Costa Rica: Staff Report for the 2016 Article IV Consultation
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International Monetary Fund. Western Hemisphere Dept.
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Publication Date:
23 May 2016
eISBN:
9781475519228
Language:
English
Keywords:
ISCR; CR; central bank; Costa Rican authorities; monetary policy; exchange rate; staff estimate; private sector; market share; terms of trade; last quarter
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Growth moderated to below trend in 2013-15. In 2015, the output gap widened notwithstanding the modest pick-up in growth to 3¾ percent. GDP is expected to return to potential over the medium-term. Inflation dove into negative territory following the sharp decline in imported oil prices, but is projected to return to the 2- 4 percent target range by end-2016. The exchange rate (XR) remained stable despite the removal of the band, and reserve accumulation resumed strongly. Risks to the outlook are tilted to the downside, notably from large fiscal deficits and high dollarization.

Abstract

Growth moderated to below trend in 2013-15. In 2015, the output gap widened notwithstanding the modest pick-up in growth to 3¾ percent. GDP is expected to return to potential over the medium-term. Inflation dove into negative territory following the sharp decline in imported oil prices, but is projected to return to the 2- 4 percent target range by end-2016. The exchange rate (XR) remained stable despite the removal of the band, and reserve accumulation resumed strongly. Risks to the outlook are tilted to the downside, notably from large fiscal deficits and high dollarization.

Overview

1. Having bounced back quickly from the global crisis, growth has moderated below trend and macro vulnerabilities, mainly from the weak fiscal position, are rising. After falling modestly in 2009, real GDP surged in 2010–12. Since then, however, growth has remained below potential, with the latter also declining. Hence, structural impediments must be removed to maintain sustained rates of economic expansion. The counter-cyclical budgetary stimulus imparted in 2009 pushed the deficit above 5 percent of GDP in 2010 (mainly through a rise in wages and transfers). The deficit has crept up further to 6 percent since then, placing the public-debt-to-GDP ratio on an unsustainable upward trajectory and fast approaching levels associated with higher risks of disorderly adjustment in emerging economies. Continuing fast expansion of dollar-denominated credit, facilitated by a stable XR, exacerbates vulnerabilities in the financial sector, rendering further improvements in regulation and supervision even more important.

2. Policy actions have been broadly consistent with past Fund advice. The authorities submitted to Congress a fiscal reform package that is in line with staff advice, though its approval will require cooperation of opposition parties (¶22). Other measures consistent with past Fund advice include: (i) the removal of the XR band in early 2015 and continued reserve accumulation (¶5), (ii) the reduction in the inflation target range in 2016 to 2–4 percent, in line with the average inflation of trading partners (¶4), and (iii) tightening of prudential requirements to discourage dollarization (¶28). The large easing of monetary policy was an appropriate response to the unexpectedly sharp decline in headline and core inflation amid low international oil prices (¶4). Additional progress is needed to implement the 2008 FSAP recommendations (¶129).

Recent Economic Developments and Outlook

A. Recent Developments

3. A third year of growth below potential has resulted in a moderate output gap. Having expanded by almost 5 percent annually in 2010–2012, growth slowed to 2½ percent in 2013–14. This reflected both gradual weakening of domestic demand following the rebound from the 2008–09 crisis as well as sluggish export growth, the latter mirroring the pace of the U.S. recovery. Growth picked up to 3¾ percent in 2015, as the boost to domestic demand from improved terms of trade, associated with lower commodity prices, and higher investment more than offset the drag from Intel manufacturing’s closure, adverse weather conditions for the main agricultural export crops, and slightly contractionary financial conditions—the latter reflecting higher real lending rates and real appreciation (¶9). Nevertheless, both private and public investment recovered significantly, the latter supported by construction of a new port terminal and public water systems. Overall, with growth below its trend rate of 4 percent during 2013-15, a negative output gap of about 1 percent of GDP has opened up (Analytical Note (AN) VIII).1 The unemployment rate has been elevated since the crisis; its slight decline in 2015 was mainly due to lower participation from discouraged workers.

A01ufig1

GDP growth, Potential and Output Gap

(Percent)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: National authorities, and IMF staff estimates

4. The central bank took advantage of the favorable shock from lower oil prices to reduce its inflation target range. Inflation increased sharply and breached its upper limit in 2014, owing mostly to the pass-through to domestic prices from XR depreciation in early 2014. The breach was short-lived, though, as the sharp decline in imported oil prices, tight monetary policy, and a widening output gap drove inflation into negative territory by the second half of 2015. The central bank reacted by cutting the policy rate by 350 basis points to 1¾ percent. It also availed itself of the propitious circumstances—with inflation projected to stay below the 3–5 target range until the end of 2016 and inflation expectations falling for the first time below the center of the range—to lower the target to 2–4 percent, in line with average inflation of trading partners.

A01ufig2

Headline Inflation

(Percent, y-o-y)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: Haver, BCCR and Fund staff calculations.
A01ufig3

Costa Rica: Inflation Decomposition

(Contribution to growth y/y, in percent)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: Haver analytics and Fund staff estimates.

5. The exchange rate has been stable despite abandonment of the band regime, and reserve accumulation has resumed strongly. After a short period of heightened volatility in early 2014, amid increased prospects for U.S. monetary policy normalization, the XR quickly stabilized again about 6–7 percent above the floor of the XR band, and remained there despite the early-2015 removal of the band, in line with Fund advice to strengthen the inflation targeting framework. A lower current account deficit—4 percent of GDP in 2015, driven by lower oil prices—as well as continued government Eurobond issuance, resilient FDI flows, and increased net foreign bank liabilities to meet renewed demand for credit in FX resulted in continued strong foreign reserve accumulation, in line with the authorities FX purchase program, to $7.8 bn at end-2015, above the IMF adequacy metrics.2 Nonetheless, in December 2015 and early 2016, reserves declined somewhat, as FX demand, including by financial intermediaries, increased and the central bank accommodated it, resulting in a flat XR.

6. The external position is close to equilibrium, with competitiveness largely unchanged in 2014–15. In the first half of 2014, a third of the 30 percent real effective exchange rate (REER) appreciation accumulated over the last decade was undone, as nominal colón depreciation outpaced a growing inflation differential. Since then, however, the REER rose steadily until stabilizing about 5 percent above its end-2013 level. At the same time, this increase is consistent with the change in the REER equilibrium value and, as a result, competitiveness has not deteriorated (Box 1). In particular, multilaterally consistent estimates under the EBA and other regression-based approaches support this view. Nevertheless, productivity-enhancing reforms (¶32) and wage restraint are needed to maintain Costa Rica’s competitiveness in world markets. Fiscal consolidation (¶18–23) would also buttress long-term external stability.

External Sustainability Assessment

Costa Rica: Implied Undervaluation (“+” = Overvaluation)

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Sources: Fund staff estimates.

7. Failure to reverse the countercyclical fiscal policies implemented during the global financial crisis put public debt on a rapid upward trend. Attempts to curb government outlays, mainly through capital expenditure cuts in 2011, were undermined by the rising transfers (to decentralized public entities) and interest bill in 2012–2013. Tax collections, after falling from precrisis levels that were boosted by GDP growth well above trend, remained stagnant, with a revenue-enhancing tax reform nullified by the Constitutional Court owing to procedural irregularities in 2012. Consequently, the central government (CG) primary deficit returned to its crisis peak of around 3 percent of GDP in 2013. The new administration that came into power in mid-2014 maintained a broadly unchanged non-interest deficit, as efforts to restrain spending and reduce tax evasion prevented a budgeted deterioration in the primary balance of more than ½ percent of GDP in 2014–15. Meanwhile, a rising interest bill has lifted the overall CG deficit to 6 percent of GDP in 2014–15, with debt exceeding 42 percent of GDP in 2015. Though the impact on domestic financing costs has been muted by the annual $1 bn external bond issuance since 2012 and aggressive monetary easing in 2015, spreads on external bonds have doubled since the 2013 tapering tantrum and the country lost its investment grade in 2014.3

A01ufig4

Central Government

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: National authorities and Fund staff estimates.

8. The authorities have developed a strategy for fiscal consolidation focused on strengthening revenue. The new government initially formulated a consolidation proposal focused on reducing tax evasion and a few exemptions. Since then, a more comprehensive plan, that is broadly consistent with staff recommendations both in its size and its emphasis on revenue enhancements through tax base widening and higher rates, has been developed (¶21).

