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Country Report Costa Rica

Country Report

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In 2011 and 2012 the Costa Rican economy grew by 4.2 and 4.9%, respectively. Inflation amounted to 4.5% in 2012, well within the official target range of 4-6 percent. Based on its well diversified economy, growing population, rising demand for its high tech exports and stable inflow of FDI, we expect the Costa Rican economy to grow by around 4% per year in the coming years. The main risk right now is the financial position of the government. Since the beginning of the economic crisis, the budget deficit rose to 4.5% of GDP in 2012. The government intended to increase tax revenues by extending the tax base, but did not succeed. Meanwhile, the current account deficit was relatively large at 5.3% of GDP in 2012, but foreign direct investment flows have remained stable and almost completely financed the current account deficit. Recently, the government proposed to raise the tax on speculative capital inflows, as it tries to limit the appreciation of the colon.

National facts of Costa Rica
National facts of Costa RicaSource: EIU, CIA World Factbook, Procomer, UN, Heritage Foundation, Transparency International, Reporters Without Borders, World Bank.

Introduction and update

In both 2011 and 2012 the Costa Rican economy grow at a higher rate than was expected a year ago. The figures for 2011 and 2012 were revised upwards with 0.5 and 1.0 percent points to 4.2% and 4.9% respectively. In particular gross fixed investment, which grew in real terms by more than 6% in both years, was strong. Private and government consumption grew in line with overall GDP. Imports and exports underperformed relatively to overall GDP. Based on its well diversified economy, growing population, rising demand for its high tech exports and stable inflows of FDI, we expect the Costa Rican economy to grow by around 4% per year in the coming years.

Since the start of the economic crisis in 2009 the government has increased public spending from 15.7% of GDP in 2012 to 19.0% of GDP in 2012, while government revenue remained at around 14% of GDP. In 2011 the Chinchilla administration intended to narrow this gap by increasing tax revenues by 2.5% of GDP through an extension of the tax base. However, the opposition blocked the reform, and the government had to lower its target to 1.5% of GDP. In December 2011 one of the opposition politicians claimed that the law was not constitutional and asked the Supreme Court to review the case. In April 2012 the Supreme Court ruled that the tax law was unconstitutional, which forced the government to present a new proposal. It is doubtful whether the new tax law will be implemented in 2013, as new elections are planned in 2014. Nevertheless, investors are still confident about the financial position of the government. In November 2012 Costa Rica issued a USD 1 billion dollar-denominated 10-year Eurobond at an interest rate of 4.25%. Especially foreign investors were interested in the issue; 51% was purchased by U.S. investors, European and Asian investors acquired little less than half and Costa Rican investors took 2%. Although the government thus still has a good access to finance, it will have to reduce the deficit in the coming years.

In both 2011 and 2012 the Costa Rican economy grow at a higher rate than was expected a year ago. The figures for 2011 and 2012 were revised upwards with 0.5 and 1.0 percent points to 4.2% and 4.9% respectively. In particular gross fixed investment, which grew in real terms by more than 6% in both years, was strong. Private and government consumption grew in line with overall GDP. Imports and exports underperformed relatively to overall GDP. Based on its well diversified economy, growing population, rising demand for its high tech exports and stable inflows of FDI, we expect the Costa Rican economy to grow by around 4% per year in the coming years.

Since the start of the economic crisis in 2009 the government has increased public spending from 15.7% of GDP in 2012 to 19.0% of GDP in 2012, while government revenue remained at around 14% of GDP. In 2011 the Chinchilla administration intended to narrow this gap by increasing tax revenues by 2.5% of GDP through an extension of the tax base. However, the opposition blocked the reform, and the government had to lower its target to 1.5% of GDP. In December 2011 one of the opposition politicians claimed that the law was not constitutional and asked the Supreme Court to review the case. In April 2012 the Supreme Court ruled that the tax law was unconstitutional, which forced the government to present a new proposal. It is doubtful whether the new tax law will be implemented in 2013, as new elections are planned in 2014. Nevertheless, investors are still confident about the financial position of the government. In November 2012 Costa Rica issued a USD 1 billion dollar-denominated 10-year Eurobond at an interest rate of 4.25%. Especially foreign investors were interested in the issue; 51% was purchased by U.S. investors, European and Asian investors acquired little less than half and Costa Rican investors took 2%. Although the government thus still has a good access to finance, it will have to reduce the deficit in the coming years.

Figure 1: Current account balance
Figure 1: Current account balanceSource: EIU
Figure 2: Fiscal indicator
Figure 2: Fiscal indicatorSource: EIU

Capital controls

Costa Rica is attracting relative large amounts of capital inflows, which leads to an upward pressure on the Costa Rican colon. To protect exports, the central bank (BCCR) has set an exchange rate band. This band runs currently from 500 to 776 colons per US dollar. In the last two and a half years, the colon has fluctuated around the upper part of the band. During this time the BCCR could prevent the colon from appreciating above the band by purchasing a relatively limited  amount of dollars. In the last three months however, the BCCR has purchased over USD 1.5bn the stabilize the Costa Rican colon, which corresponds with 26% of its foreign exchange reserves.

Figure 3: Exchange rate
Figure 3: Exchange rateSource: BCCR
Figure 4: Foreign exchange reserves
Figure 4: Foreign exchange reservesSource: BCCR, EIU

To stop further upward pressure on the colon the government of president Laura Chinchilla has presented a bill to congress to raise taxes on speculative capital inflows from 8% to 38%. Besides, it has proposed to oblige banks with foreign investors to deposit up to 25% of the value of the foreign investment with the central bank. Finally, the Minister of Finance announced that interest rates may be lowered to reduce capital inflows. However, given the fact that inflation remains relatively high, there seems  to be no room to reduce the policy rate right now. In January, inflation amounted to 5.7% and thus remained just within the target range of 4-6%.

Avoiding further appreciation of the colon may help to limit the current account deficit, which is already relatively large. In 2012 Costa Rica ran an expected deficit on its trade balance of nearly USD 5.7bn (-12.6% of GDP) and a surplus on its services balance of USD 3.8bn (8.4% of GDP). Including the income and current transfers, Costa Rica was running a current account deficit of USD 2.4bn (-5.3% of GDP). However, the current account deficit was almost fully compensated by the net inflow of foreign direct investment of USD 2.2bn. 

Economic indicators of Costa Rica
Economic indicators of Costa RicaSource: EIU
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Author(s)
Maarten van der Molen
Rabobank KEO
+31 30 21 62666

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