Costa Rica: Risk Assessment

Country Rating¹

Rating: A4

Business Climate Rating¹

Rating: A3

Risk Assessment²

Growth linked to economic developments in the United States
Economic activity surged in 2010 in phase with the upturn in the world economy, particularly the United States, market for nearly half Costa Rican exports. Economic growth was driven by sectors dependent on foreign demand - manufacturing in customs-free areas, agriculture, and tourism - and, thanks to fiscal stimulus measures, by private consumption and investment.

Heavily dependent on the external environment, this small open economy will be exposed to the slowdown forecast for the United States this year. Economic activity is expected to be driven mainly by household consumption and by investment, despite uncertainties overhanging the local and world situations. Economic growth will consequently vary little from 2010, remaining just below the levels prevailing before the 2008-2009 international crisis.

Comprehensive reform of public sector finances still pending
The stimulus Escudo plan remained in effect in 2010, and the fiscal deficit widened in consequence. Only a mild decrease is expected in 2011 with fiscal policy remaining expansionary. The public financial consolidation intended to reduce that deficit and the scale of the public debt (nearly 50% of GDP in 2011 with half in foreign currency) will necessitate enlargement of the tax base and improvement in collection effectiveness. The authorities have planned partial measures intended to increase revenues and reduce tax evasion in order to cover increased social, infrastructure and security spending. Far-reaching fiscal reform, however, regularly announced and regularly postponed has little chance of being adopted in view of the strong objections and the absence of a parliamentary majority.

Persistent weakness of external accounts
Costa Rica benefits from preferential access to the North American market under the DR-CAFTA free trade agreement (FTA) while seeking to diversify its trading, particularly in Asia. An FTA was thus concluded in 2010 with China (second largest customer country) and negotiations are underway with South Korea and Singapore. Similar agreement with the European Union is moreover expected to come into effect in 2011.

Goods and services exports and tourism will grow with the sluggishness of demand in the United States likely to be offset by the dynamism of Asian demand. Meanwhile, external accounts will be affected by higher costs for oil imports, increased demand for intermediate goods for the manufacturing sector and profit repatriation by multinationals, resulting in large trade and current account deficits. They are nonetheless expected to be almost entirely covered by foreign direct investment (FDI) with two thirds of originating in the United States. Most of the FDI continues to focus on electronics and medical equipment in conjunction henceforth with back-office services. Foreign investors are moreover apt to be attracted by newly liberalized sectors in the wake of the DR-CAFTA trade agreement, like electricity, communications and insurance.

Meanwhile, despite good solvency and liquidity indicators, the banking sector remains weakened by the extent of dollarization and the offshore sector.

Political continuity
Belonging to the same center-right Partido Liberación Nacional, Laura Chinchilla succeeded incumbent president Oscar Arias in 2010 for a four-year term in office, thus assuring the continuity of economic policy albeit with its implementation complicated by the lack of a majority in the unicameral Congress and by union opposition.

Strengths

• Stable democratic institutions and foreign policy based on neutrality since the army was abolished in 1948
• Best human development indicators in the region
• DR-CAFTA free-trade agreement with the United States and Central America since early 2009
• Main beneficiary of foreign direct investment in Central America with the presence of customs free areas
• Goal of becoming the world’s first carbon-neutral economy by 2020
• Most industrialized Central American country
• Greater diversification of foreign trade thanks to trade agreements

Weaknesses

• Exposure to natural catastrophes
• High energy dependence
• Economic and financial dependence on the United States
• Shaky public and external financial position
• Greater insecurity since becoming a drug trafficking transit hub