Potential Output Growth and Output Gap Estimates

(In percent)

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Source: Fund staff estimates.

Includes level effect on potential output of Intel exit, estimated at 0.2 percent of GDP in 2014 and 0.8 percent in 2015.

The output gap in the macroeconomic framework is slightly different from model-based estimates, as the level of potential output for each past year in the historical series reflects the estimate available at the time.

9. The recent loosening of monetary policy is expected to bring about financial conditions more supportive of growth. Real lending rates have been edging upwards since mid-2014, as limited transmission of the large policy rate cuts to lending rates thus far has been more than offset by the fall in inflation expectations. In addition, the REER has resumed its appreciating trend and credit growth has moderated. A broad-based index (FCI) developed by staff (featuring the influence on economic activity of credit, deposits, real interest rates, REER, and house prices) suggests that financial conditions were slightly contractionary in 2015, owing to higher real interest rates and real appreciation (AN III). However, this is likely to be reversed as the lower policy rates gradually complete their pass-through. Monetary transmission, though, is hamstrung by high dollarization, segmentation of the banking system, limited capital market development (¶33 and AN V), and anticipation of forthcoming upward pressures on interest rates from large budgetary financing needs.

10. The financial system appears sound, though profitability is low and dollarization continues to be a source of vulnerability. Bank capital is well above regulatory requirements and liquidity indicators are robust. While non-performing loans have remained low, profitability has declined slightly in recent years, and remains below that of regional peers. Reliance on foreign funding has continued to increase, although staff analysis suggests that associated rollover risks remain manageable even under scenarios of extreme shocks in international banking systems. Moreover, macroeconomic trends are consistent with recent and anticipated credit growth and there is little evidence of financial sector risk buildup (ANs I and II). Indeed, while the depth of Costa Rica’s financial system improved considerably in the past decade, it continues to lag those of comparable emerging markets as well as the degree of development implied by its macroeconomic fundamentals. In particular, credit to the private sector is still well below the estimated level consistent with fundamentals (ANs IV and V). Amid renewed exchange rate stability since late 2014, however, credit growth has again tilted toward FX, including to sectors without natural FX hedges, despite already high levels of bank loan dollarization.

A01ufig5

Distribution of Macro Outcomes Conditional on Real Private Sector Credit Growth

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: IMF staff estimates based on RES Macro Financial Forecast
A01ufig6

Private Sector Credit Growth by Currency

(Percent, y-o-y)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: BCCR and Fund staff calculations.

Costa Rica. Financial Soundness Indicator Heat Map

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Sources: BIS; FSIs; IMF IFS; and national authorities.

B. Macroeconomic Outlook and Risks

11. The joint view of staff and the authorities was that the economy will expand faster and inflation revert to the target range in 2016, with activity returning to potential over the medium term. Growth is expected to accelerate to 4¼ percent in 2016, slightly above potential growth, supported by: (i) dissipation of the one-off effects of Intel’s manufacturing withdrawal, (ii) further terms-of-trade improvement from the additional decline in international oil prices, (iii) domestic monetary stimulus—model simulations suggest that the monetary easing implemented in 2015 would boost GDP growth by ½–¾ percent of GDP in 2016, assuming full though gradual transmission from policy to lending rates—and (iv) sustained real credit expansion (estimated by staff to be consistent with projected GDP growth based on historical precedent).4 The output gap is anticipated to stabilize in 2016, and then mostly close over the medium term. Model simulations also suggest that the monetary stimulus, together with fading base effects from the oil price decline in 2015, would also bring inflation back to the center of the new 2–4 percent target range by end-2016. Inflation is then projected to hover around that value throughout 2017–21, buttressed by continued prudent monetary policy, while still allowing for continued monetary accommodation during the initial phase of the fiscal adjustment. The current account deficit will widen slightly to 4¼ percent of GDP over the medium-term, amid gradual recovery of international commodity prices, while partial fiscal consolidation—focused on revenue measures that increase the progressivity of the tax system and with some attendant confidence effects—is not expected to have a significant negative impact on domestic demand. The staff baseline scenario, which incorporates the measures already submitted to Congress that have a higher probability of being approved, contemplates fiscal consolidation measures of 2¼ percent of GDP over the medium term. The CG overall deficit would decline slightly to 5½ percent of GDP and the public debt ratio would reach 55 percent of GDP by 2021 (¶18 and AN VI).

A01ufig7

Real Effect of a 300bp Policy Rate Cuts with Different PT

(Percent difference from baseline)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: IMF staff calculation based on RES FSGMNote: PT=Pass-through to Lending Rates; SPPT=Slower, more persistent PT (1/3)

12. The authorities also concurred that an alternative scenario incorporating the fiscal adjustment necessary to restore debt sustainability would yield a more favorable outlook. According to staff analysis, a total correction of about 3¾ percent of GDP would stabilize public debt in the medium term within “safe levels,” with only moderate short-term output costs (¶19). Growth would be only slightly lower in initial years and higher in outer years than in the baseline case. This is not only because of significant confidence effects but also of the more balanced macro policy mix allowed by tighter budgets consistent with restoring fiscal sustainability and reducing the current account deficit. Indeed, a looser monetary stance than in the baseline would be sufficient to achieve the inflation target over the medium-term, thereby also mitigating increases in market rates associated with the normalization of U.S. monetary policy.

Costa Rica: Baseline Scenario, Partial Fiscal Adjustment 1/

(In percent of GDP, unless otherwise indicated)

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Source: Fund staff estimates.

The baseline scenario includes fiscal consolidation measures of about 2¼ percent of GDP, partly offset by a projected underlying deterioration in the primary balance mainly driven by the constitutionally mandated increase in education expenditure.

Costa Rica: Full Fiscal Adjustment Scenario 1/

(In percent of GDP, unless otherwise indicated)

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Source: Fund staff estimates.

Includes measures as in the baseline scenario and additional measures of 1½ percent of GDP.

13. The authorities agreed that risks to the outlook were tilted to the downside. Downside risks stem from both global uncertainties and weaknesses in domestic fundamentals (as detailed in the Risk Assessment Matrix):

  • External risks. The normalization of U.S. monetary policy presents moderately upside risks. Absent pronounced increases in market volatility, faster U.S. growth would have a positive impact on Costa Rican GDP, given strong trade ties, more than offsetting the negative influence of tighter global financial conditions. However, extreme bouts of market volatility— from a disorderly U.S. monetary policy normalization, stresses in emerging markets with high corporate leverage (including in FX), or heightened global geopolitical risks—could inflict serious damage, especially given Costa Rica’s weak fiscal position, bank reliance on foreign funding, and domestic credit dollarization, with associated exposures to interest rate and exchange rate risks, the latter evident only in the event of a large depreciation (¶26 and AN I). Conversely, if the nominal effective exchange rate of the colón continues to appreciate in line with the U.S. dollar, competitiveness vis-à-vis other trading partners would be negatively affected. In addition, deeper-than-expected slowdowns in the rest of the world could hamper Costa Rica’s growth, both in the short term—as the credit cycle matures in key emerging markets—and in the medium term, reflecting structurally weaker growth in advanced countries that have not fully addressed crisis legacies. At the same time, model simulations of the effect of slowdowns in foreign demand suggest that Costa Rica is less vulnerable to adverse developments in key emerging markets, including China and Brazil, than in the U.S., consistent with relative trade ties (AN VIII). In addition, the fact that Costa Rica does not have a significant offshore sector like other countries in the Central America-Caribbean region, and given also comparatively limited anti-money-laundering-compliance concerns (¶31), the country appears less vulnerable to de-risking strategies by global banks, including loss of correspondent banking services.5 Risks from energy prices are balanced, with increased volatility possibly deriving from geopolitical tensions weighing on the downside, while lower-than-anticipated prices would have moderately positive effects.

  • Domestic risks. The persistence of large fiscal deficits and the ensuing rapid rise in the public debt ratio in a passive scenario where political support for budget consolidation falls short, could render the economy vulnerable to sudden changes in financial market conditions. Also, large government gross financing requirements could lift domestic interest rates, weighing on private investment and growth. Expectations of a pick-up in interest rates driven by the government short-term financing needs are already encouraging maintenance of excess liquidity in banks, which also limits the transmission of the monetary stimulus to lending rates—model simulations suggest that if pass-through of the policy rate cuts continued to be hindered by these concerns, the short-term boost to growth from monetary stimulus would be reduced by half (¶11 and AN I). Given low profitability and heavy dollarization of the banking system, financial stability could also be jeopardized by substantial currency depreciation, mainly through higher NPLs (¶26, AN I and II).

