Fitch: Costa Rica's Svrgn Rtgs Outlook Revised to Negative.
NEW YORK--(BUSINESS WIRE)--April 28, 2003
Fitch Ratings today revised the Outlook on Costa Rica's sovereign ratings to Negative from Stable. Fitch also affirms the foreign and local currency ratings of 'BB' and 'BB+' respectively.
The negative outlook reflects fiscal slippage in recent years, which, in the context of a crawling peg exchange rate and increasing dollarization of the banking sector, has increased Costa Rica's financial vulnerability. Costa Rica's foreign exchange reserve position provides only a limited degree of protection against balance of payments shocks, raising the potential for pressure on the exchange rate. Supporting Costa Rica's ratings are the country's modest external indebtedness, a successful diversification of the export base through significant foreign direct investment (FDI), robust democratic institutions, and favorable social indicators.
The Costa Rican economy decelerated sharply from over 8% growth in 1998 and 1999 to an average of 1.7% during 2000-2002. This was driven by the global growth slowdown and lower commodity prices which adversely affected exports, as well as high domestic interest rates that have limited growth in domestic demand. The country has also been unsuccessful in making significant progress on structural reforms, such as privatization of state-monopolies and large national banks.
High fiscal deficits (resulting from a low tax intake and a rigid expenditure profile) in an environment of slow growth have led to a build-up in government debt. General government debt has increased from 39% of GDP in 1998 to over 50% at the end of 2002. Interest payments consume one-third of government revenues. The central government's fiscal deficit reached 4.3% of GDP last year, while the public sector deficit was even higher at over 5% of GDP. Government issuance of dollar-denominated domestic debt has exposed public finances to exchange rate risk.
A low savings rate of 12.7% of GDP, versus 18% for the 'BB' median, underpins Costa Rica's 'twin' fiscal and current account deficit problem, resulting in pressure on the exchange rate. Local currency interest rates have remained high in support of the currency, limiting growth and resulting in a preference for borrowing in U.S. dollars. Fiscal consolidation represents the most direct way to raise domestic savings; moreover, it could also provide room to manage sizable contingent liabilities in the banking sector. Such liabilities could arise from public sector banks, given the blanket state guarantee on deposits in these banks. Likewise private banks, given widespread dollar lending to borrowers with local currency cash flows and a lack of sufficient supervision of offshore-banking activities, could come under pressure.
Current account deficits have been significant over the past few years, reaching 5.5% of GDP last year. Fortunately, FDI has been robust as well, thereby limiting the increase in external indebtedness. Moreover, the country is well positioned to attract greater foreign capital if the Central American Free Trade Agreement with the U.S. is successfully negotiated and implemented.
The Pacheco administration has begun to address the fiscal problem, dividing its strategy in two parts: 1) a temporary Fiscal Contingency Plan implemented in 2003 to raise revenues by 1% of GDP, and 2) a Permanent Fiscal Reform that could raise at least 2% of GDP by expanding the narrow tax base, minimizing tax exemptions, implementing a value-added-tax and improving tax administration. The temporary plan expires this year. Failure to pass the Permanent Fiscal Reform this year in a divided Congress would mean that either legislation continuing the temporary plan will be required or further fiscal slippage would be in the offing.
Going forward, a stabilization of Costa Rica's sovereign creditworthiness will depend on the ability of the government to tackle fiscal deficits and implement structural reform. A comprehensive tax reform, further strengthening of bank supervision, especially of off-shore banking activities, and progress on privatization would be viewed favorably by Fitch. By contrast, continued fiscal slippage and back-peddling on structural reform could further undermine the credibility of the policy framework and increase the pressures on the exchange rate and for dollarization. A sudden exchange rate devaluation would mean a higher government debt burden, given Costa Rica's substantial level of dollar-denominated government debt.
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|Date:||Apr 28, 2003|
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