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Rating Action:

Moody's downgrades Costa Rica's government bond rating to Ba2, continued negative outlook

09 Feb 2017

New York, February 09, 2017 -- Moody's Investors Service has today downgraded Costa Rica's government bond rating by one notch to Ba2 from Ba1, and maintained the negative outlook on the rating.

The key driver behind the downgrade to Ba2 is the continued weakening of Costa Rica's fiscal profile, reflected in its rising government debt burden and persistently high fiscal deficit, which was 5.2% of GDP in 2016.

The continued negative outlook on Costa Rica's credit rating reflects Moody's expectation that a lack of political consensus to implement measures to reduce the fiscal deficit will result in further pressure on the government's debt ratios. The adverse macro-economic consequences of fiscal deterioration could increase susceptibility to event risk.

Concurrently, Moody's has today also changed the long-term foreign-currency bond ceiling to Baa3 from Baa2, while the short-term foreign-currency bond ceiling remains unchanged at P-3. The long-term foreign-currency deposit ceiling was changed to Ba3 from Ba2, while the short-term foreign-currency deposit ceiling remains at NP. The long-term local-currency bond and deposit ceilings were changed to Baa1 from A3.

RATIONALE

RATIONALE FOR THE DOWNGRADE TO Ba2

The key driver informing Moody's decision to downgrade Costa Rica's credit rating to Ba2 is the government's rising debt, which the rating agency expects will reach almost 50% of GDP this year. This higher debt burden increases the portion of revenues that are absorbed by debt-servicing requirements, reducing fiscal flexibility. Moreover, it raises the government's exposure to potential exchange rate and interest rate shocks.

The Costa Rican government's debt has risen every year since 2008, when it was almost half the current level at 25% of GDP. The government debt burden is higher than the median ratio of 43% of GDP median for Ba-rated sovereigns (2017 estimate). The difference is even greater when comparing debt to revenues, with Costa Rica's forecast to be 318% in 2017 vs. a median of 206% for Ba-rated sovereigns.

Costa Rica's rising debt burden has, in turn, increased debt-servicing costs: Moody's forecasts that government interest payments will represent over 19% of government revenues in 2017, the second-highest level among Ba-rated peers. In recent years, the government has increased its reliance on foreign-currency borrowing, as a result of which foreign-currency debt now amounts to 37% of all government debt, up from less than 30% in 2011, raising the risk to government finances of an exchange rate shock.

The main reason behind Costa Rica's rising debt burden is a high fiscal deficit, which has averaged 5.1% of GDP from 2011-2016 and may reach close to 6% of GDP this year and next. The high deficits are increasing the government's annual borrowing requirements, which Moody's estimates will reach 12% of GDP in 2017, compared with 10% in 2014. These higher annual borrowing requirements have also raised the government's exposure to potential increases in interest rates.

High fiscal deficits are a result of increased current spending, particularly wages and transfers, both part of countercyclical fiscal policies which were intended to offset the impact of the global growth shock in 2009. Since then, government spending has continued to increase and will likely reach 21% of GDP this year, up from 17.4% in 2009.

Since Costa Rica began registering higher fiscal deficits in 2010, successive administrations have sought, unsuccessfully, to pass legislation to reduce the deficits. Over that period, little of the proposed legislation was enacted into law, a result of political differences in the legislative assembly. Moody's therefore believes that high deficits are likely to continue to increase the government debt burden.

RATIONALE FOR THE NEGATIVE OUTLOOK ON THE Ba2 RATING

The negative outlook on the Ba2 rating reflects Moody's expectation that the political impasse in Costa Rica will likely keep deficits high this year and next, placing further pressure on the government's debt metrics. A lack of political agreement between the executive and legislative will make it very difficult to implement a credible transition towards a sustainable fiscal deficit, which the rating agency estimates to be around 2.5% of GDP.

There have been several attempts by both the current and prior administrations to reduce the fiscal deficit, in most cases through new legislation to raise the tax intake. However, few measures have actually been adopted, owing partly to the government's weak position in Congress during the last few administrations. Reaching a policy consensus is difficult due to increased polarization in Costa Rica's legislative assembly and the highly atomized legislature, which comprises 57 members from nine political parties. Approval of tax and fiscal reforms has stalled due to a lack of agreement between the executive and the legislature on whether to prioritize tax increases versus spending cuts, and what reforms have been approved are not enough to materially reduce the fiscal deficit.

The current government has proposed new revenue measures to Congress, including changes to the VAT. But even if the proposed legislation is approved, Moody's believes that the reduction in the fiscal deficit will not be sufficient to halt the increase in debt ratios. National elections are due early next year, and policies thereafter will depend on the administration that will assume office, likely in May 2018.

The negative outlook on Costa Rica's Ba2 rating incorporates Moody's view that continued wide fiscal deficits and higher debt could, over time, have negative consequences for other macro-economic variables, such as inflation, interest rates, and the current account balance. This, in turn, the would increase the vulnerability of the sovereign credit profile to event risks, including those stemming from international economic and financial conditions or a reversal of current robust trends in GDP growth and foreign investment.

WHAT COULD MOVE THE RATING UP/DOWN

Given the current negative outlook, Moody's considers an upgrade of Costa Rica's credit rating to be unlikely. However, the rating agency would stabilize the outlook at the current rating level if it became likely that the government will adopt structural budgetary adjustments, such as increased tax revenues, spending cuts or a combination of both, that would arrest and ultimately reverse the rise in the government's debt levels.

Evidence that Costa Rica's fiscal metrics are likely to weaken substantially and lead to a deterioration of other macro-economic indicators would likely lead to further negative rating actions. Evidence of stress in the Costa Rican banking system or a significant increase in the level of financial dollarization could also place downward pressure on the rating because it would heighten susceptibility to event risk.

GDP per capita (PPP basis, US$): 15,469 (2015 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.8% (2015 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): -0.8% (2015 Actual)

Gen. Gov. Financial Balance/GDP: -5.9% (2015 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -4% (2015 Actual) (also known as External Balance)

External debt/GDP: 45.5% (2015 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 07 February 2017, 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 materially decreased. The issuer's governance and/or management, have materially decreased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The systemic risk in which the issuer operates has materially increased. The issuer has become more susceptible to event risks.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. 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.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Gabriel Torres
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Atsi Sheth
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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