(Reuters) Fitch Ratings has affirmed Costa Rica’s Long-term foreign and local
currency Issuer Default Ratings (IDRs) at ‘BB+’. Fitch has also affirmed the
Short-term foreign currency rating at ‘B’ and the Country Ceiling of ‘BBB-‘.
The Rating Outlook is Stable.
RATING RATIONALE
The affirmation of Costa Rica’s ratings is supported by the country’s
institutional stability and strong social indicators that have facilitated large
FDI inflows, thereby contributing to steady growth, high per capita income and
better financing of the country’s large current account deficits. The ratings
are constrained by the lack of political consensus to address high structural
fiscal deficits that result in negative debt dynamics, and by limited monetary
and exchange rate policy flexibility.
Costa Rica’s diversified value-added export-based economy should continue to be
resilient in the face of sluggish global growth. Costa Rica’s economy is
estimated to have expanded 5.1% in 2012, outperforming the 4% median of ‘BB’
peers amid a fragile global economy. Fitch expects the economy to expand an
average of 4% over the next two years. Risks stem from renewed weakness in the
U.S. economy, the country’s main export destination and source of FDI flows.
Pressures on domestic interest rates stemming from hefty fiscal needs could
exacerbate already large portfolio inflows, thereby increasing challenges for
the monetary and exchange rate policy.
Costa Rica’s five-year inflation rate remains above the ‘BB’ median. However,
after a long history of double-digit inflation, an improved monetary policy
framework has raised the central bank’s credibility and could ultimately
facilitate inflation convergence with the peer median. Inflation stood within
the band of 5% plus or minus 1 percentage point for four consecutive years in
2012. Fitch expects inflation to be 5% over the next two years. Risks to
inflation arise from higher fiscal deficits, swings in international commodity
prices, and monetary expansion related to the defense of the floor of the FX
band in the context of large portfolio inflows.
In the near term, macroeconomic policy challenges have increased for the
authorities due to the large capital inflows to the country in the context of
limited exchange rate flexibility and the central bank’s persistent losses. A
high interest rate differential attracted portfolio inflows of near 3% of GDP in
2012. As a result, the central bank swiftly introduced macro-prudential
measures to prevent excessive growth in asset prices and credit which could
potentially become a source of risk for the financial system and the broader
economy.
High-quality FDI will continue to support external accounts over the forecast
period. Fitch expects the 2013 current account deficit to reach 5.0% of GDP and
to be mostly financed by FDI. However, recent strong portfolio inflows render
the capital account somewhat vulnerable to sudden stops. In addition, Costa
Rica’s international liquidity position remains weaker than rating category
peers.
High structural fiscal deficits continue to undermine Costa Rica’s credit
profile. Fitch expects deficits to average 4.8% of GDP in the next two years.
The lack of political consensus to address Costa Rica’s low revenue base and
rigid expenditure structure weighs on its fiscal profile. Authorities’ efforts
to rein in expenditure growth and improve tax collection efficiency are not
sufficient to stabilize debt at current levels. Fiscal consolidation prospects
are uncertain, as the electoral cycle is already underway. Presidential and
legislative elections will take place in February 2014.
Despite the increasing burden, the general government debt remains below the
‘BB’ median. Moreover, Fitch recognizes that Costa Rica’s debt tolerance is well
supported by its higher per capita income level (compared with peers in the ‘BB’
category), well-established social and political stability, as well as material
gains in the composition of debt. Costa Rica’s borrowing requirements are
expected to exceed 10% of GDP in 2013, but domestic liquidity and external
market access support its financing flexibility.
RATING SENSITIVITIES
The main factors that could lead to a positive rating action are:
–Greater political consensus to address structural fiscal imbalances leading to
a sustained expansion of the revenue base, improved fiscal management and
favorable debt dynamics;
–Increased monetary and exchange rate flexibility that enhances the
shock-absorption capacity of the economy
The main factors that could lead to 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
and de-dollarization process;
-A material downshift in Costa Rica’s growth trajectory.
The ratings and Outlooks are sensitive to a number of assumptions:
–Fitch’s base-case scenario assumes no recession or deepening of the financial
crisis in developed economies, most notably the U.S., and therefore a
continuation of steady FDI flows;
–Fitch assumes that no major fiscal reform will be implemented over the next
two years and that the authorities continue to restrain expenditure growth and
improve tax collection.
–Fitch assumes that the central bank will maintain its foreign exchange rate
regime and that no sustained macroeconomic imbalance will result as a
consequence of the strong portfolio inflows.
