OECD Economic Outlook, Volume 2019 Issue 1

Costa Rica

Economic activity is projected to pick up, supported by infrastructure investment and improved business sentiment upon the approval of fiscal reforms. Consumer spending will remain subdued on the back of tax increases, lower credit growth and a temporary increase in inflation, due to the introduction of a fully‑fledged VAT tax. However, an improvement in terms of trade will boost disposable income. External demand will remain robust, supported by tourism, high-tech products and business services.

Fiscal consolidation has progressed, and the approved fiscal reform and a temporary tax amnesty has raised additional revenue to help reduce the persistently high public debt. Streamlining the organisation of the public sector, and a public employment reform could help contain the deficit and make the delivery of public services more effective. Additional investment to solve large infrastructure gaps, and measures to reduce labour market mismatches and informality, improve education outcomes and strengthen competition are key to unleash the potential of tourism, lift productivity and reduce inequalities.

Economic activity is picking up

Economic activity decelerated in the last quarters of 2018 as a result of uncertainty about the approval of the fiscal reforms, and labour strikes that hit investment and the retail sector. The currency has stabilised recently in the aftermath of the approval of the fiscal reforms and economic activity has rebounded, particularly in the financial sector, IT and business services. Unemployment remains high owing to labour market and education mismatches, a complex system of multiple minimum wages and high barriers to entrepreneurship, all of which also contribute to a high informality rate.

Fiscal performance and exports: Costa Rica

1. General government gross debt as a percentage of GDP.

Source: IMF, World Economic Outlook database, April 2019; Banco Central de Costa Rica; and OECD Economic Outlook 105 database.

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Costa Rica: Demand, output and prices

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Additional measures to restore fiscal sustainability are needed

Spending restraint helped curb the public deficit in 2018 and a temporary tax amnesty has raised more than 0.6% of GDP in additional revenues. The implementation of the historic tax reform will improve fiscal sustainability and the progressivity of income tax. However, the implementation of the new fiscal rule will be key to put a halt to the rise in the debt-to-GDP ratio. Reforms to streamline the organisation of the public sector and in public sector employment would generate additional savings, improve effectiveness in the delivery of public services and decrease high inequalities. Reducing budget rigidities stemming from legally mandated spending and earmarking of government revenues would help to improve fiscal performance. Strengthening the budgetary process by implementing a multi-year expenditure framework and establishing a fiscal council would also help to control public expenditure and improve its quality.

Inflation expectations are converging towards the middle of the target range of the central bank and core inflation has remained stable, although a moderate rise is expected. The high level of dollarisation, which has recently increased, continues to impair the transmission of monetary policy, which highlights the necessity of continuing to allow the currency to float.

Growth is projected to rise moderately

Growth will increase as infrastructure investment is implemented in 2019. Rising business sentiment on the back of the approval of the fiscal reform bill will lift private investment. Improved terms of trade will raise disposable incomes but this effect will be mitigated by lower credit growth and higher taxes. Export growth will remain strong, especially in knowledge-intensive business services. Fiscal underperformance remains the main risk to the outlook, as high interest rates crowd out private investment. It could also lead to further bouts of sharp currency depreciation which would also affect confidence and domestic demand. An exacerbation of international trade tensions could also damp growth via lower exports. On the other hand, additional reforms to boost competitiveness and to put public finances on track would raise business confidence and investment.