Costa Rica’s new proposal to IMF may not be enough

Costa Rica’s second attempt to reach a deal with the IMF to obtain US$1.75bn in financing, even if successful, may not be enough to stabilize its troubled public finances. 

In a note, Fitch Ratings said Monday, “Costa Rica's wide fiscal deficit, high borrowing costs and post-pandemic economic recovery challenges could increase pressure on debt sustainability even if the country secures an IMF deal.”

Finance minister Elian Villegas confirmed Monday that the country would be moving ahead with the plan and start negotiations in January to secure the three-year emergency financing agreement.  

President Carlos Alvarado in October called off an earlier proposal to raise taxes to pay for the funding after weeks of public protests, creating a dialogue with opponents to create a joint solution.

That dialogue failed to produce any plan that does not include the IMF funding, Alvarado said earlier this month when he announced the US$1.75bn would have to be part of any solution, and the situation is getting worse every month.

The finance ministry reported the fiscal deficit just in the first 11 months of the year had reached 7.7%, with pandemic-related spending derailing hoped-for improvement from fiscal reforms passed in 2018.

The second plan, according to Fitch, targets fiscal consolidation worth 3% of GDP, of which 0.8% would come from new taxes, 1.5% from spending cuts and 0.5% from eliminating tax exemptions and redistributing surpluses from government agencies. 

“This might prove insufficient to stabilize central government debt without additional measures, and therefore, may not alleviate the pressure on Costa Rica's 'B'/Negative sovereign rating even if implemented as part of an IMF deal,” said the agency.

Fitch added the new plan “remains politically contentious,” with political gridlock representing an ongoing risk to the sovereign’s fiscal consolidation and external financing plans. 

This is made clear by the legislative assembly’s rejection of a US$245mn loan from the IDB in November, “signaling its fraught relationship with the executive.”

Without external financing, the country is being forced to rely on the domestic market for budget financing at higher borrowing costs and a steadily increasing debt burden, all of which are driving the sovereign’s interest bill on a steep incline, according to the agency.

On the current trajectory, Fitch forecasts interest payments reaching 38% of central government revenues in 2020, or 21.4% of general government revenues.

“At 5.4% of GDP, this would be the third highest ratio in Latin America below Jamaica ('B+') at 6.7% and Suriname's ('C') 6.5%, and the eighth highest of all Fitch-rated sovereigns,” said the agency.

To stabilize finances, Fitch said that with the right reforms the government could reach a primary surplus of 2.5% of GDP by 2025 – enough to stabilize the debt ratio.