A01ufig8

Real and Financial Spillovers

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Costa Rica: Passive Scenario 1/

(In percent of GDP, unless otherwise indicated)

article image
Source: Fund staff estimates.

This scenario does not include any fiscal consolidation measures, while reflecting the underlying deterioration in the primary balance mainly driven by the constitutionally mandated increase in education expenditure.

A01ufig9

Costa Rica: Financial Stability Map

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: Fund staff estimates.
A01ufig10

Real Effect of a 100bp Increase in Market Interest Rates

(Percent difference from control)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: IMF staff calculation based on RES FSGM

Costa Rica: Risk Assessment Matrix

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path discussed in this report (which is the scenario most likely to materialize in the view of the staff). The RAM reflects staff’s views on the source of risks and overall level of concerns as of the time of discussions with the authorities. The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding this baseline.

In case the baseline does not materialize.

Policy Discussions

14. Discussions focused on the policy mix appropriate for current cyclical conditions and mitigation of longer-term economic vulnerabilities. In particular, the latter centered on how to: (i) restore fiscal sustainability; (ii) improve the monetary policy framework; (iii) further enhance financial system supervision and regulation; and (iv) boost potential and inclusive growth.

A. Near-term Policy Mix

15. There was agreement that economic conditions call for a policy mix characterized by the start of fiscal tightening and continuation of a supportive monetary policy. The authorities appropriately intend to begin a gradual fiscal adjustment in 2016 (¶s16, 20). With output below potential and zero inflation, a continued accommodative monetary policy stance consistent with bringing inflation back to the target range will help offset the small contractionary impact of the tighter budgetary stance in the short term.

16. Indeed, the authorities are pursuing a sizable reduction in the deficit in 2016 as part of a gradual path toward fiscal sustainability. Although the 2016 budget6 envisaged the overall and primary deficits to edge up to 6½ and 3¼ percent of GDP respectively in a passive scenario, as a result mainly of constitutionally-mandated rises in education outlays and continued increases in interest payments, the government has submitted to Congress bills that could result in a correction of about ¾ percent of GDP relative to the budget. In staff’s view, this correction, as part of a policy mix that takes into account the cyclical position of the economy (¶20), would be suitable. Officials were also adamant that it will be critical to implement these measures as part of a comprehensive package that delivers the total budgetary consolidation measures of 3¾ percent of GDP needed to stabilize debt over the medium-term (¶s19 and 20).

17. The authorities concurred that the current expansionary monetary stance is broadly adequate. Headline inflation was negative and core inflation was below the lower bound of the 3-5 percent target range during most of 2015. Inflation is projected to return to the center of the new 2-4 percent target range by end-2016, while output remains below potential. Thus, the monetary stance—with 350 basis points in cumulative policy rate cuts to 1¾ percent, well below the estimated neutral rate of 5 percent—is appropriately expansionary (AN III). While transmission of the stimulus has been slow (¶9), domestic financial conditions are expected to gradually reflect the monetary easing, which, together with continued credit growth at a pace consistent with healthy financial deepening, should support the return of economic activity to its potential level over the medium term and of inflation within the target range in the near term (¶11). At the same time, it was noted that, if signs emerge whereby price pressures threaten to drive inflation above the mid-point of the new target range and jeopardize the still-very-recent anchoring of inflation expectations, taking into account the lags in monetary policy transmission, the central bank ought to start reversing the easing cycle. This consideration is reinforced by the prospective upward normalization of global interest rates, which could induce depreciation pressures.

A01ufig11

Policy Rate and Bank Lending Rates

(In percent)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: Nationalauthorities, and IMF Staff estimates

Neutral Interest Rate for Costa Rica. Latest Estimates

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Sources: National authorities and Fund staff estimates. Notes:

All units expressed as percent points unless otherwise stated.

(bps): Basis points

B. Safeguarding Fiscal Sustainability

18. The authorities viewed current fiscal trends as unsustainable in the long term. Staff stressed that, without any policy action, the CG deficit would be above 9 percent of GDP and debt rise to almost 70 percent by 2021. Even in the baseline scenario, which incorporates a fiscal adjustment of 2¼ percent of GDP, the CG deficit would persist at about 5½ percent of GDP by 2021, owing to a mounting interest bill and constitutionally-mandated education spending. Correspondingly, CG debt would grow to 55 percent of GDP by 2021 (from 42½ percent of GDP at end-2015), further raising vulnerabilities and potentially eroding the underpinnings of macroeconomic stability.

19. The government confirmed that a fiscal adjustment of almost 4 percent of GDP is needed to stabilize the public debt ratio. In staff’s estimates, budget retrenchment measures amounting to 3¾ percent of GDP over the medium-term would suffice to steady the share of public debt to GDP below levels which tend to weaken macro stability in emerging markets, while allowing for some desirable increases in growth-friendly capital spending (Annex III). The authorities agreed and are prepared to implement a fiscal consolidation package expected to gradually close this fiscal sustainability gap (¶21).

20. To pace consolidation, the authorities aptly intend to maintain a balance between lowering the sustainability gap and limiting any adverse impact on growth. The front-loaded fiscal consolidation appropriately planned by the government, with somewhat less than two-thirds of the total adjustment in 2016–17 and smaller corrections in subsequent years, would have only moderate output cost over the forecast period (¶12 and AN VI). Staff underscored that further postponing fiscal retrenchment would be costly, since, the longer the delay, the larger will be the improvement in the primary balance required to stabilize the public debt ratio. The authorities had the same concern. They asked staff to explain publicly that failing to deliver on the fiscal consolidation plan would increase the risk of an abrupt shift in investor sentiment and of acute financial market tensions, thus forcing a disorderly adjustment.

Costa Rica. Fiscal Consolidation Path

(Percent of GDP)

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Source: Fund staff estimates.

21. The authorities’ fiscal adjustment plans adequately focus on raising revenues, with a sizable contribution from expenditures, but full implementation is critical. The measures in the authorities’ plans broadly follow staff advice, including recommendations provided in past technical assistance by the Fund and other multilaterals.

  • The government’s strategy envisions about 2½ percent of GDP in higher taxes, consistent with staff’s advice that about two-thirds of the adjustment should consist of increases in receipts, given Costa Rica’s low revenue effort compared to other upper-middle-income countries. VAT and income tax reforms would boost collections by slightly more than 2 percent of GDP over the medium-term, and other provisions—reduced exemptions, further amendments to the corporate income tax and anti-tax evasion measures—would generate almost ½ percent of GDP. The VAT reform envisages broadening the base to include services and a gradual increase in the rate from 13 to 15 percent, starting in 2017, as well as separate increases of taxes on sales of vehicles and real estate. The bill also foresees a radical narrowing of the basic goods basket, conditional on the establishment of a transfers system that would make the VAT reform broadly revenue-neutral for lower-income households. The income tax reform introduces additional marginal rates of 20 and 25 percent on higher-income brackets, unifies the rate on capital income at 15 percent, and subjects capital gains to tax.

  • Furthermore, the authorities have already identified legislative changes—including to curtail growth of pensions paid out of the budget and transfers to decentralized entities—and administrative measures that would yield the 1¼ percent of GDP of cuts in current expenditures also required to fully close the sustainability gap.

  • The authorities share staff’s view that only the full adjustment of 3¾ percent of GDP needed to stabilize the public-debt-to-GDP ratio would be adequate from a macro-economic perspective. Indeed, a partial fiscal adjustment as assumed in the baseline scenario—with tax reform proposals currently in Congress watered down and insufficient efforts to contain spending—would result in continued large fiscal deficits driven mainly by a mounting interest bill, and significant additional debt accumulation subject to important downside risks under less favorable macroeconomic conditions (¶11 and Annex III). This would further raise vulnerabilities and potentially erode the underpinnings of macroeconomic stability.

  • The alternative full adjustment scenario assumes Congressional approval of all submitted measures, yielding 2¾ percent of GDP. Moreover, it includes administratively-determined spending cuts that would contain the growth of current spending—mostly transfers and public sector wages—to keep it throughout the medium term below the expansion of nominal GDP.

A01ufig12

Tax Revenue, 2014

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: WEO and Fund staff calculations.

