Public Information Notice: IMF Concludes Article IV Consultation with Costa Rica

October 26, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On October 6, 1999, the Executive Board concluded the Article IV consultation with Costa Rica.1


During the 1990s Costa Rica has continued to make progress in opening up the trade system, diversifying its export base, attracting substantial inflows of foreign direct investment, and improving social conditions. However, efforts to reduce the fiscal deficit on a sustained basis have proven elusive, and there is a pressing need to open up key sectors to private sector participation and to move ahead with reforms of the pension regime and the financial system.

Macroeconomic policy in 1998 was characterized by a strong expansion in aggregate demand associated with a large increase in credit to the private sector by the two largest state banks. The overall public sector deficit (cash basis) declined to 2.7 percent of GDP in 1998, owing in part to an increase in tax revenue and lower interest payments.2 In the balance of payments, the current account deficit widened to 4.4 percent of GDP, from 2.2 percent in 1997, because of strong import growth. Inflows of foreign direct investment remained large, but they were offset in part by outflows of other private capital. Net international reserves declined through September but recovered subsequently as the authorities raised interest rates on central bank paper and took steps to restrain government expenditure. For 1998 as a whole, net liquid international reserves dropped by US$150 million to the equivalent of 1½ months of imports of goods and services. Real GDP growth picked up to 6.2 percent in 1998, reflecting the surge in domestic demand, together with the initiation of operations by a large multinational computer company (INTEL). Inflation rose to 12.4 percent, from 11.2 percent in 1997, notwithstanding the decline in international oil prices.

Developments in 1999 point to a slowdown in real GDP growth to 5 percent for the year as a whole, and a decline in end-year inflation to about 10 percent. The staff estimates that the overall public sector deficit could increase to above 4 percent of GDP in 1999, owing mainly to higher interest payments. Following steps to slow credit growth and a large government bond placement in international markets, net liquid international reserves strengthened by US$425 million to 2.1 months of imports of goods and services from end-1998 to end-May 1999, remaining at about that level thereafter. Central bank interest rates have been lowered following the improvement in the reserve position. With a drop in prices of agricultural products, the 12-month rate of inflation declined to 8.7 percent in September.

In the structural area, the current administration has submitted draft legislation to the assembly to open up electricity generation, telecommunications, and the insurance sectors to private sector participation; as well as to reform the pension and severance payments systems. However, so far the authorities have encountered difficulties to garner congressional support for these reforms.

Executive Board Assessment

Directors welcomed the strong growth in real GDP in 1998-99, and the progress made so far in 1999 in reducing inflation and strengthening the international reserve position. These successes, however, were accompanied by a weakening in the fiscal position and the external current account.

Directors were of the view that fiscal consolidation would help ease pressures on domestic interest rates and reduce the vulnerability of the economy, particularly in view of the relatively large domestic public debt with short maturity. In this connection, they stressed the need to implement substantive measures to strengthen tax revenue. Directors also emphasized the need to remove earmarking practices to facilitate the elimination of unproductive outlays, and to adopt a policy of wage restraint in the public sector, including by adjusting wages on the basis of projected rather than past inflation. The recent approval of a new tax code restoring sanctions for tax noncompliance, as well as the authorities' commitment to eliminate export subsidies by year's end, were welcomed. Directors also encouraged the authorities to press ahead with their plans to improve the targeting of social expenditure to the poor.

Directors welcomed the steps taken by the central bank since the end of 1998 to slow bank lending to the private sector, including through an intensification of liquidity-absorbing open market operations. They stressed the importance of making the banking sector more competitive and efficient. In this regard, Directors noted that the preferential treatment enjoyed by state banks had led to market segmentation and was impairing the efficiency of monetary instruments. They urged the authorities to take measures to level the playing field in the banking sector, beginning with steps to eliminate the requirement that private banks deposit part of their demand deposits with state banks at below market interest rates. In the meantime, credit developments in the state banks should be monitored closely.

