COSTA RICA

The path to recovery and fiscal consolidation remains fragile

SENSITIVE RISK

Economic risk
Business environment risk
Political risk
Commercial risk
Financing risk

Economic risk
Business environment risk
Political risk
Commercial risk
Financing risk

Updated in September 2021.

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GDP	USD61.5bn (World ranking 77, World Bank 2020)
Population	5.0mn (World ranking 120, World Bank 2020)
Form of state	Presidential, representative democratic republic
Head of government	Carlos Alvarado (President)
Next elections	February 2022, presidential and legislative

Political stability, long-established democracy and institutional framework compared to regional peers
Favorable business and legal conditions compared to the rest of Central and Latin America
Relatively advanced transition to a greener and sustainable economy

High dependence on US (trade, foreign investment in a few large companies and tourism)
Large fiscal deficit, with the public debt-to-GDP ratio rising rapidly as a result

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The pandemic shock exacerbated pre-existing macroeconomic weaknesses

Costa Rica's macroeconomic outlook was already fragile prior to the pandemic despite structural reforms. As part of its accession to the OECD, Costa Rica implemented key fiscal and structural reforms aiming at containing the high fiscal deficit, boosting medium-term growth prospects and lowering the high levels of unemployment. However, the growth outlook remained fragile, with real GDP growth averaging +1.5% over 2017-2019 amid a challenging external environment, natural disaster shocks and deteriorating investor sentiment towards Costa Rica, given its widening fiscal deficits.

The recovery from the pandemic shock will be timid. We expect real GDP growth to rebound mildly to +2.5% in 2021, after a contraction of -4.8% in 2020, and then to reach +3.1% in 2022. A boost to agricultural exports and a mild recovery in the tourism sector will fuel growth in 2021, but the recovery will be mild as the country is still grappling with difficult financing conditions and mixed investor sentiment. The development of the pandemic represents a moderate risk as the country has made substantial progress on the vaccination front and responded swiftly to the shock in 2020.

We expect inflation to remain below the central bank’s inflation target (+4%) at +1.8% on average in 2021 as muted domestic demand and slow growth limits pressures on prices. As a result, we do not expect the central bank to be under pressure to tighten monetary policy in the near term. It cut the policy rate twice by a total of 150bps since the onset of the pandemic to 0.75%.

Weak public finances will remain a key risk

The fiscal outlook will remain challenging. The pandemic shock exacerbated pre-existing fiscal weaknesses, with the fiscal deficit widening to -8.9% of GDP from an average of -5.8% over 2017-2019 as revenues fell substantially and the government increased pandemic-related spending. The crisis interrupted the country’ incipient fiscal consolidation, which was building on the 2018 fiscal reform.

The fiscal adjustment required under the IMF program approved early 2021 may prove to be challenging given Costa Rica’s track record of political gridlocks in the process of approving reforms or external financing. As a result, we expect a slower fiscal consolidation than anticipated by the authorities, with a fiscal deficit narrowing to -5.5% of GDP in 2021 and -4.5% of GDP in 2022. The approval of the IMF program should nonetheless help catalyze additional official creditor support, easing financing conditions for the sovereign.

Public debt sustainability will remain a concern. High fiscal deficits over the year led to a sharp rise in public debt, from 40% of GDP in 2015 to 68% in 2020. We expect debt to stabilize around 73% GDP over the projection period. Most of the public debt is held by non-resident investors (75%), which mitigates somewhat risks related to portfolio flows. But with 40% of debt denominated in foreign currency, the country remains exposed to FX risks.

External finances should improve but remain reliant on a timely access to financing

The decline in tourism receipts and lower FDI led to balance of payment pressures in 2020. The central bank allowed the exchange rate to fluctuate, intervening to smooth market volatility, and the colon has depreciated substantially since the onset of the pandemic. The approval of the IMF program and expected additional official creditor financing should limit balance of payment pressures, but difficulties to secure external financing could lead to a renewed depreciation of the colon.

Relatively robust business environment and moderate political risks

Costa Rica’s business environment ranks fourth in Latin America and 74th globally, according to the World Bank Doing Business survey. In terms of the payment of taxes, access to credit, electricity, control of corruption, regulatory quality and rule of law, Costa Rica outperforms most of its regional peers. However, Costa Rica’s fiscal difficulties could weigh on investor risk perception in the longer run.

Political stability is well anchored but policy and political risks persist. Costa Rica’s strong political institutions, long democratic tradition and relative social stability support political stability. Fiscal reform and external financing require Congress approval and Costa Rica’s has a track record of political gridlocks, which could hamper policymaking and fiscal reforms in the medium-term, especially as the adjustment includes several contentious reforms. However, the IMF program has cross-party support, which limits implementation risks. A policy shift is probably likely after the 2022 presidential elections as there is growing anti-incumbency sentiment.

Trade structure by destination/origin

(% of total, annual 2020)

Exports	Rank	Imports
United States 43.5%	1	38.1% United States
Netherlands 7.7%	2	14.7% China
Belgium 5.3%	3	6.9% Mexico
Guatemala 5.1%	4	2.9% Guatemala
Panama 4.2%	5	2.7% Germany

Trade structure by product

(% of total, annual 2020)

Exports	Rank	Imports
Vegetables and fruits 25.8%	1	7.4% Petroleum, petroleum products and related materials
Professional and scientific instruments, n.e.s. 22.5%	2	7.2% Road vehicles
Miscellaneous manufactured articles, n.e.s. 7.6%	3	7,1% Electrical machinery, apparatus and appliances, n.e.s.
Electrical machinery, apparatus and appliances, n.e.s. 6.8%	4	4.7% Miscellaneous manufactured articles, n.e.s.
Miscellaneous edible products and preparations 4.6%	5	4.4% Medicinal and pharmaceutical products