Costa Rica. Central Government. Fiscal Consolidation Measures

(in percent of GDP)

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On the revenue side, includes staff’s assessment of the expected yield from revenue measures submitted to Congress. On the expenditure side, includes measures already submitted to Congress.

In addition to the lower yield assumed from anti-tax evasion meaures, the difference with the authorities’ plans is that it incorporates only measures that are deemed to have a higher probability of approval. The assumption in the baseline is that the proposed VAT tax rate increases will not be approved by Congress.

Reflects total adjustment needed to close the sustainability gap.

Includes measures to contain nominal growth of public wages, so that their share in GDP is gradually reduced. Also includes freeze in hiring outside education, and cuts to public compensation bonus schemes.

22. The government is considering steps to ensure durable commitment to contain expenditures, thus shoring up parliamentary support for fiscal consolidation. The executive power has a minority representation in Congress; hence approval of most budget consolidation measures requires the cooperation of opposition parties. Notwithstanding the broad consensus across the political and societal spectrum that fiscal retrenchment is needed, some opposition parties and influential lobbies have called for greater emphasis on lowering outlays. In this regard, bills currently under discussion to reform public employment conditions—thus preventing excessive automatic increases in current outlays—and a recently presented fiscal rule proposal—aimed at the preservation of government debt sustainability, broadly in line with staff advice though still requiring greater specification of its key elements—are welcome (AN VI). An agreement is likely to require simultaneous advances on all aspects of the consolidation package. Despite promising moves toward a compromise, the process could still be derailed.

23. The authorities agree that the pension system’s financial position also has to be strengthened in the long run. The pension plan run by the Social Security agency (CCSS) and the special regime for the judiciary are actuarially imbalanced. They are projected to turn a cash deficit over the long term due to system maturation and population aging. Preliminary projections suggest that an additional adjustment equivalent to about 1½ percent of GDP would be required at the general government level to ensure actuarial equilibrium of the CCSS for the next 50 years (AN VI). A study commissioned by the CCSS and the Superintendence of Pensions to be released in 2016 will determine the size the imbalance more precisely. The authorities have nevertheless already taken some measures, including the elimination of the early retirement option, and are considering increasing minimum contributions and gradually raising contribution rates over the medium-term above the scheduled increases already stipulated in 2005. Several legislative proposals currently in Congress also contemplate parametric adjustments to the special regime for the judiciary.

C. Improving the Monetary and Exchange Rate Policy Framework

24. Staff commended the authorities for their achievements in lowering inflation and endorsed their decision to further lower the target range. The central bank’s monetary policy has succeeded in preventing any durable deviations from the target range since 2009 and anchoring inflation expectations to the center of the 3-5 percent target range introduced in 2014. Based on this, the staff supported the central bank’s decision to take advantage of the recent sharp decline in inflation to revise the target range to 2-4 percent, in line with average inflation of trading partners. At the same time, staff emphasized, this move should be accompanied by fiscal consolidation to prevent the risk that an excessively tight monetary policy might be needed to contain inflation within the target range.

25. The authorities have made steady progress toward full-fledged inflation targeting, but additional steps would be useful.

  • The mission underlined that removal in early 2015 of the legal constraint to exchange rate flexibility posed by the XR band is a milestone toward establishing inflation as the undisputed anchor of monetary policy and lowering XR pass-through to inflation. It also acknowledged that the authorities’ preference for maintaining a significant role for active XR management, with an FX intervention rule aimed both at averting excessive volatility and at countering unwarranted deviations from medium-term fundamentals, is understandable, in light of the large financial dollarization.

  • However, staff advised that a gradual, contained increase in the flexibility of the exchange rate, in line with the stated policies of the central bank, would be important to further strengthen the credibility of the inflation-targeting framework, as well as to enhance the role of the exchange rate as a shock absorber and make market participants more cognizant of two-way risks in exchange markets, promoting the development and use of hedging facilities and the reduction of foreign currency mismatches, while more generally discouraging dollarization. The latter should also be pursued with the tightening of macro-prudential norms (¶28). Moreover, the mission questioned whether the lack of transparency of the triggers for the FX-intervention-rule aimed at curbing volatility might not, under circumstances less favorable than those presently prevailing (¶4), undermine confidence in the full subordination of XR management objectives to the inflation target. The central bank agreed in principle, but emphasized that allowing more XR flexibility and more transparency about the intervention policy should proceed in parallel with the transfer of all FX transactions to the open market to make the XR less prone to speculative moves. Staff saw merit in deepening the FX market, thereby facilitating higher XR flexibility.

  • Fostering growth of the underdeveloped secondary market for government securities, including through use of standardized simple instruments with conventional maturities, was also considered desirable to reinforce the effectiveness of monetary policy and enhance resilience to external financial shocks.

D. Financial Stability

26. The authorities acknowledge that currency mismatches in the private sector pose the key risk to financial stability. Staff noted that Costa Rica’s current level of credit and broader financial development is well below the threshold beyond which risks to stability outweigh the benefits from the positive impact on growth (AN IV). In particular, the current pace of overall credit expansion, not high by historical standards, seems consistent with continued healthy financial deepening. Moreover, a top-down stress test conducted by staff depicts a sound banking sector that could absorb a range of sizable shocks (AN II). However, large dollarization of bank loans was jointly identified as a serious and intensifying concern. Indeed, notwithstanding the overall long FX position of the banking system, a large depreciation of the colón may impact asset quality, given unhedged FX liabilities in large segments of the household and corporate sectors. In particular, staff pointed out that, according to the stress tests, the deterioration of bank capitalization, and related contingent liabilities for the sovereign, could be substantial (AN II). As for the macro impact, general equilibrium model simulations suggest that loan impairment and implied lower credit growth from, say, a twenty percent depreciation could reduce GDP growth by about 1½ percent over the medium-term (AN I).

A01ufig13

Effect on Real GDP of Adverse Shocks on FX and NPL

(Percent difference from baseline)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: IMF staff calculation based on RES FSGMNote: NPL= Non Performing Loans; MRP= Market Risk Premium

27. High net foreign liabilities of banks, growing household leverage, and sovereign exposures represent other vulnerabilities of the financial sector. After a period of large bank borrowing abroad incurred to fund the rapid growth of FX credit to residents, Costa Rica is among the countries in the region with highest reliance on foreign bank funding, raising concerns about rollover risks. Indeed, staff analysis, based on network model simulations of spillovers from asset quality and capital shocks in international banks, suggests that reduced foreign bank funding could lead to a significant reduction in credit in Costa Rica (Panel 5 and AN II). While the increase in private sector debt has been limited compared to other emerging markets,7 in Costa Rica it has been mainly concentrated in the household sector, and officials are aware that rising household leverage, not least via credit by non-bank commercial entities, could also endanger asset quality. Finally, it was observed that, though starting from the low levels prevailing before the global crisis, continuing brisk accumulation of holdings of government debt by banks, boosted by the large fiscal deficits, is an additional hazard, particularly in an environment where, over the medium term, interest rates are likely to increase. Although staff recognized that, based on its analysis, banks could currently sustain losses from a significant spike in interest rates on domestic government bonds without capital falling below regulatory requirements (AN II), it also expressed concern that risks from mark-to-market losses on bank exposures to the sovereign will mount without adequate fiscal consolidation.

A01ufig14

Bank Credit to the Private Sector

(in percent of GDP)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: National authorities and IMF staff estimates.

28. Supervisors recognized these risks and are taking positive steps to gradually reduce them. Staff welcomed the recent increase in capital risk-weightings on FX loans to unhedged borrowers and the extension of reserve requirements to medium- and long-term foreign bank borrowing (in addition to the existing requirement on short-term foreign borrowing). Officials explained that additional measures to further reduce vulnerabilities are currently under consideration. These include: (i) stricter provisioning on FX loans to unhedged borrowers and household debt with income-to-debt service ratios above 30 percent; (ii) counter-cyclical provisioning; and (iii) higher risk-weightings for household mortgages with high loan-to-value and income-to-debt service ratios. The mission deemed that these steps were appropriate, but it was not possible yet to determine whether they would be sufficient to achieve substantial reductions in credit dollarization and rollover risks. Staff recommended that further tightening of provisioning on FX bank lending and of reserve requirements on FX bank borrowing (the latter requiring Congressional action) should be contemplated, if there is no evidence of a reduction in banks’ FX exposures within a reasonable time frame. Additionally, the coverage of the credit bureau should be extended to loans to households granted by non-bank entities to better assess household leverage and preserve asset quality.

