Fitch Ratings has affirmed Costa Rica’s ratings as follows:
- Long-term foreign and local currency IDRs at ‘BB+’; Outlook Stable;
- Senior unsecured foreign and local currency bonds at ‘BB+’;
- Country Ceiling at ‘BBB-‘;
- Short-term foreign currency IDR at ‘B’.
Costa Rica’s ‘BB+’ IDRs reflect the following key rating drivers:
Costa Rica’s ratings are supported by its political stability and strong human development and governance indicators relative to peers. The country’s capacity to attract large foreign direct investments (FDI) inflows into high value-added manufacturing and service sectors contribute to steady GDP growth rates and solid financing of current account deficits.
Growth in Costa Rica is projected to pick up to an average 4% of GDP in the coming two years from 3.5% in 2013, mostly driven by an expected recovery in the U.S., its main trading partner. Risks to growth are mostly domestic, as rising uncertainty related to the deteriorating fiscal situation could weigh on business and consumer confidence.
High structural fiscal deficits represent a credit weakness for Costa Rica. The general government deficit widened to an estimated 5.1% in 2013 from 4.4% in 2012. Government financing needs at 10.6% of GDP will remain higher than the ‘BB’ category in 2014-2015, also fuelled by a hefty amortization schedule. However, a captive domestic investor base and access to international markets are expected to mitigate financing risks.
Consolidated general government debt, which nets out holdings of government debt by public pension funds, reached an estimated 32.4% of GDP in 2013, below the 36.2% median of the ‘BB’ category. The debt burden has increased by 12.4pp since 2008, reversing most of the reduction achieved between 2002 and 2008. The incumbent government launched a national dialogue to gradually reduce the fiscal deficit to 3% of GDP and stabilize the debt burden at 40% of GDP by 2019. Yet, fiscal consolidation is on hold until the end of the electoral cycle.
The prospects of a contested runoff presidential race and a highly divided congress after the February 2014 general elections could challenge the next administration’s capacity to build political support for a comprehensive fiscal reform. This is particularly likely in light of procedural rules in Costa Rica that provide veto power to minority parties in the legislature.
Limited exchange-rate flexibility, quasi-fiscal losses at the central bank and financial dollarization will continue to constrain monetary policy over the forecast period. The transition to a more flexible exchange rate consistent with a full-fledged inflation targeting regime is still uncertain. Fitch expects inflation to stay within the official target band of 5% +/- 1% in 2014-2015 owing to softer imported commodity prices and subdued domestic demand.
Dollarization of private credit, nearly 50% of total bank loans, represents a risk to banks’ balance sheets. Supervisory authorities have put in place corrective measures but they will take several years to be fully implemented.
Fitch forecasts that the current account deficit will average 5.2% of GDP in 2014-2015, primarily driven by a trade deficit of 13% of GDP. FDI and government borrowing are likely to cover the external gap without exerting pressure on international reserves.
RATING SENSITIVITIES
The Stable Outlook reflects Fitch’s assessment that upside and downside risks to the rating are currently balanced. The main risk factors that, individually or collectively, could trigger a positive rating action are:
- Greater political consensus to address structural fiscal imbalances leading to material fiscal consolidation and favorable debt dynamics;
- Increased monetary and exchange rate flexibility that enhances the shock-absorption capacity of the economy
- The main risk factors that, individually or collectively, could trigger a negative rating action are:
- Sustained large fiscal deficits that cause a marked deterioration in debt dynamics and emergence of fiscal financing constraints;
- Weakening of the macroeconomic policy framework that reverses the disinflation process;
- A marked deterioration in the political and business environment that impair FDI and growth prospects.
The ratings and Outlooks are sensitive to a number of assumptions:
- Fitch’s base-case scenario assumes an economic recovery in the U.S., and therefore a continuation of trade and FDI flows to Costa Rica.
- Fitch’s projections assume that budget deficits will remain elevated over the next two years in the absence of significant progress on fiscal reform. In this scenario, consolidated general government debt could reach 38% of GDP by 2015.
- Fitch assumes that market access will remain available to finance Costa Rica’s high financing needs.
- Fitch assumes that the central bank will maintain its foreign exchange-rate regime over the next two years.
- Fitch assumes that policy making will not significantly deviate from its current investor friendly stand under a new administration.
