Consultative Group for the Reconstruction and Transformation of Central America

"reconstruction must not be at the expense of transformation"

Central America After Hurricane Mitch
The Challenge of Turning a Disaster into an Opportunity

Costa Rica

A.  Summary

According to ECLAC’s estimates, losses caused by Hurricane Mitch in Costa Rica were minor. They are estimated at about US$92 million, relative to US$6.0 billion estimated as direct and indirect damages in the five Central American countries. The losses in Costa Rica represent only 0,9 % of estimated GDP for 1998. Nevertheless, the country is worried about the hurricane’s impact in neighboring countries and the repercussions it may have on migrations to Costa Rica. This could bring additional pressure on health and education spending.

In 1998, Costa Rica had strong economic growth (6.2 percent), supported by the dynamism of exports, direct foreign investments and the expansion of domestic credit. The construction sector and manufacturing industry recorded the highest growth. Economic growth translated into a lower unemployment rate (5.6 percent) and an increase in real salaries. The government persisted in controlling inflation (12.3 percent) and the fiscal deficit (2.6 percent for the entire public sector). This economic dynamism is expected to continue during 1999, depending on the management of economic policies.

Congress will discuss the opening of State monopolies. Important resources might be obtained to reduce the accumulated domestic debt. In any case, 1999 will be a key year for the government, in terms of maintaining economic policy and advancing the reforms. If the government is successful in controlling inflation, maintaining fiscal discipline and containing the tendency of increasing imports, it will be possible for the economy to grow 4.5% to 5.0% in 1999. The authorities are evaluating their fiscal situation in order to establish the desired level of public investment and the type of financing. The Government has finalized the National Development Plan, and has made presentations of the Plan to international financial institutions.

The bank's program of future operations with Costa Rica keeps in mind the economic and financial situation of the country and the priorities established by the Government for its future investment programs. In this sense, the Bank expects to finance: (i) Financial Sector Reform Program; (ii) Land Titling and Regularization Program; and (iii) Modernization of Technical Education. The support to the private sector is provided by the Inter-American Investment Corporation, the Department of Private Sector and by the Multilateral Investment Fund, all part of the IDB system.

B. Country Analysis

B.1 Recent economic situation

During 1998, the Costa Rican economy showed notable dynamism, with real growth of GDP surpassing six percent. During the 90’s, higher growth was achieved only in 1992 and 1993. This dynamism was generated by factors, including direct foreign investments, as was the case with the INTEL corporation, exports and an expansion of credit to the private sector. The activities in the Free Zone sustained the dynamism of exports. Other sectors showing great dynamism were construction, transportation and communications, electricity and water. Tourism also contributed and it was supported by the favorable United States economy and the entry of new airlines (income for tourism increased 22 percent, for a total of $ 900 million). It is estimated that, in 1998, the number of jobs increased by 5,9 percent. Important increases were registered in construction, a sector that is very sensitive to the variation of production and the financial area. As a result, the open unemployment rate dropped to 5.6 percent. Economic growth also is reflected in the increase in real salaries.


Graph 1

One of the concerns the Costa Rican delegation presented to the Consultative Group for Reconstruction, held last December at IDB headquarters, was the possible increase of illegal immigrants. The hurricane has promoted the movement of the affected populations, while the return of illegal residents to their countries of origin, has decreased. Undocumented immigrants, for all practical purposes, have access to social services, such as health and education, but they generally pay no taxes. That is to say, the load for Costa Ricans might grow with the increased number of participants in the social network.

It is estimated that in 1998, exports of goods and services increased by about 28 percent, mainly influenced by the presence of INTEL. Exports in the area of industrial manufacturing grew by almost 50 percent. According to exports destinations: sales to Mexico increased by 24 percent, sustained by the Free Trade Agreement; to the Dominican Republic grew by 76 percent, and sales to Panama climbed by 14 percent. In addition, with INTEL, exports to Asia increased enormously (165 percent). A large number of computers are assembled in Asia, and there is a great demand for microchips. For the first time ever, exports to Asia surpassed seven percent of the total.