29. Staff urged speedier implementation of the pending 2008 FSAP recommendations. Key points (Annex I) include empowering the Superintendence of Financial Institutions to conduct consolidated supervision, providing legal protection to bank supervisors in line with international best practice, strengthening bank resolution procedures, and broadening the supervisory perimeter to non-bank financial institutions, all of which require new legislation. The authorities remarked that advances remain slow due to the crowded legislative agenda, but also stressed that introduction of further legal protection for bank supervisors faces strong opposition and is constitutionally controversial. Staff commended the progress made towards full implementation of risk-based supervision, although efforts to bring it up to best standard should be stepped up. The FSAP update tentatively planned for 2017 will allow for a more thorough assessment of the financial system and determine the need for additional measures.

30. Officials reiterated their support for gradual adoption of Basel III standards. Staff concurred that it would further improve resilience of the financial system and thus welcomed the recent enactment of the Basel III Liquidity Coverage Ratio. The regulatory and risk management frameworks would also greatly benefit from introducing Basel III definitions of capital, a capital conservation buffer, and a leverage ratio. Staff analysis shows that this could be accomplished without significant detrimental effects on growth.

31. It was agreed that further improvements in the effective supervision of cross-border financial operations are critical for stability. Such a requirement has become more urgent because financial linkages within the region have been growing, though they are not yet fully understood, owing in part to data limitations but also to legal restrictions on information sharing. Enhancing transnational monitoring is especially important for Costa Rica, since conglomerate BCT operates in Panama and regional integration plays an important role in the transmission of financial shocks (AN I). In this respect, staff welcomed Costa Rica’s participation in the system of multilateral MoUs and in the Central American Council of Banking Supervisors. In addition, strengthening the AML/CFT supervision of cross-border financial operations and implementing the recommendations of the GAFILAT mutual evaluation report would assist in safeguarding the financial sector against illicit financial flows, notably to and from higher-risk jurisdictions.8 Swift adoption at the national level of the relevant recommendations in the WHD Cluster Surveillance Report on Financial Integration in CAPDR (Annex II) and strengthening of the national institutional framework in support of the medium-term Regional Macroprudential Policies Project for CAPDR would also help identify likely spillovers and assess joint risks.

Costa Rica. Financial System Assessment Program (FSAP) Main Pending Recommendations (2008)

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Note: See Annex I for details on the status of implementation.

Costa Rica. Summary of Stress Test Results

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Source: SUGEF; and IMF staff estimates.

Assumes an increase in NPLs of 8 percent of performing loans; and a 25 percent provisioning rate. The sectoral shock to NLP assumes that 6 and 10 percent of the loan portfolio to the construction and trade sectors respectively become non-performing.

Assumes a 3.5 percentage points nominal interest rate increase.

Assumes a 14 percent depreciation of the FX rate, leading to 6 percent of FX loans becoming non-performing, and a 50 percent provisioning rate.

Assumes a 10 and 8 percent per day withdrawal of demand deposits in domestic and foreign currency respectively; and a 5 and 3 percent per day withdrawal of time deposits in domestic and foreign currency respectively.

Figure 1.
Figure 1.

Costa Rica: Stress Test Results

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: SUGEF, and IMF staff estimates.Note: The Credit Risk Shock assumes an increase in NPLs of 8 percent of performing loans; and a 25 percent provisioning rate. The Interest Rate Shock assumes a 3.5 percentage points nominal interest rate increase. The FX Shock assumes a 14 percent depreciation of the FX rate, leading to 6 percent of FX loans becoming NPL, and a 50 percent provisioning rate. The Liquidity Shock assumes a 10 and 8 percent per day withdrawal of demand deposits in domestic and foreign currency respectively; and a 5 and 3 percent per day withdrawal of time deposits in domestic and foreign currency respectively.

E. Structural Reforms

32. Further structural reforms are needed to buttress Costa Rica’s competitiveness and promote inclusive growth. While Costa Rica ranks favorably in many business indicators and has been a regional leader in attracting foreign direct investment, further steps are needed to maintain the country’s competitive edge (Box 1). Staff argued that a better separation of electricity generation from the natural monopoly element associated with electricity transmission and distribution would allow private generators to compete more effectively with the state-owned enterprise ICE, thereby increasing efficiency. Besides, revised price-setting procedures to enhance cost discipline could help bring down electricity tariffs, especially for the industrial sector. The authorities observed that the private sector already participates in electricity generation and that overall electricity provision coverage and reliability in Costa Rica are high in the region. With regards to human capital, officials deemed that there were significant margins to improve the efficiency of public social and education spending, which would help protect vulnerable groups and lift outcomes without jeopardizing the budget. Expanded child-care provision and early childhood education as well as ameliorating infrastructure, including for IT, would facilitate increased female labor force participation (AN IX).

A01ufig15

Real Effect of Halving Collateral Requirements

(Percent difference from baseline)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: IMF staff calculation based on RES FSGM
A01ufig16

Contribution to Female Labor Force Participation in CRI and LA5

(Difference)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: ENAHO, 2012.
A01ufig17

Real Effect of Reducing Interest Rate Spreads

(Percent difference from baseline)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: IMF staff calculation based on RES FSGMNote: The reduction in interest rate spreads is modeled as a 100bp decrese in market risk premiums
A01ufig18

LAC and EMs: Enterprise Use of Financial Services

(Percent)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

More generally, discussions underscored that addressing infrastructure bottlenecks, especially in the transportation sector—as the fiscal adjustment creates space for higher public investment (¶19)—and streamlining business regulations, not least to facilitate entry of new firms, would also stimulate competiveness and help accelerate potential growth.

33. Staff analysis indicates that the financial sector remains underdeveloped, especially outside the banking area, relative to the country’s level of income and other determinants (¶26 and AN IV). Also, while Costa Rica ranks high for inclusion of households, that of enterprises is low relative to the country’s fundamentals (AN V). It would be important to take measures to foster capital market development including through more market-friendly debt management and issuance strategies that promote larger secondary markets for government securities (¶25), as well as through better protection of investor rights and development of a larger institutional investor base. Stepping up competition among banks, refining loan-provisioning rules to avoid high collateral requirements being used as a substitute for proper credit-risk analysis, and further ameliorating the judicial enforcement of secured and unsecured claims would also help reduce financial constraints and support financial deepening. The authorities agreed that these actions should permanently lower interest rate spreads and borrowing costs, with positive effects on credit, investment and growth.

Staff Appraisal

34. Macro prospects are generally benign, though downside risks, mainly from the weak fiscal position, prevail. Costa Rica’s economy has been expanding below trend for the past three years. Despite a growth uptick in 2015, unemployment remained high and inflation sharply declined, under the combined effect of the widening output gap and the drop in oil prices. Nonetheless, the currency has been stable and reserve accumulation resumed strongly in 2015, as the current account deficit narrowed and foreign direct investment inflows remained strong. Growth is expected to pick up again in 2016, with inflation moving to the middle of the new target range by end-year. Output is anticipated to return to potential over the medium term. However, high budget imbalances cloud the horizon. The real effective exchange rate continues broadly in line with economic fundamentals.

35. Persistence of large fiscal deficits and a growing public debt, as well as the high credit dollarization, have increased vulnerability to financial shocks. In the absence of policy action, public debt is unsustainable in the long term and could reach close to 70 percent of GDP by 2021, with attendant funding and rollover concerns. Substantial currency depreciation would likely trigger an increase in non-performing loans given banks’ sizable foreign currency lending to non-hedged private borrowers. As a small open economy, which relies on agricultural products and tourism for a third of its exports and imports all its oil, Costa Rica is also exposed to external trade shocks.

36. Current economic conditions call for immediate fiscal tightening and the continuation of an accommodative monetary policy. The authorities’ intention to start gradually reducing the fiscal deficit from this year onward is timely. The ongoing accommodative monetary policy, warranted by the low inflation and negative output gap, would help offsetting the short-term contractionary effects of the fiscal adjustment.

37. A sizable fiscal correction is the key priority and there are still margins to implement it at a measured pace. A total budgetary adjustment of 3¾ percent of GDP over the medium-term is required to stabilize the public debt ratio at a safe level. This consolidation effort is consistent with the plans announced by the government to increase revenues by about 2½ percent of GDP and decrease expenditures by around 1¼ percent of GDP. To minimize the negative impact on output and since financing is still available, the correction should be phased gradually over 2016-2020, though with a significant front-loading to lend credibility to the fiscal adjustment package.

