Press Release No. 06/178

Press Release: IMF Staff Statement on the Conclusion of the Article IV Discussions with Costa Rica

August 3, 2006

An International Monetary Fund (IMF) staff mission led by Mr. Dominique Desruelle, Division Chief in the Western Hemisphere Department, today issued the following statement in San Jose:

"An IMF mission visited San José during July 19-August 1 for the 2006 Article IV discussions with Costa Rica, to review economic developments and the authorities' policy plans. The mission met with the President of the Republic Óscar Arias, Vice-President Kevin Casas, Minister of the Presidency Rodrigo Arias, Central Bank Governor Francisco de Paula Gutiérrez, Finance Minister Guillermo Zúñiga, Minister of Foreign Trade Marco V. Ruiz, other senior public sector officials, political leaders, and representatives of the legislative assembly, public enterprises, the private sector, banks, academics, and labor unions. The mission thanks the authorities for the warm welcome and close cooperation it has received during its stay in San José.

"Over the past 18 months, Costa Rica's economic performance has been strong. Despite the oil price shock, growth has been higher than expected, supported by sound economic policies, strong external demand, and favorable conditions in international capital markets. Spending restraint and improved revenue collections have contributed to the lowest public sector deficit in a decade. Inflation, however, has remained in the double digits, although it has come down somewhat from the peak in 2005.

"The near-term outlook remains favorable. For 2006, real gross domestic product is expected to rise by 6½ percent, while inflation is likely to remain at 12 percent. Although the external current account deficit is projected to increase slightly, this is expected to be financed by continued strong inflows of foreign direct investment. To be sure, the outlook is not without risks as a cooling of the U.S. economy or a further increase in oil prices could adversely impact economic activity.

"Looking ahead, Costa Rica's main challenge is to increase economic growth in a sustainable and balanced way. Higher economic growth, combined with a significant reduction in inflation, would improve the living standards of all citizens and reduce poverty. The mission agreed with the authorities that a multi-pronged approach was necessary to accomplish these goals.

"At the center of this strategy is the initiative to pass a comprehensive fiscal reform, with a focus on the income tax and the value-added tax. The mission recommended a package of sufficient size to ensure medium-term fiscal sustainability, provide resources for the recapitalization of the central bank, and allow for an increase in spending on infrastructure, education, and other social needs. The mission agreed with the authorities' proposal to develop a multiyear budget framework, which would allow the government to present to the public a clear medium-term economic and fiscal strategy and, hence, enhance budget transparency. The mission concurred with the authorities that an increase in the level of infrastructure investments is needed, as long as efficient and transparent mechanisms are used and these investments do not increase fiscal risks.

"The mission strongly supported the governments' commitment to seeking ratification and implementation of the Central America-Dominican Republic-United States Free Trade Agreement (CAFTA-DR), and encouraged the authorities to further strengthen the financial system including by improving regulation and supervision of offshore banks.

"To improve the effectiveness of monetary policy and prepare for the eventual adoption of inflation targeting, the mission supported the authorities' plans to recapitalize the central bank and move toward a more flexible exchange rate system. Supported by prudent fiscal policy, these steps should help entrench the gradual decline of inflation to the low single digits envisaged by the authorities.

"The IMF will maintain a close policy dialogue with the authorities as they develop and implement their reform agenda. In the coming weeks, the mission will prepare a report to the IMF's Executive Board, as a basis for a Board discussion tentatively scheduled for end October."