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Costa Rica: Speedbump

Costa Rica has one of the healthiest economies in Central America.


Tightly wedged between the Pacific and Caribbean, Costa Rica is the picture of entrepreneurship and industry. Unlike most of the countries in the region, Costa Rica does not brim with mineral riches. It lacks the oil and metals deposits that abound throughout parts of the Caribbean and Latin America However, that is not to say that the country never took advantage of its comparative advantages and endowments. During its colonial days, Costa Rica was a breadbasket for Central America and the Caribbean, cultivating the wide range of crops and livestock that thrived throughout its varied climates. During the past 30 years, Costa Rica cashed in on its bounty of ecosystems and natural beauty, becoming one of the major destinations for high-end tourism. Moreover, during the last two decades, the Central American country tapped into its rich vein of highly skilled workers to become a manufacturing hub for the high tech industry. Given such a diversified economy, it is little wonder why the global credit crunch was little more than a speed bump.

After posting an average growth rate of more than 6 percent y/y during the past four years, the impact of the global credit crisis was relatively mild. Costa Rica’s GDP is expected to decline 1.6 percent y/y in 2009. The level of economic activity dropped 4.5 percent y/y during the first quarter and 2.4 percent y/y during the second quarter. However, the economy bottomed out at the end of the first half, and there are clear signs of an early recovery. We expect GDP to expand more than 4 percent y/y in 2010, thus allowing the unemployment rate to fall below the current level of 7.7 percent. The silver lining of credit crunch was the sharp decline in the inflation rate. Costa Rica’s consumer prices typically post double digit increases each year. However, they are expected to increase only 5 percent y/y in 2009. We expect inflation to remain in the mid-single digits in 2010. As a result, the central bank is changing its exchange rate policy. Instead of employing a crawling peg, it recently shifted to a banded system—thus allowing for greater flexibility. Most locals expect the colon to appreciate by the end of the year to a level of 550. One of the factors that should help appreciate the currency will be the large influx of foreign direct investment (FDI) expected next year. Government officials expect FDI to reach $2 billion in 2010, thus exceeding the highs that were posted in 2008. The effects of the global credit crunch and a sharp decline in tourism led to a 30 percent decline in FDI this year. However, a series of reforms and initiatives will allow capital inflows to resume. The government recently passed legislation allowing among other things, the liberalization of the insurance and telecommunications sectors, which sparked interest from a wide range of multinational and regional players. Moreover, the signing of CAFTA-DR led to a flurry of FDI activity in ports and infrastructure.

Unlike many Central American countries, Costa Rica is known for its solidarity and political consensus. In 1948, following a brief civil war, President Jose Figueres Ferrer abolished the military. This abolition was instrumental in allowing it to avoid the social strife and divisions that characterized most of the region during the 1970s and 1980s. This is one of the reasons why most people are sanguine about next February’s elections. Justice Minister Laura Chinchila is expected to sweep the day. A close associated of President Oscar Arias, the bounding popularity of Minister Chinchila reflects a general desire for continuity. Chinchila may be expected to win the elections, but she still faces several important challenges. The main issue will be addressing the erosion of the fiscal accounts. The decline in economic activity and a sharp increase in government spending pushed the fiscal accounts deep into the red. The fiscal deficit is expected to crest over 4 percent of GDP, thanks to large increases in infrastructure spending and social programs. Fortunately, Costa Rica enjoys strong multilateral and international investor support. Therefore, it can get easy access to financing. In sum, we believe that the country should overcome its obstacles. Costa Rica has one of the healthiest economies in the Central America. Its economic diversification and political stability allows it to enjoy a steady pattern of high economic growth and prosperity. Perhaps, this is one of the main reasons why Costa Rican bonds were one of the best performing instruments throughout last year’s global financial meltdown.

Walter Molano is head of research at BCP Securities.


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