OECD Economic Outlook, Volume 2023 Issue 2

Costa Rica

GDP will grow by 3.5% in 2024 and 3.6% in 2025. Domestic demand is projected to gradually strengthen in 2024, as monetary policy continues to ease and labour market conditions gradually improve. External demand is expected to soften in 2024 and pick up again in 2025 as global conditions improve. Inflation is projected to reach 1.9% in 2024 and 3.1% in 2025, just above the 3% target, as improved economic conditions lead to an increase in domestic inflationary pressures.

The fiscal outlook improved in 2023 and the fiscal stance will remain restrictive as the fiscal rule contains public spending. Monetary policy should continue to gradually ease as inflation remains below the target range. Increasing female labour market participation by expanding the coverage of early education and care for children below four years, improving the quality and efficiency of education and increasing the number of science graduates, would support higher growth and equity.

Economic activity strengthened amid labour market stagnation

Economic activity has strengthened through 2023, with the Monthly Index of Economic Activity increasing by 6.5% (year-on-year) in September 2023, driven by manufacturing, construction and professional services. The rapid decline in inflation (both core and headline), the decrease in interest rates that started in January 2023 and the improvement in the terms of trade strengthened private consumption in the first three quarters of 2023. This is despite employment and labour force participation remaining below pre‑crisis norms. Private investment also picked up in the first three quarters of 2023. The Confidence Index for Investment hit a 10-year record high in the third quarter of 2023. Exports accelerated in the first half of 2023, in industries in the free trade regime (medical devices and professional services) and also in the traditional regime.

Costa Rica: Inflation and labour market indicators

1. The horizontal dashed black line indicates the target inflation rate of monetary policy, and the shaded area the tolerance band around the target (2-4%). Headline and core indicate, respectively, the headline consumer price inflation rate and the core consumer price inflation rate. The core consumer price inflation rate measures consumer price inflation excluding food and energy components.

2. The horizontal blue and green dashed lines indicate the average participation and employment rates computed over the period January 2010 - December 2019.

Source: Banco Central de Costa Rica.

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Costa Rica: Demand, output and prices

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The strong appreciation of the exchange rate to the US dollar (15% year-on-year in October) the reduction in imported commodity prices and modest domestic inflationary pressures contributed to a rapid fall in headline and core inflation that reached -1.3% and 0.5% over a year earlier, respectively, in October 2023. With very low inflation, one- and two-year inflation expectations returned to the 3% target in July 2023. Improvements in the fiscal and economic outlook have led to a reduction in country risk, with the Emerging Market Bond Index spread declining by around 80 basis points between January and September 2023.

Monetary policy easing will go along with prudent fiscal policy

Monetary policy is projected to continue easing as inflation remains below the 3% target rate. The policy rate is expected to be cut by 150 basis points by the end of 2025. The central government’s primary fiscal surplus is projected to remain positive over the projection period (1.6% of GDP in 2023, 1.9% in 2024 and 2025) as the fiscal rule contains expenditures. The corresponding budget deficit is projected to be 3.5% of GDP in 2023 and 3% of GDP in 2024 and 2025, due to large public debt servicing costs. These amount to around 5% of GDP annually in 2024 and 2025. Central government public debt is expected to fall from the record-high of 68% in 2021 to 59.4% by end-2025. Fiscal costs of population ageing (pensions and health) are estimated to increase by around 0.3% of GDP per year until 2030.

Growth will slow in 2024 and pick up in 2025

Growth will slow to 3.5% in 2024 and inch up to 3.6% in 2025 as global and domestic economic conditions gradually improve. Private consumption will moderate in 2024 as the participation rate remains low and employment growth improves only slowly. High uncertainty due to geopolitical tensions will slow private investment in 2024, with public investment also remaining weak due to a lack of fiscal space. The impact of the strong terms-of-trade improvement recorded in 2023 will moderate export growth in 2024. The high degree of dollarisation of Costa Rica’s economy exposes the country to risks associated with sharp exchange rate movements. Extreme weather events related to El Niño might negatively impact economic activity and inflation. On the upside, the renewed efforts to deepen trade integration might strengthen exports.

Continued structural reforms would strengthen growth and reduce inequalities

Continuing with structural reform implementation would strengthen growth and economic resilience while reducing inequalities. Increasing female labour market participation by expanding the coverage of early education and care for children below four years, and improving the quality and efficiency of education by providing support to students with learning gaps and increasing the number of science graduates, would support higher growth and equity. To achieve net carbon neutrality by 2050, Costa Rica should maintain its 100% share of electricity produced from renewable sources, reduce emissions in the transport sector by increasing public transport use and the electrification of transport, continue to increase forest coverage, augment waste recycling and composting, and complete the sewer system coverage.