The Big Idea
Costa Rica | Election optimism
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Costa Rica’s February 1 election looks set for now to support the country’s economic reform agenda. This was the main reason for recently highlighting the country’s longer tenors as the top pick for next year. The sovereigns have outperformed its ‘BB’ peers as the market starts to anticipate a possible investment grade rating. Technicals also help, with no recent Eurobond issuance and a small stock of bonds outstanding.
The next election cycle in Latin America is quickly approaching with general elections in Costa Rica for the president and the full turnover of the Assembly. The elections are not typically a source of high volatility. Costa Rica has a strong democratic tradition with a moderate voter base.
The last election cycle featured a runoff round between two center-right candidates. The polls predict even less uncertainty this time. The incumbent candidate is the dominant frontrunner with no momentum for the open field of other candidates. The latest polls show PPSO candidate Laura Fernandez at 30% to 37% support with no other candidate that even reaches double digits. The trend Fernandez support has been increasing across almost all polls on capturing undecided voters while other candidates remain stagnant in single digits. The allocation of the 35% to45%undecided voters could easily push PPSO candidate Fernandez into a first-round win at 40%. The momentum of the first-round win could also maximize the PPSO proportion of the Assembly, with the legislature showing similar trends with 29.5% for PPSO and a distant second for PLN at 10.8% (IDESPO survey). The legislature shows the same marginal support for the other political parties. The bottom line is the potential for a more activist reform agenda.
The leadership from PPSO across the executive and the legislature should allow a break from the institutional gridlock that has weighed on the credit ratings. This is highly relevant for the Fitch sovereign rating model and the potential for a fast-track investment grade rating. The Fitch sovereign rating model has a positive bias for Costa Rica with a ‘BBB’ rating that’s then adjusted lower on the qualitative overlay of two deductions for structural features (institutional gridlock and over-regulated external borrowing) and one deduction for public finances (high interest-to-revenue ratio). The economic team is keenly aware of this rating process and is eager to address these rating penalties to achieve the investment grade rating. The motivation is obvious, and the catalyst is former Finance Minister Acosta and maybe future Assembly President. The recent presentation from PPSO deputy candidate Acosta clearly outlines the legislative priorities including constitutional reform for flexible financing. It will be important to monitor not only the presidential election results but also the legislative election results and the respective legislative agenda.
Eurobond valuations are clearly sensitive to the increasing probability of the stronger governability and the subsequent optimism about reform. The Fitch investment grade rating hinges on the constitutional reform for flexible financing. It’s a lengthy process in two separate legislative sessions; however, the successful first round approval, once sessions commence in May 2026, would suggest sufficient political support for a second vote in May 2027. The flexible financing proposal is not overly controversial with already a lengthy process since late 2024 to raise awareness on the benefits and a legislature that is typically responsive to impactful proposals. It just requires congressional leadership. The success on the reform agenda would allow for still tighter credit spreads on the convergence trade for Paraguay on the longer tenors. The more flexible financing should also reopen the Eurobond markets for Costa Rica. A small, say $1 billion, Eurobond should not be disruptive with supportive supply-and-demand dynamics and only six US dollar Eurobonds outstanding. The infrequent Central American issuers typically meet excess demand for new issuance that trades flat to the secondary curve – these strong demand dynamics that would only improve with an investment grade rating.
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