External conditions weighing on activity

While activity was dynamic during the first few months of 2022, the trend should shift towards a slowdown over the rest of the year. Less buoyant demand from the United States will affect exports of goods and services. Their primary source of growth will be the production of medical instruments and supplies produced in the maquilas of the free trade zones, as well as agricultural output (pineapples, bananas). The recovery observed at the end of 2021 and the beginning of 2022 in the tourism sector is undermined by the expected slowdown in activity in European countries and the United States, the primary sources of tourist arrivals. This will affect the hotel and restaurant industry as well as private construction. On the demand side, support will come mainly from personal consumption (64.6% of GDP in 2020) and investment (19.6% of GDP). However, both will suffer from the downturn in external conditions. The high price of imported raw materials and the depreciation of the colon will drive inflation, squeezing household budgets. The focus on purchasing power by the new President R. Chaves during his recent election campaign is not expected to result in increased support for households. Indeed, public spending will remain constrained by efforts to consolidate public accounts through significant spending cuts. Price increases will be well above the central bank’s 2 to 4% target. In this context, the central bank should continue to tighten monetary policy. After a first increase in December 2021 of 50 basis points (bps), the bank hiked rates again in January (+50 bps), March (+75 bps), April (+150 bps), and July (+150 bps) to reach a rate of 5.5%. Further increases are expected before the end of the year, depending on the evolution of inflation. This will impact private investment via an increase in credit costs.

Fiscal consolidation at risk and current account deficit subject to external conditions

While the primary (i.e., non-interest) surplus was narrowly reached by the end of 2021, thanks to growth-related solid revenues 2021, the slowdown in activity suggests a widening of the primary deficit without further public expenditure reduction measures. This will depend on whether President Chaves passes his plan to increase tax revenues by ending many exemptions and overhauling the public employment law to reduce further the wage burden (50% of government revenues are spent on wages). If not, the 1% primary surplus target in 2023 agreed upon with the IMF may not be met. This could complicate the release of new tranches of financing under the Extended Fund Facility set up in March 2021 and recently extended to July 2024. This agreement provides the country with access to a cheap source of financing (out of a total of USD 1.77 billion, USD 569 million have been disbursed in the first and second installments), replacing costly market borrowing.

In the face of high commodity prices, especially for hydrocarbons, the balance of goods deficit is expected to increase as the import bill rises. More exports of agricultural products and capital goods will be required to counteract this trend. With the tourism slowdown, the service surplus will be less of a shock absorber. The income balance will also remain in deficit due to the repatriation of dividends by foreign companies (mainly American), despite the reasonably dynamic transfers of expatriates. Ultimately, this should increase the current account deficit. Still, high FDI should be sufficient to finance this deficit. However, their lesser dynamism due to less attractive external conditions, and the outflow of capital from local pension funds to the US, will put downward pressure on the colon. This could force the central bank to intervene and thus weaken foreign exchange reserves, estimated at 3.3 months of imports at the end of 2021.

New President, but the political landscape is still fragmented

The 2022 presidential election was marked by the victory of an outsider, Rodrigo Chaves of the Partido Progreso Social Democrático (PPSD), over the candidate of the traditional PLN party, José Maria Figueres. Chaves anchored his campaign around lowering the cost of living, reducing unnecessary public spending, fighting corruption, and lowering operational costs for businesses. Despite his victory, the low turnout creates a lack of legitimacy for R. Chaves, reinforced by the lack of a majority in the assembly. With ten seats out of 57, the PPSD does not have the votes to pass its reform projects, forcing it to make compromises to form coalitions on a case-by-case basis. In this context, the President’s wish for an overhaul of the public employment law, adopted in March 2022 by the new legislature after two years of procrastination, remains uncertain. On the international scene, the question of joining the Pacific Alliance, which includes Chile, Colombia, Peru, and Mexico, has arisen after joining the OECD. The new PresidentPresident has formally requested accession on 8 July 2022. R. Chaves sees it as a step towards the broader goal of rapprochement with Asia and entry into trans-Pacific trade agreements. China is remarkably coveted as a source of tourism and investment. Tensions with neighboring Nicaragua, still amid a political crisis, remain high.