Graph 2

During 1998, economic growth also stimulated imports in general, specifically capital goods and raw materials. It is estimated that the trade deficit climbed to 6.7 percent of GDP. Nevertheless, compensated for by a surplus in the services, income and transfers account, the current account deficit, climbed to only 2.7 percent of GDP in 1998, which is similar to the 1997 level.

Although the amount of direct foreign investments for 1998 was very similar to the 1997 level, the flow of short-term capital coming into the country decreased, due to the international financial crisis In the meantime, the private sector sought more credit domestically, rather than looking for it abroad. It is estimated that the financial account surplus fell to 5 percent of GDP, a level insufficient to compensate for the trade deficit. As a result, the country sustained a slight decrease of reserves during 1998.

Given that Costa Rica, until now, has not been able to enter into the North American Free Trade Agreement, it is logical for the country to look for alternative export destinations. As a way of achieving diversity, the government pursues stronger trading ties with Mercosur, Chile, Japan, South Korea, Panama, the Dominican Republic and others. Exports have been a key factor in the economic recovery, and therefore, Costa Rica has committed itself to extend Free Trade Agreements with regional countries.

The current revenues of the central government showed a 23 percent increase, supported by the dynamism of the income tax. Also important was a new law that allowed for the reduction of Tax Savings Certificates, which are monetary incentives for exporters of non--traditional products. Current spending of the central government increased by 19 percent. The interest payments on domestic debt practically did not grow, while the interest payments on foreign debt, increased by 22 percent. Payment of Tax Savings Certificates grew by 49 percent. As a result, the central government fiscal deficit improved in 1998, to 3.2 percent of GDP. The deficit of the central bank dropped to 1.6 percent of GDP. It is estimated that the surplus of the rest of the public sector was 2.2 percent of GDP, resulting in a combined deficit of the public sector for 1998 of 2.6 percent of GDP

.


Graph 3

Given that the interests payments on domestic debt absorb almost 32 percent of the central government spending, domestic debt continues to be an important factor in fiscal behavior, and thus the government continues its efforts to control fiscal deficit and public debt. During 1998, domestic discounted public debt grew by 20 percent. Foreign debt increased during 1998 because of the placement of US$200 million in the international markets in April. In addition, in December of 1998, Taipei, China- approved a bilateral loan of US$75 million. In order to convert part of the domestic debt into foreign debt, on May 6 the government placed US$300 million in the international markets.

In 1998, the government adopted a restrictive monetary policy to control the growth of credit. In the meantime, interest rates tended to increase and have been accelerating since October. The government controlled the rate of inflation in 1998, despite strong economic growth. In the second semester of 1998, the growth of credit to the private sector was controlled, with the objective of restricting domestic demand and lowering inflation. During 1998, the average inflation rate reached 12.3 percent, slightly lower than the goal.

One factor that contributed positively to economic behavior was the rapid growth of domestic credit, especially credit to the private sector. During 1998, private credit increased by about 47 percent. In order to avoid a inflationary pressures, the government attempted to reduce the expansion of internal credit.

Exchange rate policy continues to maintain a crawling-peg system, which has been able to maintain a competitive level of the real currency exchange rate. This policy sustains the dynamism of exports. For 1998, the devaluation rate was 10.6 percent, the smallest annual change recorded since 1994. The concern over inflation was a decisive factor for adopting a slower rate of devaluation.

B.2 Hurricane Mitch Damages

According to ECLAC’s calculations, losses caused by Hurricane Mitch in Costa Rica were minor. They are estimated at about US$92 million, relative to US$6.0 billion estimated as direct and indirect damages in the five Central American countries. The losses in Costa Rica represent only 0,9 % of estimated GDP for 1998. Nevertheless, the country is worried about the hurricane’s impact in neighboring countries and the repercussions it may have on migration to Costa Rica. This could bring additional pressure on health and education spending.

The hurricane made it necessary to temporarily relocate some 16,500 people; 81 shelters were set up to attend to the displaced people. The most vulnerable population is the one that suffered the greatest impact, especially children and adolescents. A total of 2135 homes were affected in different degrees, including 242 that were totally destroyed, most of which were in Puntarenas. In the education sector, there was minor damage to 16 schools in different provinces. In the health sector, floods affected the building and equipment at the Hospital Dr. Tomás Casas.