38. Budget consolidation should rely mainly on tax increases, given a comparatively low revenue effort, but expenditure containment is a necessary complement. It is advisable to bring Costa Rica’s tax collection closer to that of other upper-middle income countries, while increasing the progressivity of the tax system, as in the government’s plan. Indeed, the announced tax measures aptly include a broadening of the base and a rate increase for the VAT, the introduction of two new brackets in the personal income tax for high earners, the reduction of tax exemptions, and a strengthening of sanctions against evasion. A refund system would compensate lower-income households for the VAT hike. A reduction in the growth of current expenditures below nominal GDP growth, in particular of public sector wages and transfers, is also necessary to fully close the fiscal sustainability gap. Current legislative proposals for public employment reform to prevent excessive automatic wage increases and for a fiscal rule to ensure public debt sustainability are useful tools to buttress longer-term fiscal discipline.

39. The authorities have appropriately strengthened the inflation-targeting framework, but greater XR flexibility is desirable. The central bank has managed to lower inflation and to anchor inflation expectations to the center of the 3-5 percent target range introduced in 2014, thus creating the conditions for the further downward revision of the target range in early 2016. The XR band was successfully removed in early 2015, thereby confirming inflation as the key objective of monetary policy, while maintaining XR stability, thanks partly to recurring FX interventions and a favorable external environment. However, a gradual increase in XR flexibility, which could be facilitated by a concurrent deepening of the FX market, would enhance the XR’s role as a shock-absorber and encourage awareness by private agents of two-way risks in exchange markets. An improvement in the central bank’s communication about FX interventions is also warranted.

40. Regulatory upgrades should primarily aim at reducing financial dollarization, but it is important also to strengthen cross-border supervision and creditworthiness scrutiny. FX lending, funded by foreign borrowing, is growing faster than lending in colones, despite the recent tightening of reserve requirements on bank foreign borrowing and increase in capital risk weights for foreign currency loans to un-hedged borrowers. Although staff analysis suggests that associated risks are currently manageable even under extreme stress scenarios, further strengthening of prudential measures may be necessary should this trend continue. The implementation of pending 2008 FSAP recommendations and the gradual adoption of Basel III standards, as well as improvements in cross-country supervision, should reinforce the existing regulatory and supervisory framework. The extension of the credit bureau’s coverage would facilitate credit risk monitoring and thus also support financial deepening. In addition, removing competition distortions between public and private banks would help lower interest rate spreads and improve credit supply.

41. Boosting Costa Rica’s growth potential and competitiveness requires energy sector reform, infrastructure upgrades, and education reform. Greater private sector participation in the energy sector along with a review of tariffs would allow for a reduction in the cost of electricity for firms. An additional investment effort is needed to address infrastructure bottlenecks, in particular in the transportation sector. Sizable government education expenditures, already close to the constitutional mandate of 8 percent of GDP, should put more emphasis on early childhood and the secondary level with the goal of reducing drop-outs in secondary grades. More generally, gains in efficiency of education and social spending would especially benefit the most vulnerable segments of the population and foster more inclusive growth.

42. It is recommended that Costa Rica remain on the standard 12-month consultation cycle.

Costa Rica: External Stability Assessment

The real effective exchange rate (REER) continues to be broadly in line with fundamentals. Staff has used various approaches to assess the appropriateness of the external balance and real exchange rate. These include descriptive quantitative indicators, regression-based methods to estimate the distance of the current account (CA) balance and the REER from the values determined by their fundamentals and desirable policy settings, as well as stability conditions for net foreign assets.

The REER has been stable in 2015 and early 2016, at a level about 6 percent higher than at the beginning of 2014. In the first half of 2014, nominal depreciation outpaced a growing inflation differential with the main trading partner (USA), resulting in substantial REER depreciation that eliminated a third of the accumulated 30 percent REER appreciation since 2003. In the second half of 2014, however, the REER appreciated by 14 percent, reversing the depreciation occurred during the first half of the year. The REER adjusted for the Balassa-Samuelson effect shows that total REER appreciation since 2003 was driven by the labor productivity differential between Costa Rica and the U.S., and therefore reflects changes in fundamentals, rather than unsustainable developments.

At the same time, the CA deficit has declined and the non-Intel export market share has increased (see chart below). The CA deficit has improved reaching around 4 percent of GDP in 2015 on the back of low fuel prices and continued strong positive services balance. While the Intel exit in 2014 had a significant impact on Costa Rican exports (16 percent less cumulatively in 2014-15), it had a muted impact on the overall trade balance due to the small domestic value added of the company. At the same time, non-Intel exports have gained export market share in the world markets increasing by 3 percent relative to 2014.

The financing structure of the CA and somewhat low external liabilities mitigate risks. The CA is largely financed by FDI inflows. While the IIP is negative at almost 45 percent of GDP, FDI comprises almost 65 percent of total liabilities. The external debt profile presents no sustainability concerns, with the external debt-to-GDP ratio set to decline into the medium term and a low share of short-term debt. Net international reserves stood at 5.8 months of non-maquila imports of goods and services at end-2014 and are above the Fund’s composite reserve adequacy metric.

A01ufig19

Real Exchange Rate Measures

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: INS; St. Louis Fed; national authorities; and Fund staff calculations.
A01ufig20

Costa Rica’s Export Share in World Exports

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

IMF’s multilaterally consistent estimates suggest that Costa Rica’s REER is broadly in line with fundamentals and desirable policy settings both in the short term and relative to medium-term benchmarks.

  • The macro-balance approach in the External Balance Assessment (EBA) estimates the sustainable CA implied by existing fundamentals and desirable policies. It points to a current account norm deficit of 4.7 percent of GDP in 2015, which is about 0.8 percent of GDP larger than the actual cyclically-adjusted deficit of 3.9 percent of GDP in 2015, implying a REER undervaluation of 3.5 percent. Identified policy gaps in Costa Rica are negative and significant at -1.7 percent of GDP, suggesting further undervaluation if corrected. Health expenditures, which are significantly higher than the world average, as well as recommended fiscal adjustment, explain 70 and 30 percent of the policy gap respectively.

  • The macro-balance approach based on the CA panel regression (which relies on medium term fundamentals and assesses the medium-term current account) estimates REER overvaluation of 3.1 percent.

    • The external sustainability (ES) approach, on the other hand, finds a moderate overvaluation of 6.8 percent. However, taking into account the favorable financial structure of external liabilities of Costa Rica, by excluding FDI from the stock of total liabilities, would imply an undervaluation of a similar size.

Staff views the results based on the macro-balance approaches, which both assess the external sector to be neither over- or undervalued, as the most reliable. The simple average across the different methodologies supports this assessment as well. Staff concludes that Costa Rica’s REER is in line with fundamentals.

Costa Rica: Implied Undervaluation (“+” = Overvaluation)

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Sources: Fund staff estimates.

The recent withdrawal of Intel operations does not reflect deterioration in external competitiveness. First, the shut down operations had a very small value added. Competitiveness of Costa Rica, as a well-educated upper middle-income country, should be assessed against other middle-income countries that operate in a different market segment with a higher value added. Second, while the withdrawal had a sizable effect on total exports, non-Intel exports gained market share in 2014 and are expected to improve further in 2015. Third, Intel research operations remained in Costa Rica indicating stable demand for highly qualified labor in the country.

While regulatory quality and efficiency has improved, some sectors continue to weigh on overall competitiveness. Costa Rica gained 21 positions in the 2016 Doing Business Survey by the World Bank driven by improved access to credit, introduction of an electronic tax payment system, and easier access to electricity. According to the Global Competitiveness Index by the World Economic Forum, however, Costa Rica’s competitiveness has remained at the same level as last year. Unsatisfactory infrastructure, concerns over inefficient government spending, and insufficient investor protection continue to weigh on competitiveness.

Figure 2.
Figure 2.

Costa Rica: Recent Developments and Prospects, Real Sector

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: National authorities; Haver Analytics; and Fund staff calculations.
Figure 3.
Figure 3.

Costa Rica: Recent Developments, External Sector

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: WEO; national authorities; and Fund staff calculations.1/ Increase implies appreciation.2/ The REER based on ULC was calculated with data for 73 percent of the trading partners. Wages are for total employment in Costa Rica and manufacturing sector in trading partners
Figure 4.
Figure 4.

