Moody's Downgrades Costa Rica's Risk Rating

Arguing that the high fiscal deficit is still on an upward trend, the rating agency downgraded the long-term and senior unsecured government bond issuer's note from B1 to B2.

Monday, February 10, 2020

Fiscal deficits averaging more than 6% of GDP since 2015 have led to higher public debt/GDP than its 'B'-rated peers, the rating agency said.

From Moody's statement:

New York, February 10, 2020. Moody's Investors Service, ("Moody's") has today downgraded the Government of Costa Rica's long-term issuer and senior unsecured bond ratings to B2 from B1 and changed its rating outlook to stable from negative.
The key drivers for today's downgrade are as follows:

1. High fiscal deficits leading to an upward trend in debt metrics which will remain above rating peers; and,
2. Recurring funding challenges resulting from relatively large borrowing requirements introduce risks to Costa Rica's credit profile

The stable outlook on the B2 rating reflects Moody's view that funding and liquidity pressures will remain contained even as debt metrics continue to rise.
In a related decision, Moody's lowered Costa Rica's long-term country ceilings: the foreign currency bond ceiling to Ba3 from Ba2; the foreign currency deposit ceiling to B3 from B2; and the local currency bond and deposit ceilings to Ba1 from Baa3. The short-term foreign currency bond ceiling and the short-term foreign currency deposit ceiling remain unchanged at Not Prime (NP).

RATINGS RATIONALE
RATIONALE FOR THE DOWNGRADE TO B2
FIRST DRIVER: HIGH FISCAL DEFICITS WILL LEAD TO UPWARD TREND IN DEBT METRICS

Fiscal deficits averaging over 6% of GDP since 2015 have pushed government debt/GDP higher than 'B' rated peers. Despite fiscal consolidation measures approved in 2018, Moody's expects these adverse fiscal trends to continue. As a result, Costa Rica's fiscal deficits, debt ratios, and interest burden will remain materially higher than those of similarly-rated peers for the foreseeable future.

Moody's projects government debt to reach 63% of GDP in 2020, higher than the 56% 'B' peer median. Because the Costa Rican government collects comparatively less revenues than its peers, its government debt-to-revenue ratio will reach 415% in 2020 compared to 263% for peers. Interest payments have been steadily increasing, and will account for over 30% of government revenues this year compared to only 10% for peers.

Although Moody's expects the 2018 fiscal reform to reduce deficits, this will happen only gradually. Last year Costa Rica's fiscal deficit reached 7% of GDP, more than double the median for similarly rated sovereigns. In 2020-22, Moody's forecasts only a small decline, with annual deficits coming just under 6% of GDP. Based on current trends, Moody's projects debt will continue to rise approaching 70% of GDP by 2022.
The fiscal reform approved in 2018 aimed to reduce the overall fiscal deficit through a combination of increased revenues and slower current expenditure growth. As full implementation will be a multi-year process that will span more than one administration, execution risks are material. Moreover, the 2019 fiscal results highlight the difficulties Costa Rica faces in its fiscal consolidation efforts. Despite an 8% increase in overall revenues last year, the government deficit was more than 1% of GDP wider than the authorities' original target, driven by increased interest costs and higher capital spending.

SECOND DRIVER: RECURRING FUNDING CHALLENGES RESULTING FROM RELATIVELY LARGE BORROWING REQUIREMENTS

A combination of high fiscal deficits and a large debt repayments pushed the government's overall funding needs to over 12% of GDP last year. Despite a small drop for 2020, funding needs will remain high. Moody's expects financing requirements close to 11% of GDP in 2020, and projects average annual funding needs to remain above 12% of GDP in 2021-22, nominal amounts that will test markets' willingness and ability to cover the government's financing needs.
Relatively large funding needs will pose recurrent financing challenges to the government. Even though funding rates have declined since the government experienced a very tight liquidity position in 2018 - a condition that required an emergency loan from the central bank - Costa Rica's international borrowing rates remain among the highest in the region, exposing the government to changes in market appetite for its debt.
Costa Rica's main funding source is local with the domestic financial markets providing three-quarters of all government funding. As the country's domestic markets lack the size and depth to meet all government funding needs over time, Costa Rica must periodically tap international capital markets. In the past, when access to international capital markets was constrained, it has resulted in pressures on domestic interest rates as the government increased its local market funding.

RATIONALE FOR THE STABLE OUTLOOK
The recommendation to assign a stable outlook reflects reduced funding concerns relative to 2018. Although Moody's expects debt to continue to rise and fiscal deficits to fall only gradually, Costa Rica has shown improved market access in the last year and Moody's base scenario is that this will continue.
WHAT COULD CHANGE THE RATING UP
Given the recent downgrade, a rating upgrade is unlikely. The current rating would be strengthened if the government effectively implements structural budgetary adjustments that materially reduce fiscal deficits, limiting the expected worsening in government debt indicators and, as a result, easing funding risks.
WHAT COULD CHANGE THE RATING DOWN
Prospects of continued fiscal deterioration that result in higher government debt metrics than what Moody's currently projects, as well as a deterioration in market access conditions associated with materially higher funding costs, could lead to a negative rating action. Evidence of stress in the banking system, or a significant increase in the level of financial dollarization could also place downward pressure on the rating.
GDP per capita (PPP basis, US$): 17,566 (2018 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 2.6% (2018 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 2% (2018 Actual)
Gen. Gov. Financial Balance/GDP: -5.9% (2018 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -3.1% (2018 Actual) (also known as External Balance)
External debt/GDP: 48.4 (2018 Actual)
Economic resiliency: baa3
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 5 February 2020, a rating committee was called to discuss the rating of the Costa Rica, Government of. The main points raised during the discussion were: The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The issuer has become increasingly susceptible to event risks.
The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
REGULATORY DISCLOSURES
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.



More on this topic

Honduras Maintains Debt Rating

June 2019

Moody's kept the rating of long-term issues and senior unsecured bonds at B1, arguing that there is a "solid fiscal framework that has stabilized debt at lower levels compared to its rated peers.

Honduras' fiscal balance behaves favorably with respect to GDP and has been enough to stabilize overall government debt at around 41% of GDP, Moody's report explains.

Moody's Downgrades Risk Rating to Costa Rica

December 2018

The rating agency reduced the long-term and senior unsecured bond issuer ratings of the Costa Rican government from Ba2 to Ba1 and changed the outlook to negative.

According to Moody's, among the main factors behind the decline is the continued and projected worsening of debt metrics in the back of large deficits despite fiscal consolidation efforts.

Moody's: Negative Outlook for Costa Rica's Debt

February 2016

The agency has changed the outlook from stable to negative, warning that there is still a lack a political consensus for approving a fiscal adjustment to reduce costs and improve the debt / GDP ratio.

The lack of political consensus to reduce the fiscal deficit will continue to put pressure on the government's rising debt burden.

Costa Rica Loses Investment Grade

September 2014

Moody's has removed the country's rating of "investment grade", citing the increase in public spending and political inability to implement fiscal reform.

From a statement by Moody's:

New York, September 16, 2014 -- Moody's Investors Service has today downgraded Costa Rica's government bond rating to Ba1 from Baa3. Moody's has also changed the outlook to stable from negative.

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