiscal consolidation from 2019 to 2022. There was also a conservative interpretation of the fiscal rule through the pandemic in 2020 with only minimal flexibility from the escape clause. There is now a track record of near two years of generating a primary fiscal surplus of roughly 2% of GDP and a budgeted 1.88% of GDP primary surplus for 2024.

Secondly, there are a few institutional guardrails. The Eurobond issuance law (10332) requires a high primary fiscal surplus as a pre-requisite for debt issuance at 1.85% of GDP in 2024, 2.25% of GDP in 2025 and 2.45% of GDP in 2026. If these criteria are not met, then the administration needs to again seek authorization prior to Eurobond debt issuance.

It’s equally important to assess the adoption of public employment reform. This represents an important medium-term reform that will provide significant budget flexibility and potential for maximum savings of 0.4%-0.6% of GDP during the first five years (third review IMF estimate). The IMF program target was adjusted to incorporate 90% of the public payrolls to a single wage spine through September 2023 after some initial delays.  This gradual multi-year adjustment would provide some budget flexibility and potential savings that could strengthen the medium-term fiscal targets.

The fiscal rule itself is not that flexible, especially since the debt ratio under reference (2022) for the 2024 budget is still above the 60% of GDP threshold. This remains the highest threshold whereby capital and current expenditures cannot exceed 65% of the average nominal GDP growth over the previous four years. This sets the most stringent parameter for the 2024 budget, especially since the nominal growth still captures the below trend average GDP growth from 2019 to 2022.  The 2025 budget would be equally austere on referencing still the higher 60% debt ratio estimated at 61.5% of GDP (2023) and the still below trend average GDP growth from 2020 to 2024.

The downshift to the next parameter (debt ratios 45% to 60%) restricts only current spending and at a slightly higher 75% of average nominal GDP growth. The exclusion of capital spending is less impactful as only a fraction of current spending. The more important transition would occur on the 2026 budget when 3.5% average increase in spending in the 2024-2025 budgets could accelerate to 6.1% on referencing the higher average nominal GDP growth post pandemic (2021-2024). This could reflect a less austere phase of spending growth of 5% to 6%, but still below the pace of nominal GDP. This is when revenues will be important to monitor, especially if there are less cyclical revenues on near-shoring in the tax free trade zones.  This fiscal rule only reverts neutral — spending at the same pace of nominal GDP — once debt ratios are below 30% of GDP. The official forecasts are for high primary fiscal surplus above 2% of GDP that would allow for debt ratios to improve towards 52% of GDP through 2028.

The fiscal rule is restrictive based on either the higher (60%) or the lower debt ratios (45%) with spending growing at a lower pace than average nominal GDP. The broader political establishment has shown clear commitment and track record to fiscal discipline with a rules-based approach for lower spending through the fiscal rule, the public employment reform and the debt issuance law. This should reassure for a trajectory of successful fiscal consolidation and still lower overall debt ratios towards the investment grade category. This should allow for gradual divergence from the illiquid BB rating category and convergence with investment grade comps.

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

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.

Important Disclaimers

Copyright © 2024 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.

The Library

Search Articles