The Big Idea
Costa Rica | Low supply, positive rating momentum
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.
Both technical and fundamentals are helping Costa Rica right now. The country benefits from a sold ‘BB’ rating as well as a low stock of bonds outstanding. An upcoming maturity next month would leave the country with one of the smallest net supplies in the region with no approval yet for Eurobond issuance this year. Its ‘BB’ credentials and illiquidity have helped buffer current market volatility, especially with no obvious US diplomatic tensions on migration, security issues or sensitive export sectors. That makes the sovereign unique in the region for its positive rating momentum and potential for outperforming if it continues moving toward investment grade.
Costa Rica has not approved a revised Eurobond law yet and instead has been buying US dollars from its central bank for the upcoming April 30 $500 million Eurobond payment. Minister of Finance Nogui Acosta confirmed $300 million of US dollar purchases in March. The rating agencies may penalize Costa Rica for its barriers to external market access. But this is much less relevant for a country with a proven track record of deep and captive local markets, even during pandemic, and its large stock of foreign exchange reserves at 15% of GDP. The central bank could also opt for more aggressive foreign exchange intervention and reserve accumulation considering the significant balance of payments surplus and subsequent real foreign exchange appreciation. This high stock of US dollar assets and abundant local liquidity could argue why the Treasury wouldn’t need to carry a level of bank deposits beyond its historical 1% of GDP. External market access is also less relevant after considering similar low cost of funding and longer tenors in domestic markets compared to Eurobond markets.
More flexible access to Eurobond markets would provide additional financing flexibility, especially for bulky transactions. Current administrative restrictions require approval by two-thirds of the legislature for any external debt issuance. There are two initiatives to bypass these restrictions. The near-term fix is the approval of “shelf” financing for multi-year issuance through 2026. This legislation should have broader political support, but it is waiting for a final push for approval. Near-term approval would allow for $1 billion in Eurobond issuance in 2025 and another final $1 billion in 2026 if the country hits targets on debt service and fiscal performance. The medium-term solution is a proposal for a constitutional reform that would bypass the individual legislative restrictions on each tranche of debt issuance. This would provide maximum flexibility to the treasury for determining their debt issuance strategy similar to other debt financing operations across Latin America.
More flexible access to the Eurobond market would be most relevant for credit ratings with restricted external financing a rating constraint across all agencies. This may even allow for a relative fast track to investment grade rating compared to the alternative 10-year trajectory to an optimal 40%-of-GDP debt ratio in 2035. The ‘BB’ rating from Fitch already benefits from a recent positive outlook with maybe a low threshold for an upgrade after the 12-month review in March next year. If Costa Rica shifts to a ‘BB+’ rating from Fitch, then it would be one notch away from investment grade.
This is where it gets interesting. The Fitch rating model already values Costa Rica at ‘BBB’ with three deductions, one of which is the “institutional gridlock that has hindered timely progress on necessary reforms and external financing…” Constitutional reform that makes external financing more flexible should allow for a push into the investment grade category if there is momentum to reach the ‘BB+’ rating next year. The Chaves administration has already been lobbying for this reform, although this is a lengthy process over two legislative sessions that would carry over into 2026. Costa Rica may be the only candidate within the ‘BB’ credits that could migrate higher. This is relevant considering that most of the targeted returns across the region are for carry returns in ‘BB’ and ‘B’ credits alike.
Restricted access to external capital markets may be a near-term disadvantage for Costa Rica’s credit rating, but it’s a near-term advantage to immunize against global financial contagion. These favorable technicals should further improve after a net reduction in the Eurobond stock to $7 billion next month and with no Eurobond issuance in 2024. There is also the potential for positive rating action towards the ‘BB+’ rating category from Fitch as the highest rated credit in the region and the possibility that the country could transfer into the investment grade category sooner than expected if there is progress on constitutional reform for flexible financing. This would allow for low beta carry returns to translate into capital returns if Costa Rica converges with credits like Paraguay for spread compression of 20 bp to 35 bp across the curve.
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