The Big Idea
Costa Rica | Charm offensive
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Cosa Rica has momentum after successive credit rating upgrades and active discussion among investors about its investment grade potential. Approval of Eurobond legislation in the remaining 12 months of the Chaves administration would satisfy investor demand for issuance and give rating agencies some rating positives. External financing flexibility and broader political cooperation would improve rating prospects after a positive outlook from Fitch on its ‘BB’ rating earlier this year. This positive momentum has helped buffer the credit against global market uncertainty. It also benefits from scarcity value as one of its seven outstanding Eurobonds matures this week, and the curve likely bull steepens on the reinvestment flows.
May should provide a unique opportunity for Costa Rica’s executive to control the legislative agenda. Successful legislative cooperation would counter concerns of political fragmentation and build on a decent track record of 60% legislative approval of submitted bills. There is motivation to push several reform bills that would improve financing flexibility, including the Eurobond issuance bill and the constitutional reform that streamlines the heavy regulations of external debt issuance. There have already been some efforts to adjust the Eurobond law, including the amendment to the unusual provisions on the placement of border scanners. The additional revisions include an agreement to reframe the fiscal and debt parameters as the pre-requisites for Eurobond issuance. There should be sufficient political sponsorship considering the prior legislative approval for multi-tranche issuance and the muti-year financing benefits that continue into the next administration for $1 billion issuance this year and $1 billion next year.
Constitutional reform that allows for regulatory financing flexibility would be quite relevant, but the process would be quite lengthy requiring verbal commitment from President Chaves in his state of the union address on May 2 and then two successive approvals across two separate legislatures this year and next year post elections. There has already been the beginning of a lobbying effort with legislative testimony from the markets, rating agencies and multilaterals and a clearly receptive political establishment to the prospects of an investment grade rating. The legislative cooperation and financing flexibility would serve two purposes from a rating perspective and reinforce perspective for the follow-through upgrade from Fitch to ‘BB+’ on the next rating review.
There are also the prospects for establishing a contingent credit line of $350 million to $500 million from CAF. This would also provide additional financing flexibility and contrast with the recent suspension of the FCL to Colombia. The rating agencies may broaden their view on liquidity risks and reconsider the depth of the local markets as well as the high 14% of GDP in foreign exchange reserves. There are also the efforts to increase the liquidity cushion with treasury deposits that now represent almost two months of local currency treasury obligations. This liquidity management would be quite relevant to Moody’s rating agency after their criticism of low treasury deposits ahead of the January 2023 Eurobond payment. Minister Acosta points out that the Eurobond payment this week was sourced from the local markets with pension funds providing 4% of GDP in annual absorption capacity.
The fiscal trajectory is also relevant with maybe accommodation for slightly lower primary fiscal surpluses so long as the high debt service continues to improve. The economic team expects the debt service of 4.8% of GDP in 2024 to gradually decline to 4.4% of GDP in 2026. There has been a sharp decline in CRC and US dollar funding rates. The latest fiscal data in February 2025 showed a similar cumulative nominal deficit to the same period last year with lower debt service offsetting the lower primary surplus. The primary fiscal surplus is no longer at the high 2% of GDP levels; however, the debt ratios continue to edge lower at below 60% of GDP last year. There has been strict compliance with the fiscal rule but limited flexibility to offset the lower revenues from the disinflationary pressures on tax revenues. There has also been proactive debt liability management to lengthen the average maturity from 5.9 to 7 years from 2020 to 2024 and lower the ratio of external versus local currency debt.
This may all provide a fast-track towards an investment grade rating with particular focus on the leadership status from Fitch with a positive outlook on their ‘BB’ rating. The Fitch rating model is quite unique with Costa Rica already rated at an investment grade rating of ‘BBB’ albeit with three negative notches from a qualitative adjustment. These notches specifically focus on structural gridlock, restricted external financing, and adverse fiscal structure. These cumulative efforts represent a charm offensive on discussion with the rating agencies to demonstrate lower liquidity risks and improving solvency risks albeit more gradual debt consolidation but less vulnerable debt dynamics. Fitch remains the leader on the positive rating momentum with the legislative agenda not only critical for the next upgrade to ‘BB+’ but crossing over the threshold into an investment grade rating. This would allow for convergence with credits like Paraguay and still strong appetite for the minimal Eurobond issuance for the core dependence on deep local markets for the majority of the financing program.
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