OECD Economic Outlook, Volume 2023 Issue 1

Costa Rica

GDP will grow by 2.8% in 2023 and 3.0% in 2024. The contribution of domestic demand to growth will moderate in 2023 due to monetary policy tightening and weak labour market conditions. External inflationary pressures are expected to fade due to the easing of commodity and transportation prices and the appreciation of the exchange rate, with inflation projected to fall to 2.4% in 2023 and be at the target rate of 3.0% in 2024.

The fiscal stance will continue to be restrictive over the projection period as the fiscal rule contains public spending. Monetary policy is expected to ease further, with a gradual decline in the monetary policy rate, as inflation is already within the tolerance band. Increasing female labour participation, by expanding the coverage of early childcare and education, and establishing virtual one-stop shops to reduce the cost to start a company, would support higher growth and equity.

Economic activity is slowing down amid decreasing inflation

Economic activity kept softening in 2022 and early 2023 with the Monthly Index of Economic Activity recording an increase of 4.0% (year-on-year) in March 2023 (+10.2% in March 2022). Private consumption has suffered from high inflation, monetary policy tightening and softer labour market conditions in the second part of 2022. Lower investment in the construction sector, due to the rise in interest rates and the postponement of public investment in infrastructure, weighed on gross fixed capital formation.

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 appreciation of the exchange rate to the US dollar in the second half of 2022 (+10% between 2022Q2 and 2022Q4) slowed exports, which nonetheless remained solid for industries operating in the free trade area (medical devices, business services). Headline and core inflation have decreased rapidly from their peaks in August 2022, reaching 2.4% and 3.4%, respectively, in April 2023, due to the reduction in imported commodity prices and the appreciation of the exchange rate. The increase in the price of the basic food basket also continues to slow but remains elevated at 11.2%. One-year ahead household inflation expectations fell to 4.1% in April 2023.

Recent financial tensions originating in the United States have not had a tangible impact on domestic financial conditions. Costa Rica’s banking system appears solid, with banks exceeding the minimum regulatory capital requirements and country risk, as measured by the Emerging Market Bond Index, decreased recently on account of an improved fiscal outlook.

Monetary policy will continue to ease while fiscal policy will remain prudent

Monetary policy is projected to continue to ease, with further policy rate reductions as inflation remains within the 2-4% tolerance band. The policy rate is expected to be cut by 150 basis points between 2023Q2 and the end of 2024. The fiscal stance will remain restrictive as the fiscal rule contains public spending. The central government primary surplus will reach 1.6% of GDP in 2023 and 1.9% of GDP in 2024. The central government deficit will increase to 3.5% of GDP in 2023, from 2.5% of GDP in 2022, as interest rate increases drive up public debt servicing costs, and then fall to 3% of GDP in 2024. Public debt should come down to 64% of GDP by 2024, from a 70% peak in mid-2021.

Growth will slow in 2023 and then recover slowly

Growth will slow to 2.8% in 2023 and edge up to 3.0% in 2024 as global and domestic economic conditions gradually improve. Falling real wages and weaker labour market conditions will hold back household real disposable income in 2023, softening private consumption. Gross fixed capital formation will be held back by high interest rates and the lack of fiscal space in the first half of 2023, and then start recovering. The improvement in the terms of trade will weigh on exports in both 2023 and 2024 but along with contained domestic cost pressures and lower external inflationary pressures will hasten disinflation. A reform of the fiscal rule, reducing its ability to contain public spending, could generate concern about debt sustainability and increase debt servicing costs. On the upside, the renewed efforts to deepen trade integration might strengthen exports.

Continuing structural reforms to boost growth and equity

Persevering with the implementation of structural reforms would strengthen growth and economic resilience and reduce 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. Establishing virtual one-stop shops could reduce the high administrative burden when starting a company. 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 strengthening the public transport network and expand the fleet of zero-emission vehicles.