Moody's Downgrades Risk Rating to Costa Rica

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.

Thursday, December 6, 2018

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.

The Costa Rican authorities disagreed with the news. The Ministry of Finance rejected "... categorically the valuations issued by the risk rating Moody's, considering them inconsistent with the achievements in recent days in relation to the fiscal situation, the level of confidence shown by investors, the fiscal forecasts from the approval of the 20.580 project, currently Law of the Republic, and the country's capacity to increase."

On the other hand, the Minister of Finance, Rocío Aguilar, said that "... The only way to explain this statement from Moody´s is that it was issued before a historic event such as the vote of the Constitutional Chamber, which unanimously, in form and substance, resolved positively the consultations on the project, and of course, before the approval in the second debate and publication of the Law to Strengthen Public Finance." See Ministry of Finance statement. (In Spanish)

From Moody's press release:

New York, December 05, 2018 -- Moody's Investors Service ("Moody's") has today downgraded the Government of Costa Rica's long-term issuer and senior unsecured bond ratings to B1 from Ba2 and changed its rating outlook to negative, concluding the review for downgrade that was initiated on 18 October 2018.

The key drivers for today's downgrade are as follows:
1. The continued and projected worsening of debt metrics on the back of large deficits despite fiscal consolidation efforts; and
2. The significant funding challenges emerging for the country as rising debt, deficits and interest costs lead to rapidly rising borrowing requirements
The negative outlook reflects Moody's view that fiscal consolidation efforts present material implementation risks that could exacerbate the country's borrowing challenges if crystallized.

In a related decision, Moody's lowered Costa Rica's long-term country ceilings: the foreign currency bond ceiling to Ba2 from Baa3; its foreign currency deposit ceiling to B2 from Ba3; and its local currency bond and deposit ceilings to Baa3 from Baa1. The short-term foreign currency bond ceiling was lowered to Not Prime (NP) from P-3 and the short-term foreign currency deposit ceiling remains unchanged at NP.

RATINGS RATIONALE
RATIONALE FOR THE DOWNGRADE TO B1
WORSENING DEBT METRICS DESPITE FISCAL REFORM EFFORTS

Moody's expects that Costa Rica's ongoing fiscal consolidation efforts will be insufficient to quickly and materially reduce its high fiscal deficits. As a result debt metrics will continue to rise in the coming years and remain much higher than countries with Ba ratings.

Fiscal deficits averaging 5.2% of GDP since 2010 have almost doubled Costa Rica's debt burden over that period. Moody's estimates that by end-2018 Costa Rica's government debt will have risen to almost 54% of GDP and 360% of revenues. In comparison the median of B1 rated sovereigns will be 54% of GDP but only 241% of revenues. Debt affordability is also worsening as interest payments will consume almost one quarter of government revenues in 2018, compared to less than 15% in 2010.

To address the high deficits Costa Rica's government has pushed a new fiscal consolidation law which was approved by the Legislative Assembly on December 3. But even with the new reform in place the budget deficit will remain high in the coming years and it will take several years even to stabilize the growth of the debt burden, longer to make any material inroads into it. The reform aims to reduce the fiscal deficit below 4% of GDP by 2023 through a combination of revenue increases and spending reductions. But several of its provisions are spread over time, and most of the forecast reduction relies on limiting the growth of current expenditures, which will be difficult in the face of popular opposition and in an environment of slowing growth; Moody's expects real GDP growth to slow to an annual average of 2.5% between 2019 and 2022.

As a consequence the reduction in the fiscal deficit will take time and the full impact of the reform will need to wait until 2022. In the meantime, while Moody's expects the reform to narrow the deficit, the rating agency forecasts it will remain high at close to 7% of GDP in 2018 and rising to around 7.5% in 2019, in contrast with official estimates which project a decline in the deficit for next year. Moody's forecasts that the debt ratio will rise to nearly 59% in 2019 and peak at around 65% in 2022.

RAPIDLY RISING FUNDING CHALLENGES AS BORROWING REQUIREMENTS RISE

More immediately, a combination of higher debt, large deficits and rising interest costs have resulted in greater annual government funding needs. Gross funding needs, which had averaged 10%-11% of GDP prior to 2018, will be in the order of 13% of GDP in 2018 and Moody's projects it will rise further to some 15% in 2019, if deficit reduction targets are missed and the government continues to increase its reliance on short-term funding.

Access to market funding at rates that are sustainable over the longer-term has been increasingly challenging as investor sentiment deteriorated in light of the lack of progress in addressing Costa Rica's large budgetary imbalances. Interest rates on foreign issuance have risen particularly fast with Costa Rican bonds today yielding almost 5% more than comparable US debt, while a year ago the difference was only 3.6%.
Limited funding options forced the government to access funding from the Central Bank of Costa Rica in September, in amounts close to 1.2% of 2018 GDP. This emergency financing mechanism must be paid back before the end of the year. The authorities' decision to use the Central Bank facility highlights the government's diminishing options in the face of rising funding pressures.

Despite the fiscal reform efforts which seem to have eased market volatility somewhat, Moody's believes that the country will remain highly exposed to adverse shifts in market sentiment in the coming years, particularly if it fails to achieve its deficit reduction targets. Since fiscal deficits will remain high for several years, reducing existing funding pressures will require a reduction in both the domestic and international interest rates Costa Rica must pay, which will be challenging in the absence of clear and rapid progress on reform. Costa Rica's government will rely heavily on external borrowing for the next several years, planning to borrow up to US$6 billion, almost 10% of GDP, from 2019 to 2023.

RATIONALE FOR ASSIGNING NEGATIVE OUTLOOK

The negative outlook reflects Moody's view that there are considerable implementation risks associated with the government's fiscal consolidation efforts that could further exacerbate the country's borrowing challenges if crystallized. The strength of the government's newfound commitment to fiscal reform remains unproven, and falling real GDP growth will make it even more difficult to meet fiscal revenue targets. Rising global interest rates for emerging market issuers will also pressure funding costs higher.

WHAT COULD CHANGE THE RATING DOWN/UP

Given a negative outlook a rating upgrade is unlikely. However, Moody's would stabilize the outlook at the current rating level if the rating agency expected the government to adopt further structural budgetary adjustments that limited the expected worsening in the government debt indicators and, as a result, eased funding risks.

Prospects of continued fiscal deterioration associated with persistently higher debt metrics and increased susceptibility market access risks would likely lead to a negative rating action. Additionally, 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$): 16,894 (2017 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 3.3% (2017 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 2.5% (2017 Actual)
Gen. Gov. Financial Balance/GDP: -6.2% (2017 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -2.9% (2017 Actual) (also known as External Balance)
External debt/GDP: 27.1% (2017 Actual)
Level of economic development: Moderate level of economic resilience
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 30 November 2018, 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 institutional strength/framework, have decreased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The issuer has become more susceptible to event risks.
The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. 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 or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt 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.



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