Costa Rica: Risk Assessment
Country Risk Rating
Business Climate Rating
- Democratic institutions (since 1949)
- Best social indicators in the region: education, health
- Services and high-tech industries (pharmaceuticals, microprocessors) attractive for FDI
- Diversified trade thanks to multiple trade agreements
- Tourism resources: hotels, national parks
- Weak public accounts
- Exposure to natural disasters
- Insufficient transport infrastructure
- Dependent on the United States in economic (FDI, exports) and financial (banks) terms
With activity returning to its pre-pandemic level in the third quarter of 2021, 2022 should continue to be marked by sustained economic momentum. Growth in the U.S. will support net exports of goods and services. This is expected to benefit manufacturing activities driven primarily by medical instruments and supplies produced in free trade zone maquilas. Tourism is expected to continue to recover - the rebound in 2021 has already closed part of the gap opened since 2019. If measures restricting travel to Europe and the United States are not reintroduced, tourism is expected to return to its pre-crisis levels by 2022. This recovery will benefit the hotel and restaurant industry as well as private construction. On the demand side, support will come mainly from private investment and consumption (19.6% and 64.6% of GDP respectively in 2020). Public consumption will continue to be constrained by efforts to consolidate the public accounts and significant spending cuts. Among these measures is the draft law on public employment, which provides for the standardization of the salary scale and could weigh heavily on the budget of civil servants if it is ultimately approved. Upward pressure is building on producer prices, with high commodity prices (especially for oil), the depreciation of the colon, and rising freight rates. However, the high unemployment rate (16.4% in August 2021), weak growth in credit to the private sector, and the output gap are expected to limit the pass-through to consumer prices. This is expected to keep inflation within the central bank's target of 2-4%. In this context, the central bank is expected to maintain its accommodative policy for the first part of 2022 with a rate of 2.9%. Despite the relatively high vaccination rate in the country compared to the regional average (70% of the population received their first jab by November 2021), a resumption of the epidemic cannot be completely ruled out and poses a downside risk to this scenario.
Initial results of fiscal consolidation and narrowing of the current account deficit
After several years of failed attempts to consolidate the public accounts, the efforts seem to be paying off. While a primary surplus (i.e. excluding interest) was only envisaged for 2023, this was achieved in the third quarter of 2021 with a cumulative surplus of 0.3%. The three-year Extended Fund Facility agreement signed with the IMF in March 2021 provides the country with access to a cheap source of financing (up to USD 1.77 billion, first installment USD 269 million) to replace costly market borrowing. The program includes reforms to reduce fiscal imbalances, such as the elimination of various tax exemptions and an overhaul of public sector salaries (30% of government spending). However, the full success of the program remains dependent on political decisions in a highly fragmented parliament. Nevertheless, the high-interest payment burden should continue to increase the debt-to-GDP ratio, which is expected to peak in 2023 before declining.
The current account deficit is expected to decline, thanks to a higher surplus in the balance of services, supported by tourism activity. However, this increase will not be sufficient to offset the increase in the goods deficit. Indeed, the dynamism of exports of capital goods and agricultural products (pineapples and bananas) will not be able to balance the growth of imports, driven by the demand for commodities, especially hydrocarbons, which are essential in manufacturing production. The income balance will remain in deficit due to the repatriation of dividends by foreign companies (mainly American), despite expatriate transfers. FDI, boosted by the global and domestic recovery, should be more than enough to cover this current account deficit and help build foreign exchange reserves. This is expected to support the colon following its depreciation in 2021.
Electoral uncertainty in a fragmented political landscape
The February 2022 presidential election, marked by a proliferation of candidates (27 in total), failed to produce a winner, and runoff in April will be needed to decide between the candidates. The management of the pandemic and the fiscal reforms undertaken by President Carlos Alvaro Quesada, in power since 2018, did not serve the candidate for his center-left party, the PAC, Welmer Ramos González. The social-democratic candidate of the Partido Liberación Nacional (PLN) and former president, José Maria Figueres Olsen, emerged from the first round in a favorable position. He will face former vice-president (2002-2006) Lineth Saborío of the center-right Partido Unidad Social Cristiana (PUSC) in the second round. The concomitant parliamentary elections have again created a very fragmented parliament. The political struggles suggest that the next administration will have a turbulent start to its term of office in May 2022.
On the international scene, after joining the OECD, there is now the question of joining the Pacific Alliance, which includes Chile, Colombia, Peru, and Mexico. While President Alvaro Quesada was opposed to this, the decision will be made by his successor. Tensions with neighboring Nicaragua, still in the midst of a political crisis, remain high.