Directors regarded the recent adoption of regulations to obtain information about the activities of financial conglomerates, including offshore operations, as a positive first step in improving banking supervision. They encouraged the authorities to move expeditiously to establish effective supervision on a consolidated basis, monitor closely the loan portfolio of Banco Nacional, and tighten regulations on connected lending and accrual of interest on problem loans.

Directors observed that the policy of adjusting the exchange rate daily on the basis of the differential between inflation in Costa Rica and its main trading partners had been largely successful in avoiding an erosion of external competitiveness. They emphasized that a strengthening of the fiscal position, together with the implementation of structural reforms, should contribute to improving external competitiveness over the medium term.

In the structural area, the authorities were encouraged to continue to build the necessary political support for reforms. In this regard, prompt approval of the draft legislation to open up electricity generation, telecommunications, and the insurance sector to private sector participation was regarded as essential to facilitating modernization and increasing productivity. Directors also stressed the importance of reforming the pension system, while ensuring its actuarial viability. In addition, they underscored the need to increase efficiency in the financial system by scaling down the activities of Banco Nacional, privatizing one large state commercial bank, and permitting the establishment of branches by foreign banks in Costa Rica.

The need to strengthen the statistical base was underscored.

Several Directors expressed concern about the implications of the HIPC Initiative for Costa Rica as a bilateral creditor, and stressed the need to find an appropriate solution to this problem.

Costa Rica: Selected Economic Indicators

  1994 1995 1996 1997 1998 Staff

Real economy (change in percent)
Real GDP 4.5 2.4 -0.6 3.7 6.2 5.0
GDP deflator 16.9 21.2 18.2 14.4 12.3 10.8
CPI (end of period) 19.9 22.6 13.9 11.2 12.4 10.0
Unemployment rate (in percent) 4.2 5.2 6.2 5.7 5.6
Gross national savings (in percent of GDP) 13.5 15.1 14.7 17.0 17.8 17.3
Gross domestic investment (in percent of GDP) 19.8 19.1 17.6 19.2 22.2 21.5
Public finance (in percent of GDP)
Combined public sector balance 1/ -8.0 -4.0 -5.2 -3.4 -2.7 -4.3
Nonfinancial public sector -4.7 -2.1 -3.2 -1.5 -1.1 -2.7
Central bank losses 1/ -3.3 -1.9 -2.1 -1.8 -1.6 -1.6
Central government domestic bonded debt 20.3 23.0 31.0 29.3 32.8 29.6
Money and credit (end-year, percent change)
Net domestic assets 20.7 9.1 13.6 18.3 27.9 17.2
Credit to the private sector 15.0 8.7 21.8 30.6 49.2 19.7
Private financial assets 2/ 21.0 24.8 25.5 17.6 19.4 21.0
Interest rates (end of period)
Six-month deposit rate 22.0 24.0 16.0 14.0 19.4
Six-month government bonds 28.9 29.4 26.6 19.3 24.0
Prime lending rate 37.0 37.0 28.0 24.5 26.5
External sector (in percent of GDP)
Trade balance -11.2 -7.3 -6.6 -6.4 -6.8 -2.2
Current account (after official transfers) -6.3 -4.0 -2.9 -2.2 -4.4 -4.2
Direct investment 2.6 5.2 4.7 5.0 5.3 4.2
Overall balance -0.3 2.7 -0.7 2.2 -1.4 1.8
Net liquid international reserves 3/
(In millions of U.S. dollars) 467.6 692.3 624.5 857.0 706.9 906.9
(In months of imports of goods and services) 1.4 1.9 1.6 2.1 1.4 1.7
External public debt 39.2 36.1 31.2 28.5 27.9 28.2
Real effective exchange rate
(percentage change, depreciation -) 3.5 0.5 -0.7 3.7 -2.2

Sources: Costa Rican authorities; and IMF staff estimates.

1/ In 1994 includes losses of the Banco Anglo Costarricense, a state bank closed in December 1994.
2/ Includes holdings of central bank and government bonds.
3/ Excludes claims on neighboring countries and balances in bilateral payments agreements.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.
2The deficit on an accrual basis was somewhat higher, as interest payments were reduced through the issue of zero-coupon bonds instead of regular bonds.


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