Fitch Revises Costa Rica's Outlook to Negative; Affirms IDRs at 'BB+'

NEW YORK--()--Fitch Ratings has revised the Rating Outlook on Costa Rica's Long-term foreign and local currency Issuer Default Ratings (IDRs) to Negative from Stable and affirmed the IDRs at 'BB+'. The issue ratings on Costa Rica's senior unsecured foreign and local currency bonds have been affirmed at 'BB+'. The Short-term foreign currency IDR has been affirmed at 'B' and the Country Ceiling at 'BBB-'.

KEY RATING DRIVERS

The revision of the Outlook to Negative reflects the following:

Costa Rica's high structural fiscal deficits, slower economic growth and difficulties in implementing tax reforms over the last decade have led to worsening debt dynamics. The sovereign maintains access to debt markets and multilateral credit lines. However, financing conditions are deteriorating due to the lower absorption capacity of the domestic public sector investor base and the rising pressure on international interest rates.

The budget deficit widened for the fifth consecutive year in 2013-2014, climbing to an estimated 5.6% of GDP, the weakest outturn since 1980. This reflects a structural deterioration in public finances. Fiscal revenue is among the lowest among rating peers owing to weak compliance and a generalized system of incentives and tax exemptions. Spending rigidity has worsened since 2008 due to increases in public sector payroll and social transfers. Interest payments to revenue exceeded 17% in 2014, more than double the 'BB' median of 7%.

Fitch expects fiscal deficits to remain elevated at 6% of GDP in 2015-2016 in the absence of material progress on tax-enhancing measures. The incoming administration aims at a 3.8% of GDP primary fiscal deficit reduction by 2019 through cost-containment, anti-evasion efforts, efficiency gains in tax administration and an overhaul of the direct and indirect taxation systems. As with various unsuccessful attempts over the last decade, congressional gridlock and adverse court rulings could delay, dilute or block fiscal reform. The new composition of the legislative assembly is more fragmented than in the past, increasing the challenges to secure the passage of a tax reform.

Debt dynamics and financing conditions have deteriorated faster than those of peers. Consolidated general government debt rose to 34.6% of GDP in 2014 from 20% in 2008. Fitch forecasts that the debt burden could surpass the 'BB' median of 40% in 2016 and would not stabilise before 2019, even if a frontloaded budget adjustment is assumed. Growth underperformance and rising borrowings costs on domestic and external debt pose downside risks to the pace of fiscal consolidation.

Fitch forecasts that economic activity could decelerate below the estimated potential of 4% in 2015-2016, mainly affected by the relocation of a large multinational microprocessors manufacturing plant to Asia. Despite the continued success of the country's investment promotion strategy, bureaucratic red tape, weak competition in the energy and financial services markets and long-standing infrastructure bottlenecks constrain growth prospects.

Costa Rica's 'BB+' IDRs are underpinned by the following key rating factors:

Costa Rica continues to attract large foreign investment into high value-added manufacturing and services industries. The country remains a competitive jurisdiction among regional and rating peers thanks to its strong social development indicators, well-educated workforce, political stability, rule of law and active free-trade agreements with China and the U.S.

Adequate international reserves and a well-diversified export base enhance the economy's capacity to absorb adverse terms-of-trade shocks. The sovereign's net external creditor status contrasts favourably with the median debtor position of the 'BB' category.

High fiscal deficits, limited albeit improving exchange rate flexibility, financial dollarization and quasi-fiscal losses at the central bank constrain monetary policy. Despite tightening policy rates, inflation ended 2014 at 5.1%, at the upper band of the official target of 3%-5%, mainly as a result of the rapid pass-through from currency depreciation to domestic prices. Dollarization of credit remains an important source of credit risk for financial institutions, as nearly half of private sector loans are denominated in foreign currency.

RATING SENSITIVITIES

The following risk factors individually, or collectively, could trigger a negative rating action:

--Failure to implement a primary fiscal deficit reduction consistent with a sustained improvement in debt trajectory;

--Evidence of sovereign financing constraints in the domestic or international debt markets;

--A marked deterioration in the business or political environment that impairs foreign investment and growth prospects.

The Outlook is Negative. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a positive rating change. Future developments that could individually, or collectively, result in a stabilization of the Outlook include:

--Greater confidence on the government's fiscal consolidation strategy that improves the prospects for debt stabilization in the medium-term.

KEY ASSUMPTIONS

Costa Rica's ratings are based on a number of key assumptions:

Fitch assumes that market access will remain available to finance Costa Rica's high financing needs in 2015-2016.

Fitch's economic growth and external forecasts factor in that the continued strengthening of the U.S. economy could improve exports and tourism activity in Costa Rica. Similarly, lower international fuel prices could reduce imports and benefit consumer spending.

Additional information is available on www.fitchratings.com

Applicable Criteria and Related Research:

--'Sovereign Rating Criteria' (Aug. 12, 2014);

--'Country Ceilings' (Aug. 28, 2014).

Applicable Criteria and Related Research:

Sovereign Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=754428

Country Ceilings

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=752194

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=975915

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Contacts

Fitch Ratings
Primary Analyst
Cesar Arias
Associate Director
+1-212-908-0358
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Todd Martinez
Associate Director
+1-212-908-0897
or
Committee Chairperson
Shelly Shetty
Senior Director
+1-212-908-0324
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Cesar Arias
Associate Director
+1-212-908-0358
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Todd Martinez
Associate Director
+1-212-908-0897
or
Committee Chairperson
Shelly Shetty
Senior Director
+1-212-908-0324
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com