Press Release No. 08/165

Press Release No. 08/165

An International Monetary Fund (IMF) staff mission led by Mr. Dominique Desruelle, Chief of the Central America Division in the Western Hemisphere Department, issued the following statement on July 3, 2008:

"An IMF mission visited San José, Costa Rica during June 30-July 3, 2008 to review recent developments and discuss policies for 2008. The mission met with Central Bank Governor Francisco de Paula Gutiérrez, Finance Minister Guillermo Zúñiga, Financial Sector Superintendent Óscar Rodríguez, members of the Monetary Board, other senior government officials, and representatives of the private sector. The mission thanks the authorities for the very close cooperation, fruitful and frank discussions, and warm reception it received during its stay in San José.

"As other countries in the region, Costa Rica is facing an increasingly challenging global environment, marked by high commodity prices and a slowing U.S. economy. Economic growth has been resilient to these large adverse shocks so far: it slowed moderately in the first few months of the year, but remained supported by domestic demand. However, the surge in commodity prices combined with domestic demand pressures pushed inflation well up. Food prices have risen twice as fast as headline inflation, which disproportionately affected the poor .

"Economic activity is expected to slow below its trend rate of about 5 ½ percent over 2008-2009, while the current account could widen further, reflecting a significantly higher oil import bill and slower export growth. The main risk to this outlook stems from further global shocks, particularly commodity price surges, which would have an additional adverse impact on growth, inflation, and the external current account position.

"The mission noted that Costa Rica was in a significantly better position to respond to such shocks now than in the past, thanks to a marked improvement in public finances, sizable foreign exchange reserves, steps taken toward a more flexible exchange rate regime in the context of the transition to inflation targeting, and measures already adopted to strengthen the financial system.

"The mission welcomed the authorities' initiatives to cushion the impact of higher food prices on the most vulnerable segments of society, while allowing the necessary pass-through of international price shocks to domestic prices. In particular, it commended the decision to focus on well-targeted social programs, including increased conditional cash transfers, child nutrition, and income support to families in extreme poverty. The mission also welcomed the envisaged technical assistance to small farmers to boost the supply of food staples.

"The mission concurred with the authorities on the need to tighten monetary policy in order to stop and, then, reverse the increase in underlying inflation. It welcomed the central bank's recent decisions to increase its policy rate, but stressed the need to raise interest rates further in the period ahead. It also welcomed the submission to congress of a bill to recapitalize the central bank. A prompt and substantial recapitalization of the central bank would increase the effectiveness of monetary policy.

"The mission congratulated the authorities on the pursuit of a sound fiscal policy, which has helped contain demand pressures and reduce public debt. It also acknowledged their continued efforts to improve tax collection, which created space for greater social and infrastructure spending. The mission encouraged the authorities to continue to exercise fiscal discipline to support the anti-inflation efforts of the central bank, and to accommodate much needed increases in targeted social spending within the 2008 budget.

"While addressing the global shocks is clearly a short-term policy priority, the mission and the authorities agreed on the need to pursue the medium-term reform program. In this regard, the mission welcomed the progress made on the CAFTA-DR implementation agenda. It concurred on the priority given to enacting legislation to enhance financial sector regulation and supervision. It reiterated that further measures will need to be taken in this area, including improvements in the legal protection of supervisors. The authorities and the mission agreed that the approval of a substantial tax reform, including a revamp of the income tax and Value Added Tax (VAT), remains a priority.

"The IMF will maintain a close policy dialogue with the authorities, keep exchanging information on global developments, and provide technical assistance in a number of areas in the period ahead. The next Article IV mission is tentatively scheduled for December 2008."