Economic studies
Costa Rica

Costa Rica

Population 5.0 million
GDP 11,729 US$
B
Country risk assessment
A4
Business Climate
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Synthesis

major macro economic indicators

  2016 2017 2018 (e) 2019 (f)
GDP growth (%) 4.2 3.3 3.0 3.0
Inflation (yearly average, %) 0.0 1.6 2.4 3.0
Budget balance (% GDP) -5.3 -6.3 -7.1 -6.9
Current account balance (% GDP) -2.3 -2.9 -3.3 -3.5
Public debt (% GDP) 44.9 48.9 53.7 57.6

 

(e): Estimate. (f): Forecast.

STRENGTHS

  • Democratic institutions (since 1949)
  • Best social indicators in the region: education and health
  • Services and cutting-edge industries (pharmaceuticals, microprocessors) attractive to FDI
  • Diversified trade, thanks to multiple trade agreements
  • Tourism resources: hotels, national parks

WEAKNESSES

  • Unsustainable public accounts
  • Exposed to natural disasters
  • Inadequate transport infrastructure
  • Dependent on the United States, both economically (FDI, exports) and financially (banks)
  • Lack of skilled workforce; unreported work
  • High income inequalities

Risk assessment

Growth supported by domestic demand but still below its potential

Growth in 2019 will be driven mainly by vibrant private consumption (64.2% of GDP in 2017), which will benefit from reduced political uncertainty following the presidential election in February 2018 and the vote on the first phase of the public accounts reform in December 2018. However, renewed opposition to the fiscal reform could undermine consumer confidence. Alternatively, failure to go ahead with further reforms would cause the colón to depreciate sharply, pushing up inflationary pressures. However, action by the central bank should make it possible to contain inflation within the target range (2%-4%), with the adoption of a tighter monetary policy (the key interest rate was hiked in October 2018 from 5% to 5.25%). Success will depend on the de-dollarisation of the economy (27% of bank loans in US dollars, 17% of GDP in mid-2018). Public consumption is expected to continue to be constrained by the size of the deficit. The fragile public finances will also be a drag on investor confidence. In addition, the government's heavy dependence on domestic financing is expected to prolong the crowding-out effect on private investment, as the bond market is still largely dominated by government bonds (USD 21.7 billion in October 2017). In addition, the financial system remains very fragile, lacking a comprehensive legal framework and a liquid secondary market for government bonds. Tourism and construction are set to attract new investment, mainly in private residential and non-residential projects, while other services, particularly telecommunications, will also grow briskly. Finally, the agricultural sector should get a lift from the recovery in banana production, which was hard hit by weather conditions in 2018, as well as in other agricultural products in response to rising external demand from the likes of China, Chile, and Peru.

Public finances in an alarming state that could affect the external accounts

The public accounts feature a very large structural deficit. Revenues are insufficient to finance the sharply increasing expenditures, with an ever-growing share going towards servicing the country’s exploding public debt. The social security system is especially fragile. Without reform, revenues will be lower than total expenditure from 2023 onwards, making it necessary to tap into reserves that will run out by 2030. After many previous attempts foundered due to the lack of political agreement, a much contested initial tax reform was approved in December 2018. The new law introduced a 13% VAT to replace the sales tax of the same amount, along with a lower rate for basic necessities. A reform of capital taxation, eliminating exemptions, and caps on wage increases for civil servants were also introduced. Under the new fiscal rule, increases in current expenditure will be linked to changes in the debt-to-GDP ratio, and no project will be approved without financing. However, broader reforms remain necessary to ensure the sustainability of public debt on a long-term basis.

The external accounts are in better shape. Exports are expected to perform strongly on increased external demand for capital goods (particularly medical devices) and agricultural goods (pineapples, bananas). However, this increase will not offset the growth in imports (trade deficit equal to 8.5% of GDP in 2017) driven by demand for capital goods and commodities (notably hydrocarbons). The balance of services, which shows a surplus thanks to tourism revenues (surplus of 9% of GDP in 2017), will not be enough to balance the current account, which will remain in deficit owing to the repatriation of corporate dividends. The country's external financing remains secured by FDI. Nevertheless, the weak public accounts constitute a risk that is exerting downward pressure on the colón (the currency’s value fell by 9% between August and November 2018), prompting the central bank to draw on its foreign exchange reserves (4.9 months of imports in the first half of 2018) to provide support.

A fragmented political landscape amid the need for reform

Carlos Alvaro Quesada, representing the Partido de Acción Ciudadana (PAC), won the presidential elections of February 2018, beating out evangelical candidate Fabricio Alvaro of the Partido de Restauración Nacional (PRN). Given how fragmented the Parliament is (seven parties sharing the 57 seats and the PAC holding just ten), he will have to compromise to carry out any legislative projects. In this context, the fight against crime and money laundering rings linked to drug trafficking, as well as the reform of public finances, will remain priorities for the government.

The business environment will continue to be affected by infrastructure deficiencies (transport and telecommunications in particular) and relatively high energy costs (electricity).

In terms of international relations, the priority will continue to be OECD membership, as well as the establishment of free trade agreements with China and South Korea.

 

Last update : February 2019

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