The transportation infrastructure had losses in highways and roads damaged by collapses, landslides and avalanches in some 1300 kilometers; the major damages occurred to the Southern Inter-American Highway, which Hurricane Cesar already had affected in 1996. 126 bridges and more than 1000 sewers were affected, mostly on the Inter-American Highway. There were, likewise, aqueducts and sewage systems that had diverse problems, principally that of Toma de Chontales, which supplies Ciudad Cortés.

The agricultural sector had the most damage (69 percent of the total), with infrastructure representing 27 percent and the social sectors all the rest. The rains, strong winds and subsequent floods affected nearly 30,000 hectares. Among the export crops affected were coffee and sugar cane, and among those grown for domestic consumption rice, tomatoes, and beans. The areas with the largest amount of lands affected were in the Valle Central Occidental, the Pacífico Central and Brunca.

B.3 Medium term perspectives

The economy has been dynamic, and that implies the risk that inflation might accelerate during the current year. Inflation could harm economic activities and lower real salaries. It is now clear that the cost of living continues to be one of the greatest concerns of the population. In order to meet the goal of the monetary program of the government, that is to say, 10 percent inflation in 1999, policies such as the restriction of internal credit are important for keeping internal demand at sustainable levels.

The situation caused by Hurricane Mitch in other countries of Central America might have a restricting effect for Costa Rican exports to regional countries. Nevertheless, the exports of food and materials (especially for construction) could increase during the Reconstruction phase. It is also possible that banana exports might grow due to lower production in the Region.

So long as the United States economy maintains good growth, tourism will be able to continue growing at its current accelerated rate. Nevertheless, it could be necessary to establish more promotion in other parts of the world market and facilitate the entry of more international airlines into the country.

The perspectives of the medium term depend on the structural reforms under discussion. If Congress approves pending laws, the country can count on revenues from the sale of the International Bank of Costa Rica, and the opening of the electromagnetic spectrum in the year 2000. In addition, in the year 2001, Costa Rica could assume the revenues from the sale of the portfolio of commercial securities of the National Institute of Securities, the National Liquor Factory and the Banco de Costa Rica. Legislation for the opening of the electricity and telecommunication sectors are under consideration by the Legislative Assembly.

Given the restrictive monetary policy, it is possible that interest rates might rise during the second semester of 1999, when the Ministry of Finance needs to place bonds on the domestic market. Nevertheless, in order to maintain fiscal stability, the reduction of the internal debt through a combination of sales of state assets and external loans is under consideration.

It is expected that the monetary policy of mini-devaluations will continue in the near future. Therefore, the real exchange rate will be maintained with stability, and exports will be able to maintain competitiveness in the international market.

 

C. Activities of the Bank

The Bank approved loans to Costa Rica in 1998 for US$16.5 million. The current portfolio, is composed of 13 loans for the public sector with an available balance of US$436 million.

The bank's program of future operations with Costa Rica is influenced by the economic and financial situation of the country and the priorities established by the Government for its future investment programs. In this sense, the Government requested bank financing for a Financial Sector Reform Program. In addition to this support Regularization of Land Titling has also been requested.

The Bank has initiated a dialogue with the Government on policies and possible reforms in the social sectors. The Government has, as the focus of its social policy, a decentralization of social services, in order to respond to communities’ demands.

Support to private sector is provided through the activities of the Inter-American Investment Corporation, and the Multilateral Investment Fund part of the IDB system.

Costa Rica
Basic Data

Macroeconomic indicators 1994 1995 1996 1997 1998
GDP (rate of growth) 4.5 2.4 -0.6 3.7 6.2
Average inflation 19.9 22.6 13.9 11.2 12.3
Balance of current account (% of GDP) -6.6 -2 -1.9 -4.4 -4.5
International reserves (months of imports) 3.9 4.1 3.7 3.3 2.7
Debt service/exports FOB (%) 23.3 24.3 21.8 19 18
Combined deficit of the Public Sector (% GDP) 8.1 3.5 5.3 3.4 4

  
Central America     Honduras    Nicaragua    El Salvador    Guatemala     Costa Rica

 

Nicaragua, May 2000   -   Honduras, February 2000   -   Stockholm, May 1999

Inter-American Development Bank