IMF Executive Board Approves US$ 735 Million Precautionary Stand-By Arrangement for Costa Rica

Press Release No. 09/124
April 13, 2009

The Executive Board of the International Monetary Fund approved last Friday a 15-month, SDR 492.3 million (about US$735 million; 300 percent of quota) Stand-By Arrangement for Costa Rica to support the country’s strategy to cope with the adverse global economic environment. The Costa Rican authorities intend to treat the arrangement as precautionary, meaning that they do not intend to draw on the Fund’s resources unless a need arises.

The authorities’ program seeks to protect macroeconomic and financial stability, and mitigate the impact of the global economic and financial downturn on growth and household incomes. It plans to achieve this by increasing exchange rate flexibility and exercising firm control of monetary policy in order to narrow the external current account deficit and lower inflation. The plan also contemplates increasing fiscal spending on key areas to minimize the impact on domestic activity and protect the vulnerable population.

As Costa Rica is not facing immediate balance of payments pressures, the Stand-by Arrangement is designed to bolster confidence in the policy framework. In particular, access to financial support from the Fund will increase considerably the country’s external financial defenses to help absorb any larger-than-anticipated balance of payments shocks and safeguard the ongoing gradual transition to greater exchange rate flexibility.

Following the Executive Board discussion on Costa Rica, Mr. Murilo Portugal, Deputy Managing Director and Acting Chair, made the following statement:

“Costa Rica’s economic fundamentals are solid, reflecting years of generally prudent policies. However, the global financial and economic turmoil entails risks to Costa Rica’s outlook in 2009 and 2010. Against this background, the authorities’ economic program seeks to preserve macroeconomic and financial stability, while supporting growth and protecting the most vulnerable segments of the population.

“The authorities’ strategy involves a gradual increase in exchange rate flexibility supported by monetary restraint, a moderate fiscal expansion, a further strengthening of the financial sector, and the mobilization of substantial precautionary financing, including from the World Bank and the Inter-American Development Bank. This financing will boost the economy’s foreign currency liquidity buffers, and provide protection against any larger-than-anticipated shocks to the balance of payments.

“The Central Bank of Costa Rica tightened monetary policy and widened the exchange rate band early this year, and is committed to keeping the monetary stance consistent with the goals of maintaining the currency band, narrowing the external current account deficit, and lowering inflation. The authorities also plan to take further steps toward adopting an inflation targeting regime, including measures aimed at strengthening the transmission mechanism of monetary policy.

“The authorities’ fiscal program aims to mitigate the effects of the downturn on activity and employment, while safeguarding medium-term sustainability. The 2009 budget envisages higher spending on education, labor-intensive public infrastructure projects, and the social safety net. By protecting public investment in human and physical capital during the downturn, the program provides a basis for the resumption of high and sustained growth in the medium term.

“Costa Rica’s banking system is generally strong. Domestic banks are funded mainly by domestic deposits and are not exposed to structured financial products. The authorities have nonetheless responded proactively to safeguard the liquidity and capital positions of banks, and have intensified the monitoring of financial soundness indicators. The government plans to strengthen further the financial sector safety net, including by establishing a system to detect stresses in banks at an early stage, creating a deposit insurance scheme, and improving the framework for bank resolution,” Mr. Portugal said.

ANNEX

Recent Economic Developments

Costa Rica benefited from a sustained growth period during 2003–07, which resulted in sustained increases in real household incomes and significant poverty reduction. Prudent macroeconomic policies during those years also helped reduce vulnerabilities, including through a substantial decline in the public sector debt-to-GDP ratio and a large increase in international reserves.

In 2008, the economy was affected by the turmoil in global financial markets and declining activity in trading partner countries. As a result, real GDP growth slowed by almost five percentage points to 2.9 percent, while surging commodity prices and demand pressures pushed inflation well into double digits and contributed—along with weakening manufacturing exports—to an increase in the external current account deficit to almost 9 percent of GDP.

Program Summary

Against this background, the authorities’ economic program for 2009 seeks to facilitate an orderly rebalancing of the economy to the adverse external environment, while mitigating negative effects on growth and household incomes. Financial support from the IMF through the Stand-By Arrangement is designed to bolster confidence by increasing the country’s financial defenses to cope with unanticipated shocks. Key elements of the authorities’ program include:

• A gradual increase in exchange rate flexibility supported by monetary restraint. The program supports the increase in the rate of crawl of the exchange rate band implemented earlier this year and the policy of the central bank to increase interest rates as needed to maintain the currency band, the reduction of the current account deficit and lowering inflation. The program is also designed to help the authorities to make progress in the transition toward an inflation targeting regime.

• Counter-cyclical fiscal policy. The authorities are using the fiscal space created through prudent policies in the years of economic expansion to help mitigate the impact of the decline in private demand on growth, employment and the poor. In particular, the program contemplates a substantial increase in spending on education, labor-intensive infrastructure projects, and the social safety net. By protecting investments in human and physical capital, the program provides a basis for a gradual return to high and sustained growth rates in the medium term.

• Strengthening the resilience of the financial sector. The authorities will seek to further enhance the supervisory framework and the safety net for the financial sector, including through the implementation of an early warning system of stress in banks, and rapid progress toward creating a deposit insurance system and strengthening the bank resolution framework.

The program’s macroeconomic framework for 2009 assumes real GDP growth to 0.5 percent, though recent data on economic activity suggests that the risks to this forecast are heavily tilted to the downside. Inflation is projected to decline to 8 percent by end-year, while the current account deficit is expected to narrow to 5.3 percent of GDP.

Costa Rica joined the IMF on January 08, 1946, and its quota is SDR 164.1 million (about

US$245 million). Costa Rica has had no outstanding IMF credits since 1997.



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