QCOSTA RICA ECONOMY – Noting the political system’s inability to agree on fiscal issues, Standard & Poor’s has downgraded, from BB to BB-, the rating for the country’s long-term debt, giving it a negative outlook.
Costa Rica Long-Term Ratings Lowered To ‘BB-‘. On Continued Fiscal Deterioration; Outlook Is Negative: Standardandpoors.com, 25 Feb 2016.
OVERVIEW
The combination of growing spending pressures and lack of tax reform has weakened Costa Rica’s public finances and raised its vulnerability to
external shocks.
We are lowering our long-term foreign and local currency sovereign credit ratings on Costa Rica to ‘BB-‘ from ‘BB’.
The negative outlook reflects the risk of a downgrade if expenditure control measures and future revenue measures fail to gradually stabilize
the government’s debt burden.
RATING ACTION
On Feb. 25, 2016, Standard & Poor’s Ratings Services lowered its long-term foreign and local currency sovereign credit ratings on the Republic of Costa Rica to ‘BB-‘ from ‘BB’. The outlook is negative. At the same time, we affirmed our ‘B’ short-term foreign and local currency sovereign credit ratings. We also lowered our transfer and convertibility assessment to ‘BB+’from ‘BBB-‘.
RATIONALE
The downgrade reflects continued fiscal deterioration that has resulted in a growing debt burden and rising interest payments. The combination of persistent spending pressures and lack of tax reform has gradually weakened the country’s public finances and raised its vulnerability to external shocks.
As the Administration of President Luis Guillermo Solis approaches its last full year in office in 2017, we think it is increasingly unlikely that it will be able to pass a substantial fiscal reform. The country’s fragmented Congress and protracted process for agreeing upon legislation have blocked the passage of comprehensive fiscal reform (including changes to income taxes and a shift to value-added taxes) for many years. As a result, we expect that Costa Rica’s general government fiscal deficit will continue increasing this year and surpass 7% of GDP in 2017, which would boost net general government debt above 45% of GDP. (According to Standard & Poor’s definition, the general government deficit includes the central bank, decentralized government agencies, and social security.) We expect that interest payments would reach almost 13% of general government revenues in 2017, from 8% in 2012.
The Solis Administration has attempted to contain spending growth while seeking to pass fiscal reform. However, general government debt has increased an average of 5.5% of GDP during the last three years, and we expect that it will increase an average of 7% of GDP during 2016-2018. Debt denominated in foreign currency accounts for just under 40% of total sovereign debt, illustrating the government’s vulnerability to an unexpected adverse change in the exchange rate, which could result in higher debt service costs. A high level of dollarization, with dollar-denominated loans accounting for around half of total loans, constrains Costa Rica’s monetary flexibility.
We project that narrow net external debt (gross external debt less official reserves, other liquid external assets held by the public sector, and financial sector external assets) will reach 48% of current account receipts (CAR) in 2016, up from 31% in 2013. Similarly, net external liabilities (total public-and private-sector liabilities to nonresidents less total external assets) may reach 149% of CAR in 2016, up from 112% in 2013. A weakening external position, combined with a rising government debt burden, could reduce the sovereign’s ability to absorb the impact of unexpected negative shocks.
Moreover, as a small, open economy, the country’s long-term GDP growth rate could suffer if recent real appreciation of the currency undermines its external competitiveness.
Costa Rica’s long – term growth prospects remain moderate, despite deceleration in 2015 following the contraction of its exports. We project GDP growth to average 3.6% in 2016-2018, with per capita GDP growing above 2% per year. We expect Costa Rica will continue to benefit from a stable political system with ample checks and balances. Costa Rica scores higher than most of its regional neighbors, as well as rated peers, in measures of economic and human development. Its per capita GDP is likely to be just under $11,000 this year.
Declining oil prices helped lower Costa Rica’s current account deficit (CAD) in 2015 to 4.1% of GDP, and despite a 15% drop in exports due to the closure of Intel’s local manufacturing operations. We project that Costa Rica’s CAD will hover around 4% of GDP in 2016 and 2017, with foreign direct investment funding more than 90% of it.
OUTLOOK
We expect that Costa Rica’s general government fiscal deficit will be around 6% of GDP in 2016, resulting in an increase in net general government debt to 42% of GDP. In our view, a comprehensive fiscal reform is increasingly unlikely, forcing the government to rely more on expenditure controls to contain fiscal slippage. Per capita GDP growth is likely to be 2.6% this year, not enough to generate the added tax revenues that could help stabilize the fiscal deficit.
There is a one-in-three chance that we could lower our rating on Costa Rica over the next six to 18 months if the country’s political leadership fails to reach consensus on fiscal measures and implement them in a timely manner to contain further deterioration in public finances. Failure to deepen expenditure control measures and gain added revenues would contribute to a steady rise in the government’s debt burden, leading to a downgrade. Continued fiscal slippage or worsening external debt conditions would significantly increase the share of government revenues devoted to paying interests.
Conversely, a fiscal correction that lowers the general government fiscal deficit and slows the rise in government debt could stabilize the sovereign’s debt burden. That, along with continued economic growth and modest current account deficits, could lead us to keep the rating at its current lev