Costa Rica: Recent Developments and Prospects, Fiscal Sector

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

1/ Gross financing needs for LA-5 are based on data from latest Article IV reports, published in 2015.Sources: National authorities; and Fund staff estimates.
Figure 5.
Figure 5.

Costa Rica: Recent Developments, Financial Sector

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: National authorities; and Fund staff estimates.
Figure 6.
Figure 6.

Costa Rica: Financial Sector Vulnerabilities

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: BIS; IFS; and Fund staff estimates.
Figure 7.
Figure 7.

Costa Rica: Competitiveness and Structural Reforms

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: World Bank, Doing Buisness Report; World Economic Forum, The Global Competitiveness Report 2015; Latin American Energy Organization (OLADE); National Center for Education Statistics, PISA tests; and Fund staff calculations based on RES FSGM.
Table 1a.

Costa Rica: Selected Social and Economic Indicators, Baseline Scenario

(Partial Fiscal Adjustment) 1/ 2/

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Sources: Central Bank of Costa Rica, Ministry of Finance, and Fund staff estimates.

Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved tax administration.

Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises, and the central bank, but excludes the Instituto Costarricense de Electricidad (ICE).

The consolidated public debt nets out central government and central bank debt held by the Caja Costarricense del Seguro Social (social security agency) and other entities of the nonfinancial public sector.

Table 1b.

Costa Rica: Selected Social and Economic Indicators, Full Fiscal Adjustment Scenario 1/ 2/

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Sources: Central Bank of Costa Rica, Ministry of Finance, and Fund staff estimates.

Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.

Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises, and the central bank, but excludes the Instituto Costarricense de Electricidad (ICE).

The consolidated public debt nets out central government and central bank debt held by the Caja Costarricense del Seguro Social (social security agency) and other entities of the nonfinancial public sector.

Table 2.

Costa Rica: Balance of Payments, Baseline Scenario (Partial Fiscal Adjustment) 1/ 2/ 3/

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

Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved tax administration.

Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new h istorical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under th e old standards.

BOP data are reported on a fifth Balance of Payments Manual edition (BPM5) basis, with some differences of presentation relative to the data on a sixth edition (BPM6) basis disseminated by the central bank.

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

Includes public and private sector debt.

Table 3a.

Costa Rica: Central Government Balance, Baseline Scenario (Partial Adjustment) 1/ 2/

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Sources: Ministry of Finance and Fund staff estimates.

Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved tax administration.

Data for 2012–15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Transfers to the Social development and Family Transfers Fund (FODESAF) are recorded in net terms.

The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.

Table 3b.

Costa Rica: Central Government Balance, Full Fiscal Adjustment Scenario 1/ 2/

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Sources: Ministry of Finance and Fund staff estimates.

Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.

Data for 2012–15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Transfers to the Social development and Family Transfers Fund (FODESAF) are recorded in net terms.

The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.

Table 4a.

Costa Rica: Summary Operations of the Central Government, GFSM 2001 Classification. Baseline Scenario

(Partial Adjustment) 1/ 2/

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Sources: Ministry of Finance and Fund staff estimates.

Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.

Data for 2012–15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Transfers to the Social development and Family Transfers Fund (FODESAF) are recorded in net terms.

The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.

Includes subsidies, transfers and other expense.

Table 4b.

Costa Rica: Summary Operations of the Central Government, GFSM 2001 Classification. Full Fiscal Adjustment Scenario 1/ 2/

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Sources: Ministry of Finance and Fund staff estimates.

Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.

Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Transfers to the Social development and Family Transfers Fund (FODESAF) are recorded in net terms.

The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.

Includes subsidies, transfers and other expense.

Table 5a.

Costa Rica: Consolidated Public Sector Operations, Baseline Scenario (Partial Adjustment) 1/ 2/ 3/

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Sources: Ministry of Finance and Fund staff estimates.

Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.

Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises and the Central Bank, but excludes the Instituto Costarricense de Electricidad (ICE).

Expenditure was adjusted downward in 2010 and upward in 2011 by ½ percent of GDP to reflect a capital project recorded in 2010 but undertaken in 2011.

The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.

Table 5b.

Costa Rica: Consolidated Public Sector Operations, Full Fiscal Adjustment Scenario 1/ 2/ 3/

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Sources: Ministry of Finance and Fund staff estimates.

Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.

Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises and the Central Bank, but excludes the Instituto Costarricense de Electricidad (ICE).

Expenditure was adjusted downward in 2010 and upward in 2011 by ½ percent of GDP to reflect a capital project recorded in 2010 but undertaken in 2011.

The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.

Table 6a.

Costa Rica: Summary Operations of the Consolidated Public Sector, GFSM 2001 Classification. Baseline Scenario (Partial Adjustment) 1/ 2/ 3/

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Sources: Ministry of Finance and Fund staff estimates.

Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.

Data for 2012–15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises and the Central Bank, but excludes the Instituto Costarricense de Electricidad (ICE).

The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.

Includes subsidies, transfers and other expense.

Table 6b.

Costa Rica: Summary Operations of the Consolidated Public Sector, GFSM 2001 Classification. Full Fiscal Adjustment Scenario 1/ 2/ 3/

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Sources: Ministry of Finance and Fund staff estimates.

Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.

Data for 2012–15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises and the Central Bank, but excludes the Instituto Costarricense de Electricidad (ICE).

The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.

Includes subsidies, transfers and other expense.

Table 7.

Costa Rica: Public Sector Debt, Baseline Scenario

(Partial Fiscal Adjustment) 1/ 2/

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Sources: Ministry of Finance; and Fund staff estimates.

Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.

Data for 2012–15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Excludes the debt issued by the Instituto Costarricense de Electricidad (ICE).

Caja Costarricense del Seguro Social (social security agency).

Table 8.

Costa Rica: Monetary Survey, Baseline Scenario (Partial Adjustment) 1/ 2/

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

Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.

Data for 2012–15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Table 9a.

Costa Rica: Medium-Term Framework, Baseline Scenario (Partial Adjustment) 1/ 2/

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

Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.

Data for 2012–15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of

External current account deficit.

Table 9b.

Costa Rica: Medium-Term Framework, Full Fiscal Adjustment Scenario 1/ 2/

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

Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.

Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about 2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

External current account deficit.

Table 10.

Costa Rica: Banking Sector Indicators 1/

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Source: Superintendency of Banks (SUGEF).

Difference between implicit loan and deposit rates.

Annex I. Costa Rica: Financial System Assessment Program (FSAP) Main Pending Recommendations (2008)

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Staff’s preliminary assessment based on updated information provided by the authorities. Source: Superintendence of Financial Institutions.

Annex II. Costa Rica: Summary of Recommendations in the WHD Cluster Surveillance Report on Financial Integration in CAPDR

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Annex III. Costa Rica: Public Debt Sustainability Analysis (Higher Scrutiny Case)

The DSA highlights Costa Rica’s unsustainable debt dynamics. The debt stock is projected to rise to 55 percent of GDP by 2021 under the baseline scenario, driven mostly by high fiscal deficits. There are substantial upside risks to the projected debt path from plausible macro shocks. Risks from relatively high financing needs are somewhat mitigated by the existence of a stable domestic investor base.

A. Key Assumptions

Debt definition. The public debt sustainability analysis focuses on the central government level where the worsening of the fiscal situation has taken place in recent years. The rest of the consolidated public sector has been broadly in balance in recent years as the cash surplus of the social security system broadly offset the small central bank deficit—resulting from its liquidity management operations—while public enterprises are broadly in balance.1 The additional adjustment needed—about 1½ percent of GDP—to close the actuarial deficit that opens up over the medium and long-term is estimated separately.

Growth and fiscal policy assumptions. The baseline reflects the estimated growth potential of 4 percent. The baseline scenario also assumes fiscal adjustment of about 2¼ of GDP based on the staff’s assessment of measures already submitted to Congress that have a higher probability of being approved. The improvement in the primary balance is smaller due to the projected deterioration in the fiscal position under a passive scenario, driven mostly by increases in expenditure on education to reach expenditure targets defined under the constitution.

