Sunday 24 January 2021

Bank of America Securities: Costa Rica seems to need a deep crisis for politicians to act

Regional report notes that although the country has one of the highest interest expenditures in the world, greater pressure in the market may be needed to change the political dynamic

QCOSTARICA – Costa Rica seems to need a deeper financial crisis for the political dynamics to change and the country to reach an agreement with the International Monetary Fund (IMF), which includes making “difficult decisions” such as reducing public spending or increasing taxes.

According to BofA Securities report, Costa Rica could resort to less conventional ways to “succeed without much effort” such as a possible intervention by the Central Bank of Costa Rica

That is one of the conclusions of Bank of America Securities, previously Bank of America Merrill Lynch (BAML), a multinational investment banking division under the auspices of Bank of America (BofA) .

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The investment bank sets off alarms at the crushed situation of Costa Rican finances, that that the interest on the debt demands more than 5% of the Gross Domestic Product (GDP), “almost a quarter of total expenses”, and ends by warning that “it will rise to 6% of GDP in 2021”, one of the indicators “highest in the world”.

The report details the situation in six countries of Central America and the Caribbean: Costa Rica, Guatemala, El Salvador, Honduras, Panama and the Dominican Republic.

The document, dated November 24, gathers the impressions of political representatives, private sector leaders and analysts from different nations, who met virtually, for six days, to discuss the challenges that the region will face in 2021 in matter of economic policy.

On the case of Costa Rica, the report cites: “Politicians would have to experience a real crisis before they are willing to make the tough decisions, some argue. By difficult decisions, we mean reaching a consensus to increase taxes and / or reduce expenses, on a new fiscal reform convincing enough to obtain an IMF program and / or restructure public debt, in order to obtain relief.”

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In the opinion of BofA Securities, the political consensus for a fiscal adjustment in Costa Rica will be difficult to reach and “a greater pressure in the market could be needed to change the political dynamics.”

In fact, the report points out, “without a deeper financial crisis, which forces a change in the political dynamics, it is unlikely” the materialization of the US$1.75 billion loan that Costa Rica would request from the IMF.

In an interview published in La Nación on December 3, President Carlos Alvarado confirmed that Costa Rica will go to the IMF and that it will present a new proposal this month.

The investment bankalso warns that “there are bulls and bears for each country, although less so for Costa Rica and El Salvador, where the consensus is more inclined towards the negative side.”

In the stock market, investors who believe that the stock market is going to rise are called “bulls” and those who believe that the stock market will go down are called “bears”.

‘On the edge of a cliff’

Participants in the report expressed that they seen Costa Rica “on the edge of a cliff.”

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“How did the oldest democracy in Latin America come to this, a country where living standards are above their peers, a benchmark for environmental policy, an economy and the (regional) beacon of development in education, security and institutions ?” reflects BofA Securities.

The question is answered by the inaction of the authorities to make these “difficult decisions.”

Given the high cost of interest on the debt, the BofA investment bank adds, perhaps “restructuring is not that far off,” since it is highly unlikely that the country will float under current conditions.

“It is not easy to imagine that a country carries on with such a heavy burden. It is not easy to foresee a turning point either, as an increase in debt stocks, the 2020 credit rating, and the maturity wall at least until 2023, suggest that there will be upward pressure on interest expenses,” the report warns.

What would happen if Costa Rica postpones the payment of interest on the foreign debt, as Ecuador did in 2019?

The poorest would suffer.

“In Costa Rica, compensation is more complicated because 80% of the debt is internal. Directly or indirectly, the restructuring could have redistributive consequences, (de facto) displacing some social groups,” warns BofA Securities.

Despite all the above, “policy makers remain confident that they can do what is necessary against the fiscal deficit and stabilize debt over time,” the report highlights.

The report reiterates that, despite a multisectoral dialogue process discredited by the legislators, “the Government’s plan is to continue in the search for the IMF program and seal it by presenting a credible fiscal plan.”

The Central Bank option

According to analysts participating in the report, Costa Rica could resort to less conventional ways to “succeed without much effort.” For example, a possible intervention by the Central Bank of Costa Rica (BCCR).

“In our judgment, the BCCR would probably give the government the same three-month loan that it provided in September 2018, around 1.5% of GDP (capped at 5% of the spending budget), and would also facilitate the conditions financing through QE,” dictates the analysis.

“QE” is an acronym for the term Quantitative Easing, which is is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment.

To put it into practice, banks increase excess reserves in the banking system, usually by purchasing financial assets on the market, whether they are stocks, private bonds, or government bonds.

Even so, the BofA Securities report says it “will not rescue the government”, much less if it implies “putting at risk” the Central Bank’s credibility mandate.

“We are talking about, arguably, one of the most professional, transparent and orthodox central banks in all of Latin America,” the report states.

 

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FACT CHECK:
We strive for accuracy in its reports. But if you see something that doesn’t look right, send us an email. The Q reviews and updates its content regularly to ensure it’s accuracy.

Ricohttp://www.theqmedia.com
"Rico" is the crazy mind behind the Q media websites, a series of online magazines where everything is Q! In these times of new normal, stay at home. Stay safe. Stay healthy.

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