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Costa Rica 2017 | FINANCE | REVIEW: CAPITAL MARKETS

Costa Rica's relatively small size represents an interesting trait of a domestic capital market with ambitions bigger than its body.

The development of Costa Rica's financial market was ranked 40th best by the World Economic Forum's (WEF's) 2016-2017 Global Competitiveness Report (GCR). Driving the competitiveness of this successful level of development are the country's banks, which were ranked 33rd for the soundness of their operations, and the legal rights of parties in the domestic financial markets. Costa Rica's capital markets, however, do not boast the same degree of recognition; the GCR ranked Costa Rica 111th and 109th in terms of the ability to secure financing through the local equity market and the availability of venture capital respectively. The shining light for the country's capital markets remains the efficacy of its regulatory controls over the securities exchange, with the regulation of the Bolsa Nacional de Valores de Costa Rica (BNV), the nucleus of local capital markets, earning a ranking of 42nd in the GCR. The BNV is also one of 22 members of the Federation of Iboamerican Exchanges, further underlying the long-term reliability of the country's capital markets' solvency as a vehicle for mobilizing capital investments in growth areas. In addition to the country's transnational financial market integration, one of the strengths of Costa Rica's capital structure is its low exposure to external volatility, an insulation perhaps best illustrated by its current account deficit; although -4.66% of GDP as of the beginning of 2016, more than 90% of the national current account is financed through net FDI, a vital relief from the pressures of excessive foreign debt burdens.

The oldest market for the exchange of securitized equity assets, the BNV was founded in 1970 by members of the National Chamber of Finance, Investment, and Credit (CANAFIC), and following the creation of the Costa Rican Development Corporation (CODESA) in 1974, the Central Bank of Costa Rica completed an initial public offering of the BNV, 100% of which was subsequently purchased by CODESA. Following a period of consultation and development, the BNV held its first trading session on August 19, 1976, before being formally inaugurated shortly after on September 29. In line with the so-called economic democratization process initiated during the early 1990s by former president Ángel Calderón Fournier, the 40% stake in the BNV held by CODESA was sold off to private investors, and the exchange is today held entirely by private entities.

The total market capitalization of the BNV stood at USD4.617 billion at the start of 2016, representing a 26.15% compound annual growth rate from the USD1.445 billion registered at the start of 2011. As of the beginning of 2016, there were 16 transaction firms brokering the exchange of shares of 10 companies listed on the BNV, a CAGR since the beginning of 2011 of -1.21% and 2.13% respectively. Since 2011, the BNV Stock Index has risen at a CAGR of 16.47 from 4,687.98 to 10,047.00 at the beginning of 2016. During the same period, the total value of fixed-income securities trading grew at a CAGR of 9.73% from USD5.158 billion at the beginning of 2011 to USD8.207 billion at the start of 2016, while the total value of share trading fell dramatically from roughly USD160 billion at the start of 2011 to just USD56 billion at the beginning of 2016, representing a -18.94% compound annual rate of decline in the market value of private Costa Rican ownership equities. Exchange rate futures trading has also fallen substantially in recent years from 29 contracts traded in 2014 to just 12 in 2015, a 58.62% YoY drop-off in forex derivative trading on the BNV. In terms of market capitalization by economic sector, industry is by far the most significant segment of the BNV, accounting for roughly 63% of the total market cap. Banking, financial, and insurance companies represented roughly 16% of the total BNV market capitalization. Publicly traded ICT firms' share of total market capitalization stood at approximately 21% at the beginning of 2016, a 5% YoY increase from beginning-2015 market cap.

The estimated value of Costa Rica's current debt market is around USD44.9 billion, around 72.6% of which is issued in Costa Rican colon, while 27.2% is US dollar-denominated, and a marginal 0.2% represents domestic inflation currency. Costa Rica has a Ba1 sovereign debt rating from Moody's, while Standard & Poor's gave it a BB and Fitch rated the country BB+ with a negative outlook. Standard & Poor's downgrade in outlook from stable to negative comes as a result of ongoing deceleration, which has in turn driven up debt financing and interest payments. The current forecast puts the estimated government budget balance at 7% in 2017, which is estimated to consequently push government debt to as much as 45% of GDP. In February 2016, Moody's also adjusted its outlook on Costa Rican Ba1-rated government bonds from stable to negative. Moody's also cited elevated budget shortcomings and increasing debt liabilities as a key driver in its decision to downgrade Costa Rica, but noted that the country's diamond in the rough is its comparatively strong national income, with its USD14,920 GDP per capita nearly doubling the USD8,845 median among other Ba-rated sovereign debt issuers.
One of the primary factors playing into the setback in Costa Rica's sovereign debt rating is the concern that government debt may increase as a result of a widening fiscal deficit. There is a position held by many, including the aforementioned credit rating agencies, that the absence of agreement among political leaders on how to reduce the fiscal deficit will leave the state budget susceptible to continued upward pressure on government borrowing. Costa Rica's gross national financing requirement for 2016 has been estimated at nearly 12% of the country's GDP, a figure that is projected to further increase in 2017 unless the government takes decisive steps to narrow the fiscal deficit through fiscal reform. While domestic financing reached just 6.2% as recently as 2013, government borrowing is expected to reach 11% of GDP in 2016 in order to meet its financing requirements, and most of this will be borrowed from the country's domestic capital markets. Needless to say, an increasing reliance on domestic debt borrowing carries with it the risks of putting pressure on local interest rates and affecting economic growth.

While Costa Rica's capital markets still have a great deal of room for improvement, the overall financial system is in good condition. Capital bases exceed mandated minimum requirements, key indicators of liquidity levels reveal a financial system that is well-equipped to support further economic expansion, and there is an increasing buildup of credit in foreign exchange markets, particularly among parties that lack an inherent hedge against forex risk. Greater development of the country's capital markets remains a primary objective of both public and private sector leaders, and one way of fostering this development is through the creation of new and innovative financial product offerings. Costa Rica's Superintendency of Securities announced that in the first half of 2016 it would include in its portfolio a new investment vehicle concentrating on highly liquid short-term securities. Progress such as this will go a long way toward containing capital financing costs, narrowing interest rate spreads, and bolstering the capacity of the financial sector to facilitate sustainable long-term economic growth.