Debt target. In theory it is difficult to justify a unique threshold for debt-to-GDP ratio as the government is deemed solvent if it can generate future primary surpluses sufficient to service its outstanding debt. Hence, protracted large budget deficits are not necessarily inconsistent with sustainability, provided that primary surpluses can be generated in the future. In practice, however, such an approach may require large future adjustments, which may not be feasible or desirable, economically and politically. A more operational definition of public debt sustainability offered in the 2003 WEO suggests that a given public debt level is sustainable if it implies that the government’s budget constraint (in NPV terms) is satisfied without unrealistically large future corrections in the primary balance. It also emphasizes the importance of liquidity conditions, because even if a government satisfies its present value budget constraint, it may not have sufficient assets and financing available to meet or roll over its maturing liabilities. As practical guidance, empirical evidence indicates that, for emerging market economies, sustaining a debt-to-GDP ratio above 50 percent of GDP may be difficult. For example, the WEO (2003) finds that the median public debt-to-GDP ratio for emerging markets in the year before a default was about 50 percent of GDP. This study also concludes that, on average, the conduct of fiscal policy in emerging market economies is not consistent with ensuring sustainability once public debt exceeds a threshold of 50 percent of GDP. Therefore, targeting an upper bound to the public debt ratio below 50 percent of GDP or so appears justifiable in the case of Costa Rica.

B. Results and Assessment

Results. In the baseline, the headline deficit remains around 5½ percent of GDP in 2021, as the higher interest bill from rising public debt—which reaches 55 percent of GDP in 2021 and stays on an upward trajectory thereafter—largely offsets the improvement in the primary balance. The average gross financing needs would be almost 9 percent of GDP in 2016-21. In the adjustment scenario, additional measures of 1½ of GDP as part of a gradual but frontloaded consolidation plan suffice to stabilize debt by 2021 at a level below 50 percent of GDP. This outcome assumes tightening in credit spreads driven by favorable market reaction to a frontloaded adjustment plan with credible measures.

Assessment. While most standard indicators are not at “danger” levels (see heat-map), the debt and gross financing needs approach the benchmarks for medium-risk assessment under stressed scenarios, and the market perception indicators are approaching the high-risk assessment. In particular, debt rises above 65 percent of GDP under the combined macro-fiscal shock–compared to 70 percent benchmark for medium risk in the heat map—with particularly high sensitivity to growth and fiscal shocks. Debt profile indicators also highlight medium risks from relatively high spreads on external bonds, with spreads approaching the 600 basis point benchmark for upper risk assessment.

Mitigating factors. A stable investor base is an important mitigating factor. Notwithstanding the medium risk ratings for external and FX debt in the debt profile indicators heat map, the share of these types of debt are at the low end of the reference range for moderate risk countries—external and FX debt represent less than 25 and 35 percent of total debt, respectively, compared to benchmark ranges of 15 to 45 for external debt and 20 to 60 for FX debt. Moreover, about 60 percent of domestic debt is held by captive local institutional investors, including the social security system, nonfinancial public sector institutions, and banks.

A01ufig21

Costa Rica: Central Government Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: Fund staff estimates and projections.1/ Public sector is defined as central government.2/ Based on available data.3/ EMBIG.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r - π(1+g) - g + ae(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; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1 + g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ 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.
A01ufig22

Costa Rica: Central Government DSA—Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: Fund staff estimates and projections.
A01ufig23
A01ufig23

Costa Rica: Public DSA—Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: Fund staff estimates and projections.1/ Plotted distribution includes program countries, percentile rank refers to all countries2/ Projections made in the spring WEO vintage of the preceding year3/ Not applicable for Costa Rica, as it meets neither the positive output gap criterion nor the private credit growth criterion.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.
A01ufig24

Costa Rica: Central Government DSA—Stress Tests

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: Fund staff estimates and projections.
A01ufig25

Costa Rica: Central Government DSA Risk Assessment

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: Fund staff estimates and projections.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ EMBIG, an average over the last 3 months, 30-Dec-15 through 29-Mar-16.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
A01ufig26

Costa Rica: Consolidated Public Sector Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Source: Fund staff estimates and projections.1/ Public sector is defined as consolidated public sector.2/ Based on available data.3/ EMBIG.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r - π(1+ g) + ae(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; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ 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.

Annex IV. Costa Rica: External Debt Sustainability Analysis

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Source: National authorities and Fund staff estimates.

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

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 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.

A01ufig27

Costa Rica: External Debt Sustainability—Bound Tests 1/ 2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2016, 131; 10.5089/9781475519228.002.A001

Sources: 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/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2016.
1

Intel’s closure resulted in both lower real GDP and lower potential output of ¾ percent of GDP in 2014–15, without any effect on the output gap in the short run.

2

After a substantial decline in 2014 reflecting in part the end of reinvestment of retained earnings by Intel, FDI remained steady in 2015, suggesting limited impact of the exit on broader FDI trends.

3

Moody’s downgraded Costa Rica’s external sovereign debt by one notch in 2014 with a negative outlook on its current Ba1 rating. S&P downgraded the sovereign by one notch to BB- in 2016, while Fitch has a negative outlook on its BB+ rating since 2015.

4

The effect of Intel’s manufacturing closure on the growth rate of potential GDP is estimated to be less than ¼ percentage points. The withdrawal is not expected to have significant impact on fiscal revenue as Intel operated in the free trade zone.

5

The authorities and the financial community confirmed that any requests for additional information on AML/CFT procedures and readiness from correspondent banks had been satisfactorily met and that there had not been any loss of correspondent accounts. Moreover, domestic banks had remained active in monitoring possible AML/CFT activity, as demonstrated by a recent case currently under investigation raised by one of the public banks.

6

Adjusted for targets in the medium-term framework (published together with the budget law) that have generally been more aligned with the authorities’ intended fiscal stance.

7

According to the October 2015 Global Financial Stability Report, private sector debt of emerging markets increased from just over 60 percent of GDP in 2005 to almost 125 percent of GDP in 2014.

8

GAFILAT is the FATF-style regional body of which Costa Rica is a member.

1

The basics output table for the DSA at the consolidated public sector level shows that the estimated sustainability gap in 2021 is lower than at the central government level, given lower actual and projected primary deficits and average interest rates at the consolidated level.

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Cover IMF Staff Country Reports
Costa Rica: 2016 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Costa Rica
Author:
International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2016: Issue 131
Publisher:
International Monetary Fund
ISBN:
9781475519228
ISSN:
1934-7685
Pages:
90
DOI:
https://doi.org/10.5089/9781475519228.002

GDP growth, Potential and Output Gap

(Percent)

Headline Inflation

(Percent, y-o-y)

Costa Rica: Inflation Decomposition

(Contribution to growth y/y, in percent)

Central Government

(Percent of GDP)

Distribution of Macro Outcomes Conditional on Real Private Sector Credit Growth

Private Sector Credit Growth by Currency

(Percent, y-o-y)

Real Effect of a 300bp Policy Rate Cuts with Different PT

(Percent difference from baseline)

Real and Financial Spillovers

Costa Rica: Financial Stability Map

Real Effect of a 100bp Increase in Market Interest Rates

(Percent difference from control)

Policy Rate and Bank Lending Rates

(In percent)

Tax Revenue, 2014

(Percent of GDP)

Effect on Real GDP of Adverse Shocks on FX and NPL

(Percent difference from baseline)

Bank Credit to the Private Sector

(in percent of GDP)
Figure 1.

Costa Rica: Stress Test Results

Real Effect of Halving Collateral Requirements

(Percent difference from baseline)

Contribution to Female Labor Force Participation in CRI and LA5

(Difference)

Real Effect of Reducing Interest Rate Spreads

(Percent difference from baseline)

LAC and EMs: Enterprise Use of Financial Services

(Percent)

Real Exchange Rate Measures

Costa Rica’s Export Share in World Exports
Figure 2.

Costa Rica: Recent Developments and Prospects, Real Sector
Figure 3.

Costa Rica: Recent Developments, External Sector
Figure 4.

Costa Rica: Recent Developments and Prospects, Fiscal Sector
Figure 5.

Costa Rica: Recent Developments, Financial Sector
Figure 6.

Costa Rica: Financial Sector Vulnerabilities
Figure 7.

Costa Rica: Competitiveness and Structural Reforms

Costa Rica: Central Government Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP unless otherwise indicated)

Costa Rica: Central Government DSA—Composition of Public Debt and Alternative Scenarios

Costa Rica: Public DSA—Realism of Baseline Assumptions

Costa Rica: Public DSA—Realism of Baseline Assumptions

Costa Rica: Central Government DSA—Stress Tests

Costa Rica: Central Government DSA Risk Assessment

Costa Rica: Consolidated Public Sector Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP unless otherwise indicated)

Costa Rica: External Debt Sustainability—Bound Tests 1/ 2/

(External debt in percent of GDP)