Statement by Mr. Guzmán, Executive Director for Costa Rica and Mr. Gramajo-Marroquin, Senior Advisor

The 2010 staff report for the Third and Final Review Under the Stand-By Arrangement (SBA) reviews the economic performance of Costa Rica. The structural benchmarks related to the deposit insurance and bank resolution framework were delayed owing to a longer-than-expected consultation process. The gains in lowering inflation should be consolidated, including through the adoption of an inflation targeting framework to bolster policy credibility. IMF support helped to maintain confidence in the consistency of policies and the strength of financial buffers.

Abstract

The 2010 staff report for the Third and Final Review Under the Stand-By Arrangement (SBA) reviews the economic performance of Costa Rica. The structural benchmarks related to the deposit insurance and bank resolution framework were delayed owing to a longer-than-expected consultation process. The gains in lowering inflation should be consolidated, including through the adoption of an inflation targeting framework to bolster policy credibility. IMF support helped to maintain confidence in the consistency of policies and the strength of financial buffers.

We thank Staff for a concise and well-written report. Our authorities broadly agree with the Staff’s assessment and recommendations.

Regarding performance under the program, all quantitative criteria for end-December 2009 and end-March 2010 were met, most with significant margins. Observance of the two end-December structural benchmarks (submission to parliament of draft laws to create a deposit insurance scheme and to strengthen the bank resolution framework) were delayed in order to permit further feedback from stakeholders but have now been completed.

After being elected in February, President Ms. Laura Chinchilla took office on May 8, 2010. The new government is fully committed to maintain macroeconomic stability and to promote structural changes, including strengthening law enforcement and boosting the quality of public education.

Recent Developments. Macroeconomic developments have been better than projections indicated during the second program review. The broad-based recovery of the Costa Rican economy is firmly underway and the output growth forecast for 2010 has been revised upward. Inflation most likely will stay in the upper limit of the Central Bank’s year-end target range of 4-6 percent in 2010. Fiscal performance in 2009 was also better than envisaged, with the combined public deficit lower than projected. The banking sector remains sound, and the deterioration in prudential indicators registered in mid-2009 has begun to reverse.

Economic Outlook. As mentioned, the outlook for the remaining of 2010 improved with respect to the second program review. Given the faster-than-expected recovery, Staff made an upward revision to the output growth rates projected for 2010 and also for 2011 (to 3.8 percent and 4.2 percent, respectively). The projected end-2010 inflation was revised upward to 6 percent due to recent increases in regulated prices, a higher-than-projected rise in food and fuel prices, and a stronger domestic demand. Although prospects for external inflows (including FDI) have improved, the external current account deficit is still projected to exceed 4 percent of GDP by end-2010 driven by a strong recovery in imports (reflecting the improvement in domestic demand).

Fiscal Policy. The Central government’s deficit at end-2009 was 3.6 percent of GDP (0.5 percentage point lower than the program’s) while the deficit of the combined public sector was 4 percent of GDP (0.8 percentage point lower than the program’s). This better-than-expected performance has to do with expenditure restraint (on wages and investment), and with a larger-than-projected surplus of the social security entity. Tax revenues were consistent with projections, mainly due to the strong performance of import-related taxes.

The authorities are strongly committed to prudent fiscal management and plan to elaborate a medium-term fiscal strategy in the second semester of 2010. They also intend to initiate fiscal consolidation in 2011.

Monetary and Exchange Rate Policy. The Authorities are of the view that the Central Bank should focus on consolidating recent gains in low inflation, which could facilitate the gradual adoption of an inflation targeting regime. Despite the recent rise in CPI inflation, which is mainly related to increases in some administered prices, our authorities believe that there is no evidence of underlying price pressures. However, bearing in mind that the improved domestic demand and the increases in commodities’ prices, mainly oil, have the potential to generate inflation pressures, the Central Bank will maintain its cautious policy stance and is ready to tighten monetary policy if needed.

The exchange rate has appreciated during the present year, approaching the lower limit of the band; however, it has recently begun to depreciate and has shown more variability. Although during policy discussions Staff suggested either the elimination of the band or a downward shift of the floor, our authorities expressed that both proposals could lead to an abrupt appreciation as occurred in 2008. However, they reiterated their intention to move further towards exchange rate flexibility, which would be consistent with the gradual adoption of an inflation targeting regime.

Financial Sector. Costa Rica’s financial system has weathered the global crisis well, while prudential indicators will improve as economic activity takes hold. Moreover, the banking sector remains well capitalized and liquid. Although the intervention of one important institution in the cooperative sector was adopted opportunely, that situation made evident some limitations in the current resolution framework. In that sense, our authorities are of the view that adopting the deposit insurance and the resolution framework, included in the draft laws sent to the Legislative Assembly, would help to improve the resilience and confidence of the financial sector.

Finally, our authorities believe that the ongoing policies are adequate to meet their social and economic objectives, those that have been effectively supported by the Stand-By arrangement. The authorities reiterate that they will continue treating the arrangement as precautionary. Looking ahead, our authorities intend to continue the close and fruitful dialogue with the Fund.

Costa Rica: Third and Final Review Under the Stand-By Arrangement: Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Costa Rica.
Author: International Monetary Fund