Costa Rica
Recent Economic Developments

In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.

Abstract

In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.

I. Overview of Economic Developments in 1995-97

A. Macroeconomic Trends

1. Costa Rica faced a slump in economic activity in 1995-96 following a sharp deterioration in the public finances and higher inflation associated with the 1993-94 political-economic cycle.1 To avert a balance of payments crisis in early 1995, the authorities increased interest rates, imposed temporary import surcharges2 and raised excise taxes, while tightening expenditure and shifting some outlays to 1996. However, legislative approval of an increase in the VAT rate (from 10 percent to 15 percent) was delayed until late in the year. In all, there was a significant strengthening of the public finances in 1995 despite a large hike in interest obligations on domestic debt (to 4.8 percent of GDP, double the 1993 level). At the same time, real GDP growth decelerated sharply, inflation rose further (mainly on account of the increase in indirect taxes), while the external position strengthened significantly in part because of a continued improvement in the terms of trade and strong growth of nontraditional exports.

2. The economy went into a recession in 1996, with private investment declining for a third consecutive year. At the same time, the public finances deteriorated once again as the slowdown in economic activity caused a weakening in tax collections, and because the government relaxed the tight rein over expenditure so as not to deepen the recession, while interest obligations continued to rise. However, there was a marked deceleration in inflation as the retrenchment in private sector spending largely offset the decline in public savings. Also, the external current account widened only slightly despite a loss in the terms of trade, reflecting a continued strong performance of nontraditional exports. By contrast, there was a large loss in net international reserves in 1996 on account of large outflows of short-term private capital as interest rate differentials narrowed from the very high levels attained in the latter part of 1995.

3. On the basis of ongoing trends, the combined public sector deficit was projected to worsen further in 1997. Consequently, in early 1997 the government adopted fiscal measures equivalent to 1.5 percent of GDP and sent to the assembly a fiscal package equivalent to another 1.5 percent of GDP. However, in the run-up to the presidential elections (February 1998) the political support for the latter measures (including the maintenance of the VAT rate at 15 percent instead of allowing it to decline to 13 percent in March 1997 as scheduled) did not materialize. Nevertheless, through continued efforts to contain noninterest current expenditure and strengthen tax collections, the government succeeded in preventing a recurrence of the political-economic cycle in 1997. In contrast to previous cycles, economic growth picked up strongly, inflation decelerated further, while foreign investment continued to increase. Also, notwithstanding a widening of the external current account deficit, there was a substantial accumulation of international reserves as private capital inflows more than doubled, reflecting a continuation of large foreign direct investment flows and a reversal of short-term outflows. At the same time, the external public debt to GDP ratio declined further to 30 percent in 1997 from 36.6 percent of GDP in 1995.

4. The central bank continued to adjust the nominal exchange rate daily in 1996-97, taking into account the relative rates of inflation of Costa Rica and its major trading partners and the international reserve targets, with the basis of adjustment shifted in 1996 from past to targeted inflation.3 However, the colón appreciated by 2.5 percent in real effective terms during 1996-97 because of an appreciation of the U.S. dollar vis-à-vis other major currencies over this period (Figure 1).

Figure 1.
Figure 1.

Costa Rica Exchange Rate Developments

(1990=100)

Citation: IMF Staff Country Reports 1998, 999; 10.5089/9781451960402.002.A001

Source: IMF Information Notice System.1/ Trade weighted index of nominal exchange rates deflated by seasonally adjusted relative consumer prices. An increase (decrease) indicates appreciation (depreciation).

B. Output, Employment, and Prices

5. Real GDP growth, which had slowed from an average of 5.4 percent in 1993-94 to 2.4 percent in 1995, turned negative in 1996. Notwithstanding continued large flows of foreign investment into the Free Trade Zones and in-bond industries, private investment (including changes in inventories) declined further in 1996 mainly as a result of the hike in real interest rates, which impacted adversely highly leveraged firms, and reflecting also uncertainties regarding the sustainability of the stance of the fiscal policy (Statistical Appendix Table 1). Moreover, there was little progress in structural reforms and in steps to increase private sector participation in the economy, while a deteriorated infrastructure and the high cost of public utilities relative to the trading partners continued to affect adversely external competitiveness. Private consumption also declined in 1996 following a small increase in 1995, and there was a slowdown in the growth of public consumption and a decline in inventories. In all, domestic aggregate demand declined by over 5 percent in real terms in 1996 on top of the contraction of almost 1 percent in 1995. By contrast, exports of goods and services grew by more than 8 percent in real terms in 1996, somewhat faster than in 1995. Imports of goods and services increased by 2 percent in real terms in 1996, and the external current account deficit widened only slightly to 1.3 percent of GDP notwithstanding a deterioration in the terms of trade.

Table 1.

Costa Rica: National Income Accounts

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

6. The construction sector was the hardest hit with its output declining by 10 percent in 1996, followed by a 4 percent decline in the manufacturing sector and 0.5 percent decline in the agricultural sector (Statistical Appendix Table 2). In manufacturing, output of wood and wood products and textiles fell by 15 percent and 12 percent, respectively, while in the agricultural sector, declines in output were most notable in coffee and bananas, reflecting in part the adverse effects of hurricane Caesar (Statistical Appendix Tables 3 and 6).

Table 2.

Costa Rica: Gross Domestic Product by Sector

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Sources: Central Bank of Costa Rica; and Fund staff estimates.
Table 3.

Costa Rica: Volume of Agricultural Production

(In thousands of metric tons)

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Source: Central Bank of Costa Rica.

7. Led by a recovery in domestic private demand, including for housing, and by manufactured exports, real GDP grew by an estimated 3.2 percent in 1997. The expansion in private consumption was associated with a sharp increase in credit (Statistical Appendix Tables 24 and 25) and the impact on personal disposable income stemming from a significant decline in mortgage rates. The latter, together with a reactivation of the low income housing program by the National Housing Bank, have contributed to the rapid and strong recovery of construction activities.

Table 24.

Costa Rica: Changes in Banking System Domestic Credit by Origin, Destination, and Financing

(In billions of colones; end of period)

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Source: Central Bank of Costa Rica.
1/

After payments arrears.

2/

Includes counterpart USAJD grants and counterpart unrequited foreign exchange.

Table 25.

Costa Rica: Classification of Loans by Economic Activity

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Source: Central Bank of Costa Rica.
1/

As of October 1997.

2/

For 1997, annual percentage change corresponds to October 1997-December 1996.

8. The unemployment rate, which had remained stable at 4 percent during 1992-94 rose to 6.2 percent in 1996 but declined to 5.7 percent in 1997 (Statistical Appendix Table 13). Data through the end of 1996 indicate that since 1994 employment fell in the manufacturing and construction sectors, but remained mostly unchanged in agriculture. Although employment in the public sector fell by about 4 percent, it grew by about 2 percent in the private sector. In line with the fluctuations in economic growth, the average monthly real wage, which had jumped by 22 percent in 1993-94, stagnated in 1995 and declined by almost 5 percent in 1996 (Statistical Appendix Tables 11 and 12).

Table 13.

13. Costa Rica: Employment 1/

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Sources: “Multiple Purpose Household Survey, Employment Module,” General Directorate of Statistics and Census; Ministry of Economy, Industry and Commerce.
1/

Data from a survey conducted every year in My.

2/

Basic services include water and gas.

3/

Includes international organizations.

Table 11.

Costa Rica: Average Monthly Wages 1/

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Sources: Social Security Agency; and Central Bank of Costa Rica.
1/

Data for June of each year.

2/

Nominal wages deflated by the consumer price index.

Table 12.

Costa Rica: Minimum Wage Index

(1984=100)

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Sources: Ministry of Labor; and Central Bank of Costa Rica.
1/

Nominal minimum wages deflated by the consumer price index. Minimum wages are increased twice a year in January and July.

9. Following a sharp increase over 1994-95, inflation (as measured by consumer prices) fell from 22.5 percent during 1995 to 14 percent during 1996 (Statistical Appendix Table 8). The continued decline in private demand and the increase in the share of imported durable consumption goods in total supply, more than offset the adverse impact on domestic prices of increases in the international prices of oil and cereals and the weakening in the public finances (Statistical Appendix Table 10). This situation reversed in 1997, as the international prices for oil and cereals declined sharply and the public finances strengthened, while at the same time private domestic demand recovered significantly. However, part of the increased demand was channeled to imports which together with no changes in the price of housing services contributed to a further reduction of inflation in 1997 to 11.2 percent.

Table 8.

Costa Rica: Price Indicators

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Source: Central Bank of Costa Rica.
1/

In January 1995, Costa Rica adopted a new CPI index based on a larger number of goods and on a geographically wider sampling area. For comparison purposes, the 1995 indices reported in this table have been converted into the old basis.

Table 10.

Costa Rica: Energy Prices

(End of period)

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Source: Central Bank of Costa Rica.

C. The Public Finances

10. Following a marked improvement in 1995, the combined public sector deficit widened to 5.3 percent of GDP in 1996 due largely to an increase in interest payments on domestic government debt—associated with both a higher stock of debt (from 18 percent of GDP in 1995 to 26 percent in 1996) and continued high interest rates (about 22.5 percent during 1996) (Statistical Appendix Table 14). The weakening of the public finances also reflected higher noninterest current expenditure in the central government— particularly transfers and wages, and a smaller operating surplus of the public enterprises. In addition, the operating losses of the central bank rose further on account of higher interest payments on stabilization bonds. The domestic financing requirement of the nonfinancial public sector amounted to 4.0 percent of GDP in 1996 compared with 2.7 percent in 1995.

Table 14.

Costa Rica: Summary Public Sector Operations

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Sources: Ministry of Finance; and Fund staff estimates.
1/

Excludes transfers to cover the losses ofBanco Anglo Costarricense, a state commercial bank closed in December 1994.

2/

Includes rescheduling.

3/

Includes central bank losses.

11. Concerned about the rapidly rising fiscal deficit, which on the basis of ongoing trends was projected to widen to about 6.5 percent of GDP in 1997, the authorities announced in December 1996 an ambitious fiscal package involving measures equivalent to 3.0 percent of GDP, and plans to increase private sector participation in road construction and management of ports and airports and to privatize public assets of about 8 percent of GDP over 1998-99. In early 1997, the authorities moved swiftly to implement fiscal measures that did not require approval by the assembly. These included (a) an increase of 15 percentage points on the consumption tax on diesel and gasoline (0.6 percent of GDP); (b) doubled the number of large taxpayers subject to close monitoring (0.2 percent of GDP); (c) delayed the reduction of import duties on consumption and intermediate goods to 1998 (0.1 percent of GDP); and (d) cut net lending by the social security agency and investment by public enterprises (0.4 percent of GDP). They also submitted draft legislation to maintain the VAT rate at 15 percent instead of allowing it to decline to 13 percent in March 1997 as scheduled (0.7 percent of GDP), increase the excise tax on luxury cars (0.1 percent of GDP), cut budgeted central government expenditure in goods and services, transfers and capital outlays (0.6 percent of GDP), and cancel debt to nonconsolidated public agencies and enterprises (0.3 percent of GDP). Of the latter, only the excise tax on luxury cars was implemented. Moreover, the privatization proposals were diluted and formulated at a slower pace than planned, with pertinent legislation not submitted to the assembly until October 1997.4

12. In addition to the measures implemented earlier in the year, the improvement of the public finances in 1997 (the combined public sector deficit was reduced to 3.7 percent of GDP) was achieved mainly through sustained efforts to reduce central government noninterest current expenditure, and to strengthen tax administration to offset for the loss of revenue from the reduction in the VAT rate. Also, across-the-board wage increases were kept in line with targeted inflation, and central government interest obligations on domestic debt and central bank losses declined, reflecting a sharp drop in the average interest rates on government paper (to about 18 percent) which stemmed in part from changes to the auction mechanism implemented in March 1997 (see below, subsection D). In addition, there were delays in the implementation of the investment program of the electricity and telephone company (ICE) on account of administrative red tape.

13. During 1994-96 the overall deficit of the central government has ranged from 4.5-5.3 percent of GDP, compared with deficits averaging 1.9 percent of GDP in 1992-93 (Statistical Appendix Tables 15, 16, 17, and 18). The widening in the deficit in recent years has been due almost entirely to increases in interest payments on the domestic debt which rose steadily from an average of 2.6 percent a year in 1992-93 to 5.4 percent in 1996 (see Chapter III). Over the same period, noninterest current expenditure rose from about 12 percent of GDP to 13.4 percent, with most of the increase accounted for in wages, pension payments, and transfers to the private sector. Fixed capital outlays have remained largely unchanged at less than 1 percent of GDP since 1992, with the result that the quality of the country’s infrastructure has deteriorated markedly. Despite the weakening of tax collections resulting from the slowdown in economic activity, revenue performance strengthened by more than 1.5 percentage points of GDP in 1995-96 owing to the increase in the VAT rate (September 1995) and excise taxes on fuels, which more than offset for a decrease in import duties resulting from a lowering in import tariffs and a sharp deceleration of imports.

Table 15.

Costa Rica: Summary Central Government Operations

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Sources: Ministry of Finance; and Fund staff estimates.
1/

Includes capital revenue.

Table 16.

Costa Rica: Operations of the Central Government

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Sources: Ministry of Finance; and Fund staff estimates.
1/

Pension contributions of government employees are excluded from both revenue and expenditure.