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Country Report Costa Rica

Country Report

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Intel has announced that it will relocate its production plant to Asia, severely denting Costa Rica’s GDP. Furthermore, with the government failing to address structural fiscal problems, Moody’s has downgraded the sovereign to below investment grade.

Strengths (+) and weaknesses (-)

(+) Strong institutions

Costa Rica has strong institutions and a stable democracy.

(+) High value added sectors

Partly due to the well-educated labor force, Costa Rica’s main economic sectors (manufacturing, transportation, communication and tourism) are in the higher value-added segment of their respective markets.

(-) Narrow tax base

The combination of a narrow tax base (14.5% of GDP in 2012) and rigid government expenditures restricts the government’s room to maneuver with regard to economic policies.

(-) Fragmented political landscape

Political cooperation has been historically difficult. Therefore, hardly any progress has been made on multiple fronts, including government finances. 

Key developments

1. Fragile government finances lead to Moody’s downgrade

Costa Rica posted a fiscal surplus in both 2007 and 2008, after years of fiscal tightening. Afterwards, everything has taken a turn for the worse, as the country has posted deficits in excess of 4% of GDP since. As a result, government debt increased from 39% of GDP in 2008 to 55% of GDP in 2013.This year will be no exception, as the expectation is that the budget deficit will come in at over 5% of GDP. Further growth of public debt pressure is expected, as the government remains unwilling to undertake any significant steps to alter the financial position of the government.

Figure 1: Public finances
Figure 1: Public financesSource: EIU
Figure 2: External finances
Figure 2: External financesSource: EIU

In order to reduce the deficit, Costa Rica would need to increase the narrow tax base, which is only about 15% of GDP. Also, on the expenditure side, the vast amount of fixed expenditures needs to be cut down. Currently, some 87% of expenditures are legally mandated expenditures and are therefore difficult to cut back. However, incoming president Solís (since May 2014) has already stated his intention not to implement any tax reforms in his first two years in office.

Given these trends, rating agency Moody’s has decided to downgrade Costa Rica by one notch, thereby taking the country out of the investment grade category. This may have a knock-on effect on the Costa Rican debt ratio, as supply of funds will be limited, and the interest rate therefore higher.

2. Intel is leaving, denting Costa Rican exports

Intel has been a large part of Costa Rica’s success story of the past few decades. It entered the country 17 years ago to build a chip factory, in order to export to (primarily) the US. Intel’s impact has been big both indirectly (Costa Ricans are much higher educated than regional peers), but also directly. Intel was responsible for 4.5% of GDP and 17% of Costa Rica’s exports. Its departure will leave a undeniable hole in the economy.

Intel has stated that it will build a Research and Development laboratory in Costa Rica, a testament to the country’s growth in terms of human capital. However, this will only partially help to reduce the damage. Furthermore, Costa Rica seems to aim for even further growth in the tourism sector. However, any specific projects to increase the growth potential of that sector have yet to be presented.

Factsheet of Costa Rica
Factsheet of Costa RicaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Costa Rica is one of the most stable and democratic countries in Central America. The current deadlock between political parties prevents the government from implementing necessary fiscal measures. In addition, Costa Rica’s international relations are quite strong, although the country is having some disputes with Nicaragua regarding its northern border. This is the result of Nicaragua’s plan to build a canal linking the Atlantic and the Pacific Oceans, which may partially be routed through a contested border river. With a homicide rate of 10 people per 100,000 inhabitants, Costa Rica is relatively safe compared to other countries in the region. Crime levels have however increased somewhat in recent years, and mostly relate to drug trafficking.

The creation of a free trade zone in 1982 has helped Costa Rica to develop a modern and dynamic export sector. The policy has attracted multiple foreign manufactures, and the manufacturing and transportation sectors now make up two-fifths of the economy and have generated high-quality jobs. However, due to high energy and labor costs, many companies are now relocating towards Asia. The combination of high income inequality and the fact that people feel poorly represented by politicians may cause social tensions in the future. The tourism sector is another important sector in Costa Rica’s economy, especially since it brings in foreign currency, compensating for the country’s large trade deficits. The main tourist attractions are nature related, including volcanos, beaches, wildlife and national parks.

Economic indicators of Costa Rica
Economic indicators of Costa RicaSource: EIU
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Author(s)
Jeroen van IJzerloo
Rabobank KEO

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