The Big Idea
Costa Rica | Ratings upgrade
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Costa Rica has benefited from one of the fastest upgrades from ‘B’ to ‘BB’ in the history of Latin America. Thanks go to Fitch for that, but the other rating agencies are now converging toward ‘BB’ with market valuations already aligned to other ‘BB’ credits in the region. The country’s election cycle offers either an opportunity or a distraction from legislative reform. Successful reform could open the door to a fast-track investment grade rating from Fitch even after the latest inaction and legislative paralysis have unwound earlier optimism on the reform agenda.
The recent upgrade of Costa Rica from Moody’s to ‘Ba2’ reaffirms the positive rating potential across the region and restarts debate on whether Costa Rica can get to investment grade. Fitch remains the leader with a ‘BB’ rating and positive outlook up for review early next year. The latest fiscal data through July shows encouraging trends with a primary surplus edging higher relative to last year while the nominal deficit shifts lower. This is quite impressive considering the approaching election cycle and attests to some institutional independence from political interference.
The cumulative January-to-July 2025 fiscal surplus has shifted higher to 1.2% of GDP against 1.0% of GDP for the same period last year while the nominal fiscal deficit trends lower at 2.5% of GDP compared to 2.8% the year before. Spending is contracting in part from lower debt service, lower capital expenditures and mostly flat spending across the other categories. The fiscal rule is now the backbone of fiscal discipline and necessary considering suboptimal revenues from low trend inflation. The deflationary trend has dragged down tax revenues as well as economic sectors sensitive to foreign exchange after pronounced real foreign exchange appreciation. Headline growth remains resilient with the central bank cautiously making monetary policy easier. Declining debt ratios at 57.3% of GDP in July 2025 suggest a gradual track towards investment grade.
Circumstances look supportive for an upgrade to ‘BB+’ from Fitch with a focus on favorable fiscal trends and much lower debt service. The shift to a ‘BB+’ threshold looks manageable given resilient headline growth and fiscal discipline. The more important transition is from the speculative to the investment grade category. This is where Costa Rica already benefits from a unique ‘BBB’ rating from Fitch on their sovereign model but then downshifts to ‘BB’ on the 3-notch penalty of the qualitative overlay. The fast-track scenario for Costa Rica is to reduce the penalty of “legislative gridlock and over-regulation on external financing.” This was exactly the plan under the proposal to revise the Eurobond law and submit a constitutional reform for flexible financing.
The challenge is to prioritize the legislative agenda and negotiate the absolute two-thirds majority. Is this feasible under the fast-approaching election cycle and the other distractions of ordinary sessions? There was lost momentum after the conclusion of extraordinary sessions in July and the turnover of Finance Ministry leadership. However, there is still potential with renewed effort on the Eurobond law under the newly appointed Finance Minister Lucke with a focus on the extraordinary agenda in November (parallel to budget discussions). This is the precursor for more important constitutional reform.
The timing of the election cycle could allow back-to-back approval of constitutional reform over two separate congressional sessions. The next few months should decide whether this possibility play out. This would allow a breakout from the ‘BB’ pack with recent underperformance relative to Guatemala. My preference is on the shortest tenors. The strong supply-and-demand technicals should allow short tenors to trade tighter to peers. And low rollover and financing risks and low integration to global financial markets should provide defensive characteristics and less sensitivity to the broad market in a risk-off scenario after significant spread compression.
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