The Big Idea
Costa Rica | Lower primary surplus
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Costa Rica’s fiscal balances for the first half of the year show a primary surplus of 0.9% of GDP, leaving the full-year target of 1.85% of GDP looking ambitious. The numbers trend below the same period last year, and a rigid budget and slowing tax revenues are creating pressure. The country’s fiscal rule should restrict spending in the second half of the year, but full-year performance is extremely sensitive to revenues and foreign exchange competitiveness. Debt ratios have dipped below 60% of GDP through June. This momentum should still require primary fiscal surpluses close to 2% of GDP, base on official simulations. And getting Costa Rica to investment grade requires the gradual improvement in debt ratios below 50% of GDP.
Costa Rica’s official press release emphasizes the debt ratio that dipped below 60% of GDP. This shows a clear deceleration from the spike of 68% of GDP in 2020 and the structural transformation on the fiscal accounts from a primary deficit of 2.6% of GDP in 2019 to a primary surplus of around 2% of GDP in 2022 and 2023. The 59.4% of GDP debt ratio in June 2024 is running 18 months ahead of target. The press releases credits the improvement to the proactive debt liability and funding strategy as well as the foreign exchange rate differential. However, the 2% of GDP primary fiscal surplus remains the anchor for debt consolidation.
The primary fiscal surplus at 0.9% of GDP in the first half of the year is still below the 1.4% of GDP for the same period last year. There is variability to the monthly data that doesn’t allow for a simple full-year extrapolation. However, the full-year target of 1.85% of GDP appears ambitious with almost every month this year underperforming relative to the same month last year. The explanations are two-fold on both higher-than-expected mandated spending and a deceleration in revenues.
There were obligations on retroactive public salary payments in March, April, and June. The fiscal rule will have to restrict spending later this year from the current high 9% year-over-year pace in the first half. The fiscal rule only allows for a 3.5% year-over-year increase in spending against the 2023 budget, or 7.1% year-over-year against the actual 2023 spending.
Spending restraint, however, is not enough. The VAT contributions from the manufacturing sector have declined in the first half versus the same period last year under the constraints of a strong foreign exchange rate and above-neutral policy rate. It’s unusual that the central bank has adopted more conservative advice than the IMF with the policy rate on hold for the last two meetings and still in slightly restrictive territory given persistent deflation. This slowdown in revenues is starting to recover in June at 5% year-over-year with still strong GDP growth of 4.3 year-over-year in the first half and some foreign exchange flexibility beginning in May. This would suggest a slightly higher pace of revenues in the second half of the year..
If we assume full compliance with the fiscal rule and a small recovery in revenues in the second half, this would allow for a primary surplus close to 1% of GDP. The fiscal rule is inherently weaker under any negative shocks to revenues. The structural rigidity of already low spending wouldn’t allow for further cutbacks to compensate against a disappointment on revenues.
What are the implications of a missed target? The prospects for lower fiscal surpluses may postpone Eurobond issuance and slow the consolidation on the debt ratios. There are no macro restrictions for the $1 billion Eurobond issuance this year based on the over completion of the 2023 targets (1.15% of GDP primary surplus and 68.2% of GDP gross debt). However, the 10332 Eurobond law stipulates the installation of scanning equipment at several areas of border crossing prior to Eurobond issuance. This now requires an amendment under advisement from the US Embassy to install the scanners in different locations. For the $1 billion of Eurobond issuance in 2025, the macro tests stipulates a primary surplus of 1.85% of GDP in 2024 as a pre-requisite. The missed fiscal target this year would restrict this issuance. Finance Minister Acosta has already submitted to the legislature the revisions to the Eurobond law that would postpone the $2 billion of issuance into 2025 and 2026. These revisions may face political resistance on the tensions between the legislature and the executive as well as pushback to the Eurobond funding strategy on the sensitivity to funding costs and foreign exchange appreciation.
The slower pace of fiscal consolidation is not ideal but would not likely impact credit ratings with a consolidation of strong credit risk within the illiquid ‘BB’ credit category. Costa Rica would also benefit on more favorable technicals with no near-term Eurobond supply that reaffirms the small $7.5 billion stock outstanding. There are also the checks and balances of the spending restraint from the public employment reform and the fiscal rule that should reinforce the structural primary surplus. However, budget rigidity exposes the fiscal targets to any disappointment in revenues with limited flexibility to further restrict spending. The burden shifts instead to the central bank on the importance of foreign exchange competitiveness, especially under the export-led growth model and near-shoring ambitions.
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