Costa Rica: Staff Concluding Statement of the 2023 Article IV Mission, Fifth Review under the Extended Fund Facility, and Second Review Under the Resilience and Sustainability Facility Arrangement
October 27, 2023
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
San José:
An International Monetary Fund (IMF) staff team, led by Mr. Ding Ding,
visited San Jos
é during October 18–27. The staff team held discussions on the 2023
Article IV consultation with the Costa Rican authorities. The
consultation focused on how to institutionalize the significant
progress achieved in the past few years over the medium term. The Costa
Rican authorities and IMF staff also reached a staff-level agreement on
the policies needed to complete the fifth review of the Extended Fund
Facility (EFF) and the second assessment of reform measures under the
Resilience and Sustainability Facility (RSF) Arrangement.
Despite strong growth momentum, inflation has declined sharply.
Real GDP growth is expected to reach around 5 percent this year, supported
by buoyant exports and recovering domestic demand. Growth is expected to
moderate to 3½ percent in 2024, which is broadly in line with the
medium-term potential growth rate. Headline inflation has been negative
over the past four months as global commodity prices fell and a stronger
currency helped to reduce goods prices. Inflation is expected to rise back
within the Central Bank of Costa Rica (BCCR)’s tolerance band by mid-2024.
The value of the colón has stabilized near its long run
historical average in real effective terms and international reserves
buffers are strong.
The rapid decline in inflation should allow monetary policy to return
to a neutral setting by mid-2024, assuming the economy evolves
according to staff’s baseline forecast.
The BCCR appropriately raised interest rates (to 9 percent) in 2022 to
counter the global inflation shock and anchor inflation expectations. As
inflation receded, the BCCR appropriately lowered the policy rate and should
continue to normalize its policy stance
to ensure that inflation converges decisively to the BCCR’s target
. Risks to inflation are broadly balanced as those from weak domestic price
pressures are offset by the potential for higher global energy or other
import prices. Policy decisions should continue to be data-dependent,
forward-looking, and supported by clear and transparent communications, with
due attention to the two-sided risks to inflation. Going forward, the
authorities should persist in their efforts to further strengthen the BCCR’s
autonomy, governance, and operational framework.
A deeper and more liquid foreign exchange (FX) market and greater
exchange rate flexibility would strengthen the transmission of monetary
policy to activity and inflation.
Costa Rica has a shallow FX market and faces some degree of currency
mismatch arising from dollarization. In principle, this could justify
deploying targeted FX intervention to mitigate excessive exchange rate
fluctuations. However, in most circumstances, the exchange rate should be
allowed to move freely in response to market conditions. The BCCR should
explore the reduction of the impact of its operations in the FX market by
aligning the timing of BCCR purchases of FX on behalf of the non-financial
public sector (NFPS) with the sale of FX to these entities. A more flexible
exchange rate and greater transparency in BCCR FX operations would both
allow monetary policy to have its full effect on activity and inflation and
incentivize the deepening of the FX market (including the use of FX hedging
instruments). To complement this more restrained approach to FX
intervention, further institutional and technical reforms would be useful
to improve the functioning of the FX market and strengthen market
participants’ ability to manage currency risks.
The banking system appears resilient to adverse shocks and planned
reforms will improve financial oversight.
Capital and liquidity metrics are comfortable, and provisioning is
adequate, although high dollarization introduces vulnerabilities. Planned
amendments to the bank resolution and deposit insurance law will clarify
the government’s role in the resolution regime and strengthen crisis
management. The approval of regulations to incorporate socioenvironmental
and climate change risks into credit portfolio assessments and efforts to
incorporate climate effects in stress tests are important steps forward.
Legislation should also be passed to align the regulatory treatment of all
banks to provide a level playing field. This should include phasing out the
public guarantee for state-owned banks’ deposits as the deposit guarantee
covering the entire banking sector becomes fully effective. The parafiscal
contributions of state-owned banks should be converted into a single budget
transfer and private banks should no longer be required to contribute part
of their short-term deposits to the
Sistema de Banca para el Desarollo
(Development Bank System) for lending to underserved sectors. Regulatory
limits on credit card fees should be continually set to further promote
efficiency and competition while protecting consumers.
The 2018 tax reform and spending restraint have been successful in
reducing the public debt burden.
The cumulative primary surplus to September was 1.7 percent of GDP and the
authorities are on track to exceed their end-2023 target. The ratio of gross
debt-to-GDP has continued to decline despite the government’s efforts to
build up liquidity buffers. The authorities’ plan to achieve a primary
surplus of at least 1.85 percent of GDP in 2024 will help underpin fiscal
sustainability. Staff’s baseline medium-term primary surplus forecast of 2
percent of GDP would reduce debt to about 50 percent of GDP by 2035.
Revenue gains achieved through the 2018 tax reform should be restored
even as the efficiency and progressivity of the tax system is improved.
After exceeding expectations for much of the past few years, revenue growth
has started to slow, and tax revenues as a share of GDP continue to be
below those of Costa Rica’s peers. Recently approved tax laws, for example,
10.381 and 10.390, will unfortunately erode revenues and reduce the
progressivity, equity, and efficiency of the tax system. Broadening the
corporate and personal income tax bases, introducing a dual personal income
tax, and eliminating VAT exemptions would help arrest this trend. The
implementation of the global minimum tax under the G20/OECD two-pillar
solution provides an opportunity to target tax incentives for the special
regimes to ensure that Costa Rica is not ceding tax revenues to other
jurisdictions. The automatic exchange of information for tax purposes will
support international efforts to reduce tax evasion and safeguard the
integrity of the global tax system. Implementing a feebate scheme would
help to further decarbonize the economy by incentivizing a reduction in
vehicle greenhouse gas emissions. Finally, income tax exemptions of the
salario escolar and aguinaldo should be reconsidered since
they are inefficient, inequitable, and costly.
Ongoing spending restraint is expected to continue to drive fiscal
consolidation and reduce interest burdens.
Continued spending restraint in compliance with the fiscal rule ceilings is
a critical part of efforts to reduce debt. Recent revisions to the fiscal
rule appropriately preserve the broad coverage of spending categories and
exclude entities that produce under market conditions or without government
control. However, some exclusions have an unclear rationale and, by further
reducing the institutional coverage of the rule, weaken the institutional
framework for fiscal policy. Spending ceilings are expected to increase in
the coming years, especially as debt falls, which will create some room for
more public investment and social assistance spending. Ongoing reforms to
make public investment more efficient and climate resilient and to improve
the effectiveness of social spending are being implemented in anticipation
of the scaling up of these spending programs. Passing a bill to unify the
debt management office and granting the executive more flexibility to issue
external debt would help lower fiscal financing costs.
The public employment bill modernizes the wage
structure, improves performance incentives, and is expected to reduce wage
expenditures over the medium term. This important law has been
implemented for the executive branch already. All other institutions
covered by the law should implement its provisions expeditiously.
Free trade zones are an important driver of growth
but supply side reforms should foster more broad-based improvements in
productivity. To further develop linkages to the domestic economy
and leverage these zones as a broader growth engine, it will be important
to improve the business environment outside of the zones. This could
involve increasing digital connectivity, reducing electricity costs, and
strengthening educational outcomes. Such reforms would further enhance
Costa Rica’s standing as an attractive investment destination and reduce
the need for tax incentives for foreign direct investment. Increasing the
participation of women and migrants in the formal labor market would
increase fairness, productivity, and long-term growth.
We welcome the staff-level agreement that has been reached on the
policies needed to complete the fifth review under the EFF and the
second review under the RSF.
Subject to approval by the IMF Executive Board, the completion of the fifth
review under the EFF will make available about SDR 206 (US$ 271 million),
while the expected completion of programmed reform measures under the first
and second RSF assessments will make available about SDR 369 million (US$
485 million). The authorities have published guidelines to assess the
impact of public projects on climate change, prepared legislation to
introduce a feebate scheme for vehicles, and approved regulations to assess
climate change-related risks to bank credit quality. The authorities are
expanding their climate transition fiscal risk analysis and intensifying
efforts to attract climate financing from both official lenders and from
the private sector.
The IMF team is grateful to the Costa Rican authorities and other
counterparts for the productive discussions and hospitality during the
mission.
IMF Communications Department
MEDIA RELATIONS
PRESS OFFICER: Randