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Costa Rica

Author(s):
International Monetary Fund
Published Date:
July 2011
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BACKGROUND

1. Costa Rica weathered the global crisis well, but its fiscal position weakened considerably. The authorities’ response to the crisis consisted of a supportive fiscal stance and increased recourse to external resources, (including through a 15-month precautionary Stand-By arrangement with the Fund that expired in July 2010). In the event, the output loss was moderate, the balance of payments adjustment was orderly, and the financial system remained sound. The fiscal position, however, deteriorated significantly as a result of much lower-than-expected revenues and higher-than-envisaged increases in current expenditure.

2. The administration that took office in May 2010 has proposed a tax reform to reduce the fiscal deficit. President Laura Chinchilla is committed to improve law enforcement, education, and infrastructure. In January 2011, the administration submitted a tax reform proposal to the Legislative Assembly. The government has also taken steps to improve tax administration.

3. Exchange system and statistics. Costa Rica has accepted the obligations of Article VIII, sections 2, 3, and 4. Its exchange system is free of restrictions on the making of payments and transfers for current international transactions. Data provision is broadly adequate for surveillance.

RECENT ECONOMIC DEVELOPMENTS

4. Economic growth resumed in 2010, while inflation remained subdued (Figure 1). Following a 1.3 percent decline in 2009, real GDP grew by 4.2 percent in 2010, initially led by a recovery in inventories and public consumption and later by private consumption. Annual inflation increased from 4 percent in 2009 to 4.6 percent at end-March 2011 (within the 4-6 percent official target range). Core inflation also increased moderately (to 4 percent). More recently, the rise in international food and fuel prices has pushed inflation expectations further above the ceiling of the inflation target range.

Figure 1.Costa Rica: Recent Economic Developments

Sources: Country authorities; and Fund staff calculations.

1/ CA-4 includes median growth rates of Guatemala, Honduras, El Salvador and Nicaragua. LA-5 includes median growth rates of Brazil, Chile, Colombia, Mexico and Peru.

5. The external current account deficit widened in 2010, but private capital inflows recovered (Figure 2). Following a sharp contraction of trade, export growth rebounded in 2010 (6.5 percent) but was outpaced by the growth rate of imports (19.6 percent), raising the external current account deficit to 3.6 percent of GDP (2 percent in 2009). The surplus in the capital account also increased significantly, as the private sector deleveraging observed in 2009 ended, and net public sector inflows increased (including a US$500 million loan from the World Bank). As a result, the overall balance of payments recorded a surplus of over US$550 million (1½ percent of GDP) during the year.

Figure 2.Costa Rica: External Developments

Sources: Country authorities; and Fund staff calculations.

1/ The increase in international reserves of September 2010 reflects a US$500 million disbursement from the World Bank. The decrease in international reserves of February 2011 reflects the amortization of a US$250 million bond.

Private Capital Account(In millions of U.S. dollars)
20092010Change
Private capital account2911,6811,390
FDI1,3471,450103
Non-FDI flows-1,0562311,287
Of which: Banking sector-727136863
Of which: Nonfinancial private sector-32995423
Source: Fund staff based on Central Bank of Costa Rica.
Source: Fund staff based on Central Bank of Costa Rica.

6. The exchange rate appreciated and reached the bottom of the band in late 2010. From mid-2009 to April 2011, the colón appreciated by some 15 percent vis-à-vis the U.S. dollar (14 percent in real effective terms). The colón reached the appreciated end of the exchange rate band in December 2010, and has remained within 2 percent of the floor since then. The appreciation pressures stemmed from higher private capital inflows, and were supported by some portfolio rebalancing toward colón-denominated assets.

Nominal Exchange Rate

Source: Central Bank

7. The central bank adopted measures to contain the appreciation pressures. Starting in August 2010, it has lowered the policy interest rate by a total of 250 basis points (to 6.5 percent); and in September 2010 it launched a 16-month program of foreign exchange purchases for a total of US$600 million (Figure 3). The cumulative purchases under the program reached the announced US$600 million target in April 2011.

Figure 3:Costa Rica: Reserve Coverage in International Perspective1

Source: Fund staff estimates.

1/ End-2010 staff estimates for gross international reserves.

2/ Gross international reserves at end 2010 in percent of external debt at remaining maturity in 2010, plus the current account deficit projected for 2011.

8. The authorities kept the inflation target range for 2011 unchanged at 4–6 percent, and adopted measures to enhance monetary control. The increased inflation risks led the central bank to postpone a planned reduction in the inflation target to 3–5 percent. The authorities also established a deposit facility for banks that, combined with a previously existing lending facility, created a corridor for short-term interest rates, and introduced new instruments to mop up excess liquidity. These measures have stabilized short-term interest rates at the bottom of the corridor.

Interest Rate Corridor

Source: Fund staff based on Central Bank.

9. The fiscal deficit continued to widen (Figure 4). Government spending continued to increase in 2010, including in wages and current transfers; and the consolidated public sector deficit rose to 5½ percent of GDP (4 percent in 2009). Public sector debt at end-2010 reached 39.4 percent of GDP, up from 36 percent in 2008.

Figure 4.Costa Rica: Fiscal Developments

Sources: Ministry of Finance and Fund staff estimates.

1/ Excluding the electricity company.

Primary Government Expenditures

(real terms)

Sources: Ministry of Finance; and Fund staff estimates.

10. The banking sector remained resilient. Although banks’ profitability declined (the return on equity fell from 14.3 percent in December 2008 to 8.3 percent in December 2010), the change was largely attributable to the economic slowdown and other transitory effects. Moreover, capitalization and liquidity levels remain adequate. Nonperforming loans have stabilized below 2 percent of total loans (Figure 5). Credit growth to the private sector remained subdued in 2010, but has started to pick up in 2011. The share of bank loans and deposits denominated in U.S. dollars continued to decline, although the latter remains above pre-crisis levels. (Figure 6).

Figure 5.Costa Rica: Comparative Financial Soundness Indicators

Sources: Country authorities; and Fund staff calculations.

Figure 6.Costa Rica: Bank Deposits and Credit

Sources: Country authorities; and Fund staff calculations.

1/ Adjusted by exchange rate.

2/ December 2007 and latest available data for 2010.

Effective Capital Adequacy Ratio
200820092010
CAPDR 1/14.415.516.1
Costa Rica15.115.916.4
Source: Surpervisory authorities, and Fund staff estimates.Notes:

Regional unweighted average.

Source: Surpervisory authorities, and Fund staff estimates.Notes:

Regional unweighted average.

MACROECONOMIC OUTLOOK AND RISKS

11. The economic outlook is generally positive. Supported by the global recovery and strong inflows of foreign direct investment (FDI), real GDP is projected to grow by 4.3 percent in 2011 and stabilize at 4½ percent over the medium term (somewhat below pre-crisis rates). Higher global food and fuel prices and the one-off impact of the tax reform (expected to be approved in the second half of 2011) would push inflation above 7 percent in 2011; thereafter inflation is projected to fall gradually to about 4 percent. The external current account deficit is expected to increase to 4.8 percent of GDP in 2011 and stabilize at about 5.2 percent over the medium term, and be fully financed by strong FDI and other capital flows.

12. Risks to the medium-term outlook are somewhat tilted to the downside.

  • Risks to the growth outlook appear balanced. Concerns about the strength of the global recovery are subsiding, while lax global financial conditions may induce further capital inflows and fuel domestic demand and activity growth.
  • Higher global commodity prices pose risks for the inflation outlook. Continued global price pressures could push headline inflation further above the official target range, which in the absence of corrective policies could ignite second round effects and keep inflation above the target range for a prolonged period of time.
  • Fiscal policy’s capacity to respond to adverse shocks will be limited. The government’s fiscal strategy may result in a moderate increase in the public debt to GDP ratio, even after taking into account the revenues from the tax reform. There are also risks that the increase in public debt is higher than envisaged.

POLICY DISCUSSIONS

13. Focus of the consultation. Discussions with the authorities centered on the appropriate policy mix at the current stage of the economic cycle; and medium-term reforms to: (i) ensure fiscal sustainability; (ii) improve the effectiveness of monetary policy; and (iii) increase the resilience of the financial system.

A. Near-term Policy Mix

14. There was broad agreement that containing second round effects from higher global food and fuel prices is a key policy challenge. Although inflation has remained subdued, staff highlighted the upward risks to the inflation outlook stemming from lags in the transmission mechanism and entrenched backward-looking indexation, including for public sector wages. Those factors contributed to a large pass-through to inflation in Costa Rica during the global price shock of 2007–08. The authorities were of the view that inflation risks would be lower this time around because the surge in commodity prices is taking place when there is still slack in the economy.

World Commodity Prices and Domestic Inflation

Source: Central Bank, and Fund staff estimates.

15. Continued capital inflows also present risks to the inflation outlook. Lax global financial conditions will remain a push factor for capital flows to emerging economies. Staff noted that, as long as the exchange rate band remains in place, those inflows would put pressure on the Central Bank’s sterilization capacity and, in the end, result in higher inflation and a real appreciation of the colón.

16. Staff encouraged the authorities to take prompt action to preserve the significant gains on the inflation front attained in recent years. Concretely, staff recommended:

  • Restraining domestic demand growth through further fiscal effort. Staff noted that the fiscal outturn projected for 2011 (a consolidated public sector deficit of about 5½ percent of GDP) was too expansionary given the rebound in private domestic demand. The authorities agreed, in principle, and noted that a recent presidential directive freezing employment levels in the central administration and reducing operational expenditures below the levels contemplated in the budget would generate some savings. However, additional expenditure reducing measures were not regarded as viable.
  • Standing ready to raise interest rates before core inflation increases. Staff underscored that, if fiscal policy remains loose, efforts to attain the inflation target would place a considerable burden on monetary policy. The authorities indicated their intentions to evaluate the monetary policy stance at the first signs of second-round effects on inflation. However, they were of the view that those inflationary pressures are not likely to materialize for a while.
  • Allowing the nominal exchange rate to appreciate. The authorities indicated they remained committed to a more flexible exchange arrangement, but considered that conditions were not propitious for the elimination of the exchange rate band, as it could result in a large appreciation of the colón. They argued that given current loose global financial conditions, macroeconomic policy tools may be insufficient to fend off a large undershooting. Staff noted that the risk of a large or prolonged undershooting of the nominal exchange rate following the termination of the band could be mitigated through a tighter fiscal stance and sterilized intervention. The authorities indicated their preference for waiting until temporary appreciation pressures subside rather than doing away with the bands.

17. Staff encouraged the authorities to develop a strategy to reduce backward-looking indexation practices. In particular, it recommended to start using forward-looking measures of inflation (such as the mid-point of the official inflation target) to adjust prices and wages set by the government (including the minimum wage). The authorities agreed that forward-looking measures would be preferable but noted that any changes to current practices would require building consensus and, in some cases, changing legislation, both of which were likely to take some time.

B. Safeguarding Fiscal Sustainability

18. The mission developed a scenario incorporating the government’s fiscal plans. The scenario envisages an increase in government revenues of 3 percentage points of GDP in the next five years (mainly as a result of the proposed tax reform and improvements in tax administration, Box 1) and an increase in expenditures of about 1 percent of GDP (reflecting planned spending in the areas of security, education and infrastructure1). With these assumptions, the consolidated public sector deficit (central government deficit) would decline to about 4¼ percent of GDP (3¾ percent of GDP) by 2016, while the public debt to GDP ratio would rise to about 46 percent of GDP. The authorities thought that the scenario made too conservative assumptions regarding the gains from the tax reform and were of the view that the fiscal deficit would decline more rapidly to debt stabilizing levels.

19. The mission encouraged the authorities to adopt more ambitious fiscal consolidation targets. It noted that Costa Rica had been able to respond effectively to the global crisis in large part because of the significant fiscal consolidation it had undertaken in the years prior to the crisis. Staff argued that a priority of fiscal policy should be to regain the capacity to respond in a similar way to future adverse shocks by placing the public debt to GDP ratio on a downward path, and bringing the ratio below 35 percent of GDP over the medium term. The authorities indicated that reducing the public debt ratio to pre-crisis levels would be challenging, but stressed that they will make every effort to keep the public debt at prudent levels, including through expenditure restraint.

Box 1Revenue Mobilization Strategy

The Costa Rican government has developed a strategy to increase tax revenues over the medium term. The strategy comprises a tax reform and tax administration efforts, which the authorities expect to yield 2½ percent of GDP and about 1 percent of GDP, respectively.

A comprehensive tax reform proposal was submitted to the National Assembly in January 2011. The main measures contemplated in the bill include: replacing the 13 percent sales tax for a 14 percent full-fledged value-added tax (VAT); a significant broadening of the VAT base to include key services that are currently exempt (e.g. private education and health); reducing the basic consumption basket that will be exempt from the VAT; the introduction of a 15 percent tax rate on capital gains; increasing the tax rate on dividends (from 5 to 15 percent) and on interest received on exchange-traded securities, bank deposits and public debt securities (from 8 to 15 percent); introducing a 15 percent tax rate on external payments made to top-tier banks and other institutions; and raising selective taxes on vehicles and property transfer taxes. The authorities’ estimates of the yield of the components of the proposed reform are shown in the table.

Tax reform proposal
MeasuresExpected yield *

(in percent of GDP)
Total2.5
Value added tax1.7
Broadening of tax base1.4
Of which: Reduction of basic consumption basket0.7
Of which: Taxation of services0.8
Increase in tax rate (from 13 to 14 percent)0.3
Income tax0.6
Broadening of tax base0.6
Increases in tax rates0.1
Excise taxes and other0.2
Source: Fund staff based on Ministry of Finance.

Estimated by the Ministry of Finance.

Source: Fund staff based on Ministry of Finance.

Estimated by the Ministry of Finance.

The proposed tax reform would improve the efficiency and equity of Costa Rica’s tax system. Adoption of the proposed measures would require modernizing the method to determine the VAT liability, bringing it in line with international practices. It would also increase the equity of the system by eliminating exemptions currently benefiting the higher income segments of the population. The authorities estimate that 60 percent of the additional revenue would be generated from households in the top 20 percent income bracket.

The government’s strategy also contains measures to reduce tax evasion. Planned actions include increasing tax compliance controls by 20 percent, fostering the use of debit and credit card transactions, establishing reference values for a set of imported products, and broadening the tax regime for small contributors.

Box 2Risks to Fiscal Sustainability

Following an important decline through 2008, Costa Rica’s public debt to GDP ratio rose in the aftermath of the global crisis. From end-2008 to end-2010, the public debt to GDP ratio increased by about 4 percentage points, to near 40 percent.

The policies envisaged by the current government would not stabilize the public debt to GDP ratio. The staff’s scenario discussed with the authorities, which assumes that the tax reform is approved in the second-half of 2011, would result in an increase in the public debt to GDP ratio of more than 6 percentage points between 2010 and 2016. Even though the scenario assumes significant increases in tax collection, the expenditure path would leave the fiscal deficit above debt-stabilizing levels.2

The risks that the public debt to GDP ratio rises faster than in the baseline scenario are high. Results from a stochastic public debt sustainability exercise, based on an estimated fiscal reaction function, show that, by end-2016, the median public debt ratio could be in the range between 50 percent of GDP (panel estimates) and 57 percent (time series estimates). These results illustrate the challenges that the authorities will confront to maintain the public debt close to the deterministic trajectory of the baseline scenario under their planned fiscal policies.

Stochastic public debt analysis

(time series)

Source: Fund staff estimates

Stochastic public debt analysis

(panel data)

Source: Fund staff estimates

20. There was agreement that the approval of the proposed tax reform was critical for fiscal sustainability. A significant increase in government revenues is necessary to contain debt dynamics, given the planned expenditure path (Box 2). Staff noted that the revenue-enhancing emphasis of the proposed reform was appropriate given Costa Rica’s relatively low revenue-to-GDP ratio. The expected broadening of the tax base and the emphasis placed on improving the equity of the tax system also are commendable. While the tax reform is facing some opposition in the Legislative Assembly, the authorities expressed confidence about its approval, highlighting that the private sector and political parties are cognizant of the need to increase public revenues.

Public Sector Debt Trajectory

Source: Fund staff estimates.

Tax Revenues

Source: National authorities. * Includes Brazil, Chile, Colombia, Mexico and Peru.

21. A strategy to reduce government expenditures in percent of GDP over the medium term is necessary. Although capital expenditure has remained broadly stable as a share of GDP in recent years, current government expenditures, including the wage bill, have increased sharply, and have reached levels that are high compared to countries of similar level of income and government revenues. The mission noted that the recent directive to freeze vacancies and reduce operational expenditures (vis-à-vis the budget) in 2011 was an important first step, but stressed that it would not be sufficient to reduce current expenditures’ share in GDP. Staff argued that a medium-term expenditure framework that keeps current expenditure growth below the (projected) growth rate of nominal GDP for several years was necessary to lower the share of current expenditures to GDP and regain fiscal space.

Current Noninterest Expenditure

Source: National authorities. * Includes Brazil, Chile, Colombia, Mexico and Peru.

22. The mission welcomed the planned improvements in tax administration. Staff and the authorities concurred that there is substantial scope to strengthen tax administration and reduce tax evasion, and that the improvements in these areas would contribute importantly to the fiscal consolidation strategy. In this connection, staff welcomed the adoption of a new information system by the tax administration agency, which would help increase information crosschecks and tax compliance controls. Staff estimated that improved tax administration would generate additional revenues of about ½ percent of GDP over the next five years. The authorities, however, considered that the gains would be significantly larger.

23. Other reforms to strengthen the fiscal frameworks also were discussed. There was broad agreement that, once fiscal consolidation was firmly underway, it would be desirable to develop fiscal rules with countercyclical elements. Reforms aimed at lessening budget rigidities, such as revenue-earmarking, would also be desirable.

C. Monetary and Exchange Rate Policies

24. The mission encouraged the authorities to speed up the transition to an inflation targeting framework. The mission acknowledged the important steps taken in recent years to modernize the monetary policy framework (including the announcement of an official inflation target and the widening of the exchange rate band). However, it noted that a prolonged transition process risks losing credibility. To accelerate the transition, staff recommended:

  • Increasing exchange rate flexibility. Staff underscored that moving toward a more flexible exchange rate regime, preferably by eliminating the band, would clarify the primacy of the inflation objective, help anchor inflation expectations, and enhance the transmission mechanism between policy rates and market rates. The authorities restated their intention to eliminate the exchange rate band before the adoption of full-fledged inflation targeting, but considered that the present juncture was not appropriate to take such step (¶15).
  • Phasing out the interest rate corridor. There was agreement that the interest rate corridor established in October 2010 had enhanced monetary control, and that it would be advisable to deepen the reform by adopting a single policy rate. In line with this, the authorities indicated that they plan to narrow the corridor for short-term interest rates and establish the mid-point of such corridor as the benchmark policy rate.
  • Recapitalizing the central bank. Staff argued that a stronger capital base for the central bank would help insulate monetary policy decisions from balance sheet considerations. The authorities indicated that they were examining options to recapitalize the central bank but considered that fiscal space in the short run was too tight to make significant progress in this area.

25. Notwithstanding the recent appreciation, the exchange rate seems broadly in line with medium-term fundamentals. Exchange rate assessments based on the standard methodologies suggest an overvaluation of the colón in the order of 2–6 percent, well within the margin of error. Favorable prospects for foreign direct investment, which are expected to cover the non-interest current account deficit over the medium term, are key for this result. Nonetheless, staff underscored that a fiscal consolidation strategy centered on expenditure restraint would help mitigate the risks of an excessive appreciation of the colón. In addition, there was agreement that continued efforts to reduce the costs of doing business and increase efficiency would be beneficial for competitiveness.

D. Financial Sector

26. While acknowledging that the financial system had weathered the crisis well, the mission discussed enhancements to banking sector supervision and regulation. It noted that the legal framework remained weak and that progress in implementing the recommendations from the 2008 FSAP had been slow (Box 3). The mission stressed the importance of seeking congressional approval of the legislation submitted in 2004 and 2010 to enhance consolidated supervision, establish a deposit insurance system and strengthen the bank resolution framework. It noted that, while the financial system is sound, the measures were necessary to reduce risks to financial stability, as they would equip the regulatory and supervisory authorities with the tools and legal protections to take appropriate actions on a timely basis if a financial institution faces difficulties. The authorities reiterated their commitment to seek approval of the legislation, but indicated that the tax reform had the highest priority.

27. The mission welcomed progress to introduce risk-based supervision. It encouraged the authorities to supplement those efforts with enhancements of the regulatory framework (e.g., issuing norms on liquidity, operational, country and market risks) and further strengthen soundness classification. It also suggested that the authorities undertake periodic stress tests of financial institutions. The mission welcomed the plans to monitor systemic risk and introduce Basel III capital and liquidity buffers.

Real Exchange Rate Assessment(Percent deviation from estimated equilibrium) (+ = overvaluation)
Macrobalance approach6
ERER approach6
External stability approach2
Source: Fund staff estimates
Source: Fund staff estimates
Supervisory Practices(Scale from 0 to 10, 10 = Best International Practices)
CRIDOMSLVGTMHNDNICPANAVGE
Risk-Based Supervision4.85.74.25.44.53.84.74.7
Consolidated Supervision6.44.26.28.37.17.47.86.8
Supervisory perimeter6.64.31.83.73.13.94.54.0
TOTAL6.04.84.15.84.95.05.75.2
Source: Fund staff based on supervisory authorities’ responses to questionnaires.
Source: Fund staff based on supervisory authorities’ responses to questionnaires.

COLOR CODE:

Less than 10 percent above or below the regional avge

Above regional average

Below regional average

28. The authorities were encouraged to explore ways to level the playing field between public and private banks. Staff noted that long-standing regulatory distortions of the Costa Rican financial system have allowed public banks to benefit from state guarantees on all liabilities, and be exempt from taxation on their dollar-denominated deposits and from contributions to the development finance system. In addition, the appointment of their directors falls outside the purview of the Superintendency of Financial Institutions (SUGEF).

Box 3Main Recommendations of the 2008 FSAP Update-Status

Principal Recommendations (By area, excluding financial sector development issues)Status 1/
A. Prudential Supervision and Regulation
Amend the legal framework in order to provide protection for supervisors while performing their responsibilities in good faith.NI
Introduce pertinent laws for the Superintendency of Banks (SUGEF) to be able to supervise banking groups (including offshore structures) on a consolidated basis. Upon the approval of such laws the SUGEF should issue without delay operational regulations to ensure its rapid implementation by the banking system. 2/PL
Increase supervisory focus on banks’ own risk management systems, in part through incentives for banks to classify and provision correctly their loans. 3/FI
Broaden the base of reserve requirements to include short term lines of credit.FI
Apply higher risk weight ratios to unhedged borrowers for capital adequacy purposes.NI
The SUGEF should issue a new regulation enhancing the complementarities of the work of bank supervisors and external auditors.FI
The National Council of Financial Sector Supervision (CONASSIF) should take into account IFRS when issuing new regulations. 4/FI
Modify the funding arrangements for supervision, in line with international best practices.NI
B. Crisis Management and Bank Crisis Resolution Framework
Amend article 155 of the Central Bank law in order to grant the SUGEF an appropriate range of supervisory tools to require a bank to take prompt remedial action and to impose penalties in accordance with the gravity of a situation.PL
Amend the rating system for prompt corrective actions, to include new directives that allow the SUGEF to take an appropriate range of remedial actions and supervisory decisions.PI
Improve the early warning system, to allow the adoption of remedial actions in a timely manner.PI
Eliminate the emergency loan window and improve the design and operational arrangements of the ordinary rediscount window, including by establishing prudential limits in terms of regulatory capital. 5/NI
Establish a deposit insurance scheme, in line with international best practices.PL
Amend the bank resolution legal framework to include purchase and assumption type techniques.PL
Enable voluntary, extra-judicial corporate restructuring agreements.FI

FI: fully implemented; PI: partially implemented; PL: pending legislation; NI: Not implemented.

The draft law on consolidated supervision was submitted to the Legislative Assembly in 2004. The Superintendency of banks has issued several regulations.

Regulation on overall risk management (approved on June 25, 2010).

Regulation on information of entities and financial conglomerates (last updated on June 15, 2010).

The BCCR strengthened its emergency liquidity toolbox during the crisis by introducing high-access liquidity lines and improving the design of repo operations. However, the emergency lender of last resort window has not been discontinued and repo operations are not linked to prudential limits in terms of regulatory capital.

FI: fully implemented; PI: partially implemented; PL: pending legislation; NI: Not implemented.

The draft law on consolidated supervision was submitted to the Legislative Assembly in 2004. The Superintendency of banks has issued several regulations.

Regulation on overall risk management (approved on June 25, 2010).

Regulation on information of entities and financial conglomerates (last updated on June 15, 2010).

The BCCR strengthened its emergency liquidity toolbox during the crisis by introducing high-access liquidity lines and improving the design of repo operations. However, the emergency lender of last resort window has not been discontinued and repo operations are not linked to prudential limits in terms of regulatory capital.

STAFF APPRAISAL

29. Costa Rica’s recovery is firmly underway and its economic outlook is favorable. Real GDP is expected to grow by more than 4 percent in 2011 and by about 4½ percent over the medium term, supported by sizable and stable flows of foreign direct investment. However, a key challenge is to adopt more flexible and forward-looking macroeconomic policies.

30. The rise in world food and fuel prices and lax global financial conditions will present challenges. Higher commodity prices will put upward pressures on inflation and impact more severely the poorer segments of the population, while abundant global liquidity will continue to induce private capital inflows. A coordinated policy response to mitigate the risks posed by these external factors would be advisable. Such response should comprise a tighter fiscal stance than the one contemplated in the 2011 budget, the elimination of the exchange rate band, and readiness to tighten monetary policy before second round effects of the price shock materialize. Introducing forward-looking inflation measures in the indexation mechanisms controlled by the government also would be helpful.

31. Given the external environment, the fiscal stance envisaged for 2011 is too expansionary. Even assuming that the tax reform is approved and starts yielding revenues in 2011, the consolidated public sector deficit is projected to close the year at about 5½ percent of GDP, broadly the same as in 2010. The sustained recovery of private domestic demand and the sizable increase in public debt since 2008 would have called for a significant withdrawal of fiscal stimulus, as was recommended previously.

32. The proposed tax reform is sound and, if approved, will be key to safeguard fiscal sustainability. Broadening the tax base and improving the equity of the tax system are strong elements of the proposed reform. Planned efforts to strengthen tax administration also are appropriate and should be supplemented with mechanisms to make them permanent.

33. It would be advisable to set more ambitious targets for fiscal consolidation centered on expenditure restraint. The government’s fiscal program may result in a gradual rise in the public debt ratio and carries risks. The authorities are encouraged to reconsider their fiscal program and set targets aimed at rebuilding the fiscal space used in recent years. These efforts should be anchored on a path that lowers the share of government expenditures (including the wage bill) on GDP.

34. The upgrading of the monetary policy framework should receive higher priority. Costa Rica’s transition to an inflation targeting framework is taking too long and may compromise the central bank’s credibility. Maintaining the exchange rate close to the appreciated end of the exchange rate band despite continued capital inflows could raise doubts about the primary objective of monetary policy and the authorities’ commitment to transition to inflation targeting. The authorities are encouraged to consider an opportune time to abandon the exchange rate band and deploy an effective communication strategy to establish the primacy of the inflation target. Plans to narrow the corridor for short-term interest rates and establish the mid-point of such corridor as the policy rate are welcome.

35. Although the Costa Rican banking system remains sound, legislation to further strengthen supervision and prudential regulations has not yet been approved. The authorities are encouraged to seek support for the approval of the bills submitted in recent years to enhance consolidated supervision, establish a deposit insurance system and strengthen the resolution framework. In addition, the authorities should explore ways to level the playing field between public and private banks.

36. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Table 1.Costa Rica: Selected Economic Indicators
Per capita GDP (2010, U.S. dollars)7,843Unemployment (2010, percent of labor force)7.3
Population (July 2010, millions)4.6Poverty (2009, percent of households)18.5
Life expectancy (2009, years)79.1Extreme poverty (2009, percent of households)4.2
Est.Projections
200720082009201020112012
(Annual percentage change, unless otherwise indicated)
National Income and Prices
Real GDP growth7.92.7-1.34.24.34.4
GDP deflator9.412.48.27.85.87.2
Consumer prices (end of period) 1/10.813.94.05.87.56.5
External Sector
Terms of trade (deterioration -)-2.8-1.14.90.8-3.1-0.2
Real effective exchange rate (eop; depreciation -)1.53.82.112.3
Money and Credit
Monetary base33.011.95.111.29.711.5
Broad money17.916.19.61.312.611.4
Bank credit to private sector38.331.84.54.411.711.6
(In percent of GDP)
Public Finances
Combined public sector primary balance 2/5.02.8-0.9-2.7-2.5-0.5
Combined public sector overall balance 2/1.20.2-4.0-5.6-5.6-3.9
Central government0.3-0.3-3.6-5.6-5.6-4.0
Decentralized government entities1.30.60.40.50.50.6
Public enterprises (excluding ICE)0.30.00.00.20.00.0
Central Bank-0.7-0.2-0.8-0.6-0.5-0.4
Combined public sector debt (excluding ICE) 2/42.536.038.439.442.042.8
Of which: External public debt9.78.67.27.16.87.0
Combined public sector debt (including ICE) 3/45.339.542.542.845.446.1
Savings and Investment
Gross domestic investment24.727.615.920.020.220.8
Gross national savings18.418.213.916.315.415.8
External Sector
Trade balance-11.3-16.8-7.0-10.0-11.6-12.2
Current account balance-6.3-9.3-2.0-3.6-4.8-5.0
Foreign direct investment6.26.94.64.14.64.5
(In millions of U.S. dollars, unless otherwise indicated)
Change in net international reserves (increase -)-999315-268-561-400-300
Net international reserves4,1143,7994,0664,6275,0275,327
In months of nonmaquila imports of G&S3.84.74.04.24.14.1
Gross domestic product26,32229,83829,24135,78040,16743,112
Sources: Central Bank of Costa Rica; Ministry of Finance; and Fund staff projections.

The projection for 2011 includes a one-off impact from the tax reform (assumed to be approved later in 2011).

Combined public sector = central government + central bank + decentralized government entities + public enterprises, excluding the Instituto de Electricidad (ICE).

Includes debt by the Instituto de Electricidad (ICE) guaranteed by the government.

Sources: Central Bank of Costa Rica; Ministry of Finance; and Fund staff projections.

The projection for 2011 includes a one-off impact from the tax reform (assumed to be approved later in 2011).

Combined public sector = central government + central bank + decentralized government entities + public enterprises, excluding the Instituto de Electricidad (ICE).

Includes debt by the Instituto de Electricidad (ICE) guaranteed by the government.

Table 2.Costa Rica: Balance of Payments(In millions of U.S. dollars, unless otherwise indicated)
Est.Projection
2007200820092010201120122013201420152016
Current Account-1,646-2,787-574-1,299-1,936-2,156-2,331-2,490-2,625-2,757
Trade balance-2,985-5,013-2,037-3,588-4,642-5,259-5,957-6,485-6,808-7,230
Export of goods (f.o.b.)9,2999,5558,8389,41710,38211,22011,89712,70413,57914,417
Import of goods (f.o.b.)12,28514,56910,87513,00415,02416,47917,85419,18920,38721,647
Services1,7342,2012,1882,6613,0753,4483,8474,2444,5584,923
Income-865-417-1,084-740-751-851-817-913-1,108-1,253
Current transfers470442359368382507596664733802
Financial and Capital Account2,2732,5136432,0972,3362,4562,6312,7652,8753,007
Foreign direct investment1,6342,0721,3391,4501,8411,9361,9942,1282,1992,347
Non-FDI flows618433-754597495520637637676661
Public sector01130236669234365385435435
Disbursements236737596776569771816836636636
Amortization-237-726-295-410-500-537-451-451-201-201
Private sector618422-1,056231425286272252241226
Errors and Omissions213-41-10-237000000
Change in Net Reserves (increase -)-839315-59-561-400-300-300-275-250-250
(Annual percentage change)
Exports of goods (f.o.b.)
Value14.82.8-7.56.510.38.16.06.86.96.2
Volume9.2-4.4-4.63.65.04.75.35.75.85.5
Imports of goods (c.i.f.)
Value12.718.2-25.419.615.69.78.37.56.26.2
Volume3.78.6-21.014.36.06.56.76.96.26.2
Of which: oil
Value15.644.7-40.735.340.56.32.63.54.55.0
Volume4.62.6-3.76.46.05.55.04.54.04.0
(In percent of GDP)
Current account-6.3-9.3-2.0-3.6-4.8-5.0-5.1-5.2-5.2-5.2
Non-oil current account-0.8-2.32.31.11.00.80.50.40.30.3
Export of goods (f.o.b.)35.332.030.226.325.826.026.026.426.927.3
Import of goods (f.o.b.)46.748.837.236.337.438.239.139.840.440.9
Non-oil goods imports (f.o.b.)41.241.833.031.731.532.433.434.334.935.4
Income-3.3-1.4-3.7-2.1-1.9-2.0-1.8-1.9-2.2-2.4
Direct investment6.26.94.64.14.64.54.44.44.44.4
Memorandum Items:
Net international reserves (US$ million) 1/4,1143,7994,0664,6275,0275,3275,6275,9026,1526,402
In months of non-maquila imports3.84.74.04.24.14.14.14.04.04.0
In percent short-term debt 2/96.788.4133.7138.3133.4129.4122.0139.5126.5129.0
Sources: Central Bank of Costa Rica; and Fund staff estimates.

Includes valuation adjustments of US$160 million in 2007 for reclassification of capital contribution to FLAR and US$209 million in 2009 for the SDR allocation.

Public and private sector external debt on remaining maturity. Includes trade credit.

Sources: Central Bank of Costa Rica; and Fund staff estimates.

Includes valuation adjustments of US$160 million in 2007 for reclassification of capital contribution to FLAR and US$209 million in 2009 for the SDR allocation.

Public and private sector external debt on remaining maturity. Includes trade credit.

Table 3.Costa Rica: Central Government Balance(In billions of colones)
Est.Projections
200720082009201020112012
Revenues2,1052,4902,3632,6172,9973,756
Tax revenues 1/2,0292,4092,2622,4922,8623,605
Direct taxes5847587658469321,166
Sales tax7989378319201,1101,480
Excise, customs, and others647714666726820959
Nontax revenues 2/7681101125135151
Expenditure2,0622,5362,9703,6494,0694,615
Current non-interest1,4271,7762,2752,7483,1303,502
Wages7138571,1151,3491,5881,779
Goods and services7388106121167171
Transfers 2/6418321,0541,2781,3751,551
Of which: social security324372445506598667
Interest454415393452550650
Of which: adjustment for TUDES 3/357533507571
Capital180279302449389464
Primary balance497370-213-580-522-210
Overall balance43-46-606-1,032-1,072-859
Total financing-43466061,0321,072859
External (net)-21-49-18624722131
Domestic (net)-22957937851,050728
Central government debt3,7473,8914,5875,5516,6647,586
Domestic2,6122,7533,6114,4205,4706,198
External1,1351,1389761,1311,1941,387
Memorandum items:
Non-interest expenditure nominal growth (percent)21.527.925.324.110.112.7
Of which: current17.724.428.120.813.911.9
Non-interest expenditure real growth (percent)11.112.716.217.43.85.3
Of which: current7.79.718.814.37.44.6
Nominal GDP (in billions of colones)13,59815,70216,76418,81920,74023,147
Sources: Ministry of Finance and IMF staff.

Assumes that the tax reform submitted to the National Assembly becomes effective in the second-half of 2011.

Transfers to the Social Development and Family Transfers Fund (FODESAF) are accounted for in net terms.

TUDES is an inflation-indexed bond whose value is adjusted monthly in line with inflation and that pays a fixed rate coupon twice a year, calculated over the adjusted value of the bond. The inflation adjustment of the principal is not reflected as interest expenditure in the official fiscal accounts, but is added in the Fund presentation of the fiscal balance.

Sources: Ministry of Finance and IMF staff.

Assumes that the tax reform submitted to the National Assembly becomes effective in the second-half of 2011.

Transfers to the Social Development and Family Transfers Fund (FODESAF) are accounted for in net terms.

TUDES is an inflation-indexed bond whose value is adjusted monthly in line with inflation and that pays a fixed rate coupon twice a year, calculated over the adjusted value of the bond. The inflation adjustment of the principal is not reflected as interest expenditure in the official fiscal accounts, but is added in the Fund presentation of the fiscal balance.

Table 4.Costa Rica: Central Government Balance(In percent of GDP)
Est.Projections
200720082009201020112012
Revenues15.515.914.113.914.416.2
Tax revenues 1/14.915.313.513.213.815.6
Direct taxes4.34.84.64.54.55.0
Sales tax5.96.05.04.95.46.4
Excise, customs, and others4.84.54.03.94.04.1
Non-tax revenues 2/0.60.50.60.70.70.7
Expenditure15.216.117.719.419.619.9
Current non-interest10.511.313.614.615.115.1
Wages5.25.56.77.27.77.7
Goods and services0.50.60.60.60.80.7
Transfers 2/4.75.36.36.86.66.7
Interest3.32.62.32.42.72.8
of which: adjustment for TUDES 3/0.30.50.20.30.40.3
Capital1.31.81.82.41.92.0
Primary balance3.72.4-1.3-3.1-2.5-0.9
Overall balance0.3-0.3-3.6-5.5-5.2-3.7
Total financing-0.30.33.65.55.23.7
External (net)-0.2-0.3-1.11.30.10.6
Domestic (net)-0.20.64.74.25.13.1
Central government debt27.624.827.429.532.132.8
Domestic19.217.521.523.526.426.8
External8.37.35.86.05.86.0
Memorandum items:
Non-interest expenditure nominal growth (percent)21.527.925.324.110.112.7
Of which: current17.724.428.120.813.911.9
Non-interest expenditure real growth (percent)11.112.716.217.43.85.3
Of which: current7.79.718.814.37.44.6
Nominal GDP (in billions of colones)13,59815,70216,76418,81920,74023,147
Sources: Ministry of Finance and IMF staff.

Assumes that the tax reform submitted to the National Assembly becomes effective in the second-half of 2011.

Transfers to the Social Development and Family Transfers Fund (FODESAF) are accounted for in net terms.

TUDES is an inflation-indexed bond whose value is adjusted monthly in line with inflation and that pays a fixed rate coupon twice a year, calculated over the adjusted value of the bond. The inflation adjustment of the principal is not reflected as interest expenditure in the official fiscal accounts, but is added in the Fund presentation of the fiscal balance.

Sources: Ministry of Finance and IMF staff.

Assumes that the tax reform submitted to the National Assembly becomes effective in the second-half of 2011.

Transfers to the Social Development and Family Transfers Fund (FODESAF) are accounted for in net terms.

TUDES is an inflation-indexed bond whose value is adjusted monthly in line with inflation and that pays a fixed rate coupon twice a year, calculated over the adjusted value of the bond. The inflation adjustment of the principal is not reflected as interest expenditure in the official fiscal accounts, but is added in the Fund presentation of the fiscal balance.

Table 5.Costa Rica: Combined Public Sector Operations 1/(In billions of colones)
Est.Projections
200720082009201020112012
Non-financial public sector
Revenues3,1873,7003,7684,1794,6725,625
Tax revenues 2/2,0552,4372,2892,5202,8933,640
Nontax revenues172161218245270301
Social security contributions8711,0571,1861,3321,4681,638
Operating balance of public enterprises894675834146
Expenditure2,9263,6404,3025,1305,7396,476
Current non-interest2,2212,7553,4284,0474,5825,127
Wages9771,2011,5451,8392,1482,404
Goods and services288355387441520569
Transfers9561,1991,4971,7671,9142,153
Interest418383381446561662
Of which: adjustment for TUDES 3/-34118284139
Capital286503493637596687
Of which: central government180279302449389464
Of which: rest of non-financial public sector106224192188207224
Nonfinancial public sector primary balance679443-154-504-506-189
Nonfinancial public sector overall balance26160-535-951-1,067-851
Central government43-46-606-1,032-1,072-859
Decentralized government entities172101735058
Public enterprises (excluding ICE)464-23100
Total financing-261-605359511,067851
External-17-54-1882475108
Domestic-244-67237041,063743
Central Bank balance-96-29-138-88-104-116
Combined public sector balance (includes Central Bank)16531-673-1,039-1,171-967
Public sector debt (excluding ICE)5,7775,6596,4437,4118,6739,790
Domestic4,4574,3065,2366,0767,2908,233
External1,3201,3531,2071,3351,3831,557
Memorandum items:
Public sector debt (including ICE)6,1586,1997,1278,0519,38810,573
Non-interest expenditure nominal growth (percent)21.429.920.419.410.612.3
Of which: current19.924.024.418.013.211.9
Non-interest expenditure real growth (percent)11.014.611.613.04.34.9
Of which: current9.79.315.411.76.84.6
Nominal GDP (in billions of colones)13,59815,70216,76418,81920,74023,147
CPI Inflation (period average)9.413.47.85.76.07.0
Sources: Ministry of Finance and IMF staff estimates.

Combined public sector = central government + central bank + decentralized government entities + public enterprises, excluding the Instituto de Electricidad (ICE).

Assumes that the tax reform submitted to the National Assembly becomes effective in the second half of 2011.

TUDES is an inflation-indexed bond whose value is adjusted monthly in line with inflation and that pays a fixed rate coupon twice a year, calculated over the adjusted value of the bond. The inflation adjustment of the principal is not reflected as interest expenditure in the official fiscal accounts, but is added in the Fund presentation of the fiscal balance.

Sources: Ministry of Finance and IMF staff estimates.

Combined public sector = central government + central bank + decentralized government entities + public enterprises, excluding the Instituto de Electricidad (ICE).

Assumes that the tax reform submitted to the National Assembly becomes effective in the second half of 2011.

TUDES is an inflation-indexed bond whose value is adjusted monthly in line with inflation and that pays a fixed rate coupon twice a year, calculated over the adjusted value of the bond. The inflation adjustment of the principal is not reflected as interest expenditure in the official fiscal accounts, but is added in the Fund presentation of the fiscal balance.

Table 6.Costa Rica: Combined Public Sector Operations 1/(In percent of GDP)
Est.Projections
200720082009201020112012
Revenues23.423.622.522.222.524.3
Tax revenues 2/15.115.513.713.413.915.7
Non-tax revenues1.31.01.31.31.31.3
Social security contributions6.46.77.17.17.17.1
Operating balance of public enterprises0.70.30.40.40.20.2
Expenditure21.523.225.727.327.728.0
Current non-interest16.317.520.521.522.122.1
Wages7.27.69.29.810.410.4
Goods and services2.12.32.32.32.52.5
Transfers7.07.68.99.49.29.3
Interest3.12.42.32.42.72.9
of which: adjustment for TUDES 3/0.00.30.10.10.20.2
Capital2.13.22.93.42.93.0
of which: central government1.31.81.82.41.92.0
of which: rest of non-financial public sector0.81.41.11.01.01.0
Nonfinancial public sector primary balance5.02.8-0.9-2.7-2.4-0.8
Nonfinancial public sector overall balance1.90.4-3.2-5.1-5.1-3.7
Central government0.3-0.3-3.6-5.5-5.2-3.7
Decentralized government entities1.30.60.40.30.00.0
Public enterprises (excluding ICE)0.30.00.00.20.00.0
Total financing-1.9-0.43.25.15.13.7
External-0.1-0.3-1.11.30.00.5
Domestic-1.80.04.33.75.13.2
Central Bank balance-0.7-0.2-0.8-0.5-0.5-0.5
Combined public sector balance (includes Central Bank)1.20.2-4.0-5.5-5.6-4.2
Public sector debt (excluding ICE)42.536.038.439.441.842.3
Domestic32.827.431.232.335.135.6
External9.78.67.27.16.76.7
Memorandum items:
Public sector debt (including ICE)45.339.542.542.845.345.7
Non-interest expenditure nominal growth (percent)21.429.920.419.410.612.3
of which: current19.924.024.418.013.211.9
Non-interest expenditure real growth (percent)11.014.611.613.04.34.9
of which: current9.79.315.411.76.84.6
Nominal GDP (in billions of colones)13,59815,70216,76418,81920,74023,147
Sources: Ministry of Finance and IMF staff estimates.

Combined public sector = central government + central bank + decentralized government entities + public enterprises, excluding the Instituto de Electricidad (ICE).

Assumes that the tax reform submitted to the National Assembly becomes effective in the second half of 2011.

TUDES is an inflation-indexed bond whose value is adjusted monthly in line with inflation and that pays a fixed rate coupon twice a year, calculated over the adjusted value of the bond. The inflation adjustment of the principal is not reflected as interest expenditure in the official fiscal accounts, but is added in the Fund presentation of the fiscal balance.

Sources: Ministry of Finance and IMF staff estimates.

Combined public sector = central government + central bank + decentralized government entities + public enterprises, excluding the Instituto de Electricidad (ICE).

Assumes that the tax reform submitted to the National Assembly becomes effective in the second half of 2011.

TUDES is an inflation-indexed bond whose value is adjusted monthly in line with inflation and that pays a fixed rate coupon twice a year, calculated over the adjusted value of the bond. The inflation adjustment of the principal is not reflected as interest expenditure in the official fiscal accounts, but is added in the Fund presentation of the fiscal balance.

Table 7.Costa Rica: Monetary Survey(In billions of colones, unless otherwise indicated)
Est.Proj.
20072008200920102011
Central Bank
Net foreign assets2,1252,1862,4202,4922,764
Net international reserves2,0372,0902,2722,3502,608
(In millions of US$)4,1143,7994,0664,6275,027
Net Medium-Term Foreign Assets107116140140140
Net domestic assets-1,097-1,035-1,210-1,147-1,288
Net domestic credit-429-547-792-926-1,000
Capital account (-)1,1821,2191,2661,3461,471
Other items net (-)-5-193-270-159-122
Monetary stabilization bonds (-)-1,845-1,513-1,414-1,407-1,637
Monetary base1,0281,1511,2101,3451,476
Currency546575613665724
Required reserves482576597680752
Other Depository Institutions
Net foreign assets-313-420-20-87-250
Net domestic assets6,1757,6748,1288,1839,368
Net domestic credit8,09710,06411,08711,77613,694
Credit to nonfinancial public sector (net)3383165868721,572
Credit to the private sector6,0137,9258,2818,6459,657
Credit to financial corporations (net)1,7451,8232,2212,2602,465
Capital account1,2371,5971,8292,0362,362
Other items (net)-685-793-1,129-1,557-1,964
Liabilities5,8627,2548,1088,0969,118
National currency3,4813,9404,2994,7315,092
Foreign currency2,3813,3143,8093,3644,026
Financial System
Net foreign assets1,8121,7662,4002,4052,514
Net domestic assets5,6406,8857,0787,1948,294
Net domestic credit6,2918,2218,8169,22811,001
Capital account55378564690891
Other items (net)-595-957-1,174-1,344-1,816
Broad money (M4)7,4538,6519,4789,59910,808
Memorandum Items:
(Percent changes)
Monetary base33.011.95.111.29.7
Broad money (M4)17.916.19.61.312.6
Credit to the private sector (National Currency)45.227.18.311.413.8
Credit to the private sector (Foreign Currency) 1/30.038.2-0.3-5.28.3
(In percent of GDP)
Monetary base7.67.37.27.17.1
Broad money (M4)54.855.156.551.052.0
Credit to the private sector (National Currency)25.528.028.428.229.1
Credit to the private sector (Foreign Currency)18.822.421.017.717.4
Sources: Central Bank; and Fund staff estimates.

Measured in U.S. dollar terms.

Sources: Central Bank; and Fund staff estimates.

Measured in U.S. dollar terms.

Table 8.Costa Rica: Indicators of External Vulnerability
Projection
200720082009201020112012
Merchandise exports (percent change)14.82.8-7.56.510.38.1
Merchandise imports (percent change)12.718.2-25.419.615.69.7
Terms of trade (percent change)-2.8-1.14.90.8-3.1-0.2
Current account balance (in percent of GDP)-6.3-9.3-2.0-3.6-4.8-5.0
Central bank net international reserves (in US$ millions)4,1143,7994,0664,6275,0275,327
In months of next year’s imports of nonmaquila goods and services3.84.74.04.24.14.1
In months of next year’s imports of nonmaquila goods and services199.3183.3189.9174.7179.2181.2
In percent of M427.524.424.224.524.524.4
In percent of deposits in foreign currency86.163.760.369.865.766.7
In percent of short-term external debt 1/96.788.4133.7138.3133.4129.4
Public external debt service (in percent of GDP)1.63.01.61.71.71.4
External debt (in percent of GDP)32.130.528.025.224.024.2
External debt (in percent of exports)65.766.865.867.363.763.2
REER appreciation (+)1.53.82.112.3
Sources: Central Bank of Costa Rica; and Fund staff estimates.

Public and private sector external debt on remaining maturity. Includes trade credit.

Sources: Central Bank of Costa Rica; and Fund staff estimates.

Public and private sector external debt on remaining maturity. Includes trade credit.

Table 9.Costa Rica: Medium-Term Framework(Annual percentage change; unless otherwise indicated)
Projection
2007200820092010201120122013201420152016
Real GDP7.92.7-1.34.24.34.44.54.54.54.5
Consumption6.93.32.13.73.83.83.93.83.83.8
Private consumption7.53.21.53.43.73.73.83.83.83.8
Government consumption2.34.46.75.94.64.94.63.44.04.0
Gross domestic investment-1.222.2-36.729.15.97.77.87.46.36.9
Fixed capital formation18.111.0-9.82.64.67.18.07.46.67.1
Exports of goods and nonfactor services9.9-2.6-6.04.85.15.65.76.15.95.5
Imports of goods and nonfactor services4.36.5-19.914.25.26.46.56.65.95.8
Consumption (contribution to growth)4.92.41.52.72.82.82.82.72.72.7
Investment (contribution to growth)3.72.5-2.40.61.01.61.81.71.61.7
Inventories (contribution to growth)-4.02.8-8.14.70.40.20.10.10.00.0
Net exports (contribution to growth)3.3-5.07.7-3.80.1-0.2-0.2-0.10.10.0
Investment and savings (in percent of GDP)
Savings24.727.615.920.020.220.821.522.022.422.9
National savings18.418.213.916.315.415.816.416.917.217.7
External savings 1/6.39.32.03.64.85.05.15.25.25.2
Gross domestic investment24.727.615.920.020.220.821.522.022.422.9
Private sector18.619.618.515.516.316.717.417.818.218.6
Public sector3.24.03.64.23.63.73.73.83.83.9
Inventory changes2.94.0-6.30.20.30.40.40.40.40.4
Balance of payments (in percent of GDP)
Current account balance-6.3-9.3-2.0-3.6-4.8-5.0-5.1-5.2-5.2-5.2
Trade balance-11.3-16.8-7.0-10.0-11.6-12.2-13.0-13.5-13.5-13.7
Services6.67.47.57.47.78.08.48.89.09.3
Income-3.3-1.4-3.7-2.1-1.9-2.0-1.8-1.9-2.2-2.4
Current transfers1.81.51.21.01.01.21.31.41.51.5
Financial and capital account8.68.42.26.45.85.75.85.75.75.7
Direct investment6.26.94.64.14.64.54.44.44.44.4
Capital flows2.31.5-2.62.31.21.21.41.31.31.2
Public sector0.00.01.01.00.20.50.80.80.90.8
Private net capital2.31.4-3.61.31.10.70.60.50.50.4
Errors and omissions0.8-0.10.0-0.70.00.00.00.00.00.0
Change in net reserves (increase -)-3.21.1-0.2-1.6-1.0-0.7-0.7-0.6-0.5-0.5
Memorandum items:
GDP deflator9.412.48.27.85.87.26.05.14.54.3
CPI (avg)9.413.47.85.76.07.06.05.04.24.0
CPI (eop)10.813.94.05.87.56.55.54.54.04.0
Net international reserves (millions of US$)4,1143,7994,0664,6275,0275,3275,6275,9026,1526,402
Sources: Central Bank of Costa Rica; and Fund staff estimates.

External current account deficit.

Sources: Central Bank of Costa Rica; and Fund staff estimates.

External current account deficit.

Table 10.Costa Rica: Banking Sector Indicators(In percent)
MarJunSepDecMarJunSepDecMarJunSepDecJanFeb
2008200920102011
Capitalization
Risk-adjusted capital ratio15.514.714.515.115.215.415.416.016.516.416.817.317.217.5
Capital-to-assets ratio12.812.812.813.313.313.513.713.914.314.514.914.814.714.9
Asset quality
Nonperforming loans to total loans1.21.11.21.51.82.02.12.03.12.22.01.81.91.8
Non-income generating assets to total assets16.617.018.118.219.118.919.018.619.618.718.317.417.517.3
Foreclosed assets to total assets0.20.20.20.30.40.40.50.60.60.70.80.80.80.8
Loan loss provisions to total loans1.81.71.71.81.91.92.01.92.12.11.91.81.81.8
Management
Administrative expenses to total assets4.84.64.54.44.34.34.24.14.14.14.24.34.34.3
Noninterest expenses to gross income77.279.682.279.378.977.475.776.881.685.986.985.084.384.3
Total expenses to total revenues90.691.091.792.593.093.593.795.296.597.297.296.295.995.8
Profitability
Return on assets (ROA)1.51.61.71.81.71.61.51.11.01.01.01.21.21.2
Return on equity (ROE)11.812.213.414.314.312.411.58.77.67.27.28.38.88.9
Interest margin to gross income34.029.425.620.820.420.821.720.717.514.414.416.617.517.6
Liquidity
Liquid assets to total short-term liabilities87.584.680.183.094.9101.299.693.493.291.193.690.190.890.8
Liquid assets to total assets32.529.727.427.730.031.130.730.631.430.630.630.731.031.1
Loans to deposits103.1107.3109.8109.7101.998.698.498.997.195.897.297.896.996.6
Liquid assets to deposits48.544.641.042.143.744.843.743.944.842.643.343.844.144.2
Sensitivity to market risk
Net open FX position to capital19.021.719.520.422.822.926.425.422.221.717.318.818.217.3
Other
Financial margin 1/7.87.67.77.98.08.37.97.77.88.08.18.28.28.3
Credit growth (over a year ago)38.340.033.527.820.613.110.44.51.32.50.24.25.45.2
Deposit growth (over a year ago)22.423.821.325.421.923.124.615.96.35.40.35.47.57.7
Source: Superintendency of Banks.

Difference between implicit loan and deposit rates.

Source: Superintendency of Banks.

Difference between implicit loan and deposit rates.

Table 11.Costa Rica: External Debt Sustainability Framework, 2006-2016(In percent of GDP, unless otherwise indicated)
ActualEst.ProjectionsDebt-stabilizing Non-interest Current Account 6/
20062007200820092010201120122013201420152016
Baseline: External debt31.932.130.528.025.224.024.225.025.926.927.9-3.9
Change in external debt-2.00.2-1.6-2.6-2.7-1.30.20.80.91.01.0
Identified external debt-creating flows (4+8+9+10)-5.8-5.5-1.4-2.0-5.5-1.2-0.20.10.20.30.2
Current account deficit, excluding interest payments3.44.68.20.92.94.24.44.54.33.83.5
Deficit in balance of goods and services6.14.89.4-0.53.33.94.24.64.74.54.4
Exports49.248.845.742.537.537.738.238.639.239.940.5
Imports55.353.655.142.040.841.642.443.243.944.444.9
Private sector debt creating flows-0.41.20.1-3.2-1.8-0.50.20.40.50.60.6
Net non-debt creating capital inflows (negative)-6.5-7.2-7.0-4.6-4.1-4.6-4.5-4.4-4.4-4.4-4.4
Automatic debt dynamics 1/-2.7-3.0-2.61.7-4.4-0.3-0.4-0.4-0.20.30.6
Contribution from nominal interest rate1.21.61.21.00.70.60.60.60.91.41.8
Contribution from real GDP growth-2.6-2.2-0.80.4-1.0-1.0-1.0-1.0-1.1-1.1-1.2
Contribution from price and exchange rate changes 2/-1.2-2.4-3.00.2-4.2
Residual, incl. change in gross foreign assets 3/3.95.7-0.2-0.52.8-0.10.50.60.70.70.7
External debt-to-exports ratio (in percent)64.965.766.865.867.363.663.464.765.967.468.8
Gross external financing need (in billions of US dollars) 4/5.86.910.38.56.67.78.79.610.811.813.2
In percent of GDP25.926.134.429.218.419.220.221.122.423.424.9
Scenario with key variables at their historical averages 5/24.423.422.221.019.718.5-5.5
10-Year Historical Average10-Year Standard Deviation
Key Macroeconomic Assumptions Underlying Baseline
Real GDP growth (in percent)8.87.92.7-1.34.24.33.14.34.44.54.54.54.5
GDP deflator in U.S. dollars (change in percent)3.78.310.4-0.717.54.26.17.62.81.50.90.30.3
Nominal external interest rate (in percent)3.95.94.13.33.14.40.92.82.52.83.75.76.7
Growth of exports (US dollar terms, in percent)13.916.16.1-8.97.96.19.612.98.77.17.26.76.3
Growth of imports (US dollar terms, in percent)15.713.316.6-25.418.88.113.614.59.38.07.16.05.9
Current account balance, excluding interest payments-3.4-4.6-8.2-0.9-2.9-3.61.9-4.2-4.4-4.5-4.3-3.8-3.5
Net non-debt creating capital inflows6.57.27.04.64.14.81.54.64.54.44.44.44.4

Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure 7.Costa Rica: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)

Source: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten year historical average for the variable is also shown.

2/ Permanent 1/1 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

3/ One-time real depreciation of 30 percent occurs in 2010.

Table 12.Costa Rica: Combined Public Sector Debt Sustainability Framework, 2006-2016(In percent of GDP, unless otherwise indicated)
ActualEst.ProjectionsDebt-Stabilizing Primary Balance 9/
20062007200820092010201120122013201420152016
Baseline: Public sector debt 1/47.342.536.038.439.441.842.343.043.844.846.0-0.2
Of which: foreign-currency denominated18.313.511.911.711.311.511.711.511.311.111.0
Change in public sector debt-3.8-4.8-6.42.40.92.40.50.70.81.01.1
Identified debt-creating flows (4+7+12)-7.3-9.1-4.51.91.32.0-0.20.20.30.60.7
Primary deficit-3.2-4.3-2.61.73.12.91.31.31.31.31.3
Revenue and grants22.323.423.622.522.222.524.324.524.724.925.0
Primary (noninterest) expenditure19.119.120.924.225.425.525.625.926.026.126.2
Automatic debt dynamics 2/-4.1-4.8-1.80.2-1.8-0.9-1.5-1.2-1.0-0.7-0.6
Contribution from interest rate/growth differential 3/-4.9-4.2-3.30.0-1.8-0.9-1.5-1.2-1.0-0.7-0.6
Of which: contribution from real interest rate-1.2-1.0-2.3-0.4-0.40.60.20.60.81.21.3
Of which: contribution from real GDP growth-3.7-3.2-1.00.4-1.4-1.5-1.6-1.7-1.8-1.8-1.9
Contribution from exchange rate depreciation 4/0.8-0.61.40.2-1.1
Other identified debt-creating flows0.00.00.00.00.00.00.00.00.00.00.0
Privatization receipts (negative)0.00.00.00.00.00.00.00.00.00.00.0
Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.0
Other (specify, e.g. bank recapitalization)0.00.00.00.00.00.00.00.00.00.00.0
Residual, including asset changes 5/3.54.2-2.00.5-0.40.40.60.50.50.40.4
Public sector debt-to-revenue ratio 1/212.3181.3152.9171.0177.3185.6174.0175.3177.2180.3184.0
Gross financing need 6/0.7-1.2-0.24.05.55.64.24.14.14.24.3
In billions of U.S. dollars0.2-0.3-0.11.22.02.31.81.92.02.12.3
Scenario with key variables at their historical averages 7/35.632.328.925.622.419.4-1.0
Scenario with no policy change (constant primary balance) in 2010-201641.643.946.449.051.954.9-0.3
10-Year Historical Average10-Year Standard Deviation
Key Macroeconomic and Fiscal Assumptions Underlying Baseline
Real GDP growth (in percent)8.87.92.7-1.34.24.33.14.34.44.54.54.54.5
Average nominal interest rate on public debt (in percent) 8/9.27.76.66.76.98.31.27.67.67.37.37.47.4
Average real interest rate (nominal rate minus change in GDP deflator, in percent)-1.8-1.7-5.8-1.4-0.8-1.51.91.90.71.72.33.13.3
Nominal appreciation (increase in US dollar value of local currency, in percent)-4.14.0-10.3-1.711.3-4.37.1
Inflation rate (GDP deflator, in percent)11.09.412.48.27.89.71.65.76.95.65.04.34.1
Growth in real primary spending of combined public sector (in percent)5.711.014.611.613.08.24.64.34.95.15.15.05.1

The public sector comprises the central government, decentralized entities, public enterprises (excluding ICE), and the central bank.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π(1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

The public sector comprises the central government, decentralized entities, public enterprises (excluding ICE), and the central bank.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π(1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure 8.Costa Rica: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Source: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten year historical average for the variable is also shown.

2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.

3/ One-time real depreciation of 30 percent 10 percent of GDP shock to contingent liabilities occur in 2009, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

1

The Legislative Assembly is expected to approve a constitutional amendment mandating an increase in education spending to 8 percent of GDP by 2014 (about 1 percent of GDP above the current level).

2

The authorities’ estimate of the revenue yield of the tax reform is higher than staff’s (see Box 1), reducing the deficit to debt-stabilizing levels.

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