January 19, 2017 / 4:43 PM / 2 years ago

Fitch Downgrades Costa Rica to 'BB'; Outlook Revised to Stable

(The following statement was released by the rating agency) NEW YORK, January 19 (Fitch) Fitch Ratings has downgraded Costa Rica's Long-Term Foreign- and Local-Currency IDRs to 'BB' from 'BB+'. The Outlooks were revised to Stable from Negative. The issue ratings on Costa Rica's senior unsecured Foreign- and Local-Currency bonds are also downgraded to 'BB' from 'BB+'. The Country Ceiling was downgraded to 'BB+' from 'BBB-'. The Short-Term Foreign- and Local-Currency IDRs are affirmed at 'B'. KEY RATING DRIVERS The downgrade reflects Costa Rica's deteriorating debt dynamics driven by large fiscal deficits and continued institutional gridlock preventing progress on reforms to correct fiscal imbalances. Costa Rica's central government fiscal deficits have grown over the last five years, reaching 5.7% of GDP in 2015 (the general government deficit reached 4.6% of GDP in 2015, which incorporates surpluses of public pension funds). Despite the estimated 0.6% of GDP improvement in 2016 (due largely to administrative measures), the fiscal deficit is expected to rise over the next two years as a result of a higher interest burden and spending rigidities. The government's tax reform proposals to rein in the fiscal deficits have made little progress in Congress given its fragmented structure and the cumbersome legislative process. The outlook for passage of the crucial VAT and income tax proposals (estimated to provide close to 2% of GDP in additional revenues) has significantly diminished as the February 2018 congressional and presidential elections approach. Fitch's new baseline scenario does not incorporate passage of any meaningful tax reform measures in the forecast period through 2018. As a result of the large fiscal imbalances, Costa Rica's debt burden has risen rapidly over the last decade. Gross general government debt doubled to an estimated 41% of GDP in 2016 from 20% of GDP in 2008 (Fitch's general government figures net out around 4% of GDP in public pension holdings of government debt). The debt burden will continue to rise in the absence of meaningful tax measures, with debt expected to reach over 60% of GDP within the next decade. The Stable Outlook reflects Costa Rica's resilient growth and financing flexibility in the captive local market, which has been able to accommodate the large fiscal deficits, mitigating Fitch's previous concerns over the financing flexibility of the sovereign. A dynamic and diversified export base and a vibrant tourism sector have underpinned Costa Rica's solid economic performance, with GDP growth estimated to have reached 4.2% in 2016. Fitch forecasts growth of above 4% in both 2017 and 2018. In 2016, Costa Rica was largely able to meet its financing needs in the local market by tapping sizeable liquidity among various public-sector entities, after congressional authorization for external bond issuance ended in 2015. Furthermore, the fall in the oil price and the buoyancy of export and tourism receipts have underpinned an improvement in Costa Rica's external finances, with the current account deficit falling to an estimated 3.5% of GDP in 2016 from 4.5% in 2015. Inflation averaged 0.7% in 2016, well below the central bank's 3%+/-1pp target due to the fall in oil prices at the beginning of 2016 and a relatively steady exchange rate (until the latter part of the year). As a result, the central bank's monetary policy has remained accommodative over the last 12 months with policy rates on hold after a cumulative 350 basis point cut in 2015-Jan 2016. Inflation is expected to converge to the central bank's target in 2017. High fiscal deficits, limited exchange rate flexibility, high financial dollarization and quasi-fiscal losses at the central bank continue to constrain monetary policy. Costa Rica's 'BB' ratings are supported by structural indicators that are strong relative to peers, including high per capita income, social development and governance standards. The ratings are also supported by the country's successful economic model centered around high value-added service and manufacturing activities, which supports robust growth and foreign direct investment inflows. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Costa Rica a score equivalent to a rating of 'BBB+' on the LT FC IDR scale. In accordance with its rating criteria, Fitch's sovereign rating committee decided to adjust the rating indicated by the SRM by more than the usual maximum range of +/- 3 notches because of the extent of Costa Rica's intractable political gridlock and sharply rising debt burden. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: --Structural: -2 notches, to reflect a long track record of institutional gridlock that is not captured in the county's high governance indicators, as reflected by repeated failure to produce meaningful fiscal reform because of congressional fragmentation and judicial injunctions. --Fiscal: -2 notches, to reflect our expectation that debt will continue to rise over the medium- to long-term in the absence of more substantive fiscal reform, as well as a rigid expenditure profile dominated by indexed salaries, rising interest payments, and constitutionally mandated spending in such areas as education, which makes fiscal consolidation difficult. The SRM is Fitch's proprietary multiple regression rating model which employs 18 variables based on three-year centered averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output in assigning the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The following risk factors individually, or collectively, could trigger a positive rating action: --An easing of political gridlock that improves overall fiscal management, including passage and implementation of meaningful tax reforms; --Meaningful progress on a fiscal consolidation strategy that improves the prospects for debt stabilization; --Higher growth that improves fiscal and government debt dynamics. Future developments that could individually, or collectively, result in a negative rating action include: --Significant fiscal slippage that leads to a sharper deterioration in debt dynamics; --Evidence of sovereign financing constraints; --A deterioration in prospects for foreign investment and growth. KEY ASSUMPTIONS Fitch assumes that in absence of authorization of a Eurobond issuance, Costa Rica will be able to meet its high deficit financing needs in 2017-2018 through reliance on the local market and/or through alternative external financing sources. Fitch forecasts that U.S. growth and continued lower oil prices will support economic growth in Costa Rica in 2017-2018. Contact: Primary Analyst Richard Francis Director +212-908-0858 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Todd Martinez Associate Director +1-212-908-0897 Committee Chairperson Tony Stringer Managing Director +44 203-530-1219 Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: elizabeth.fogerty@fitchratings.com. Additional information is available at www.fitchratings.com Applicable Criteria Country Ceilings (pub. 16 Aug 2016) here Sovereign Rating Criteria (pub. 18 Jul 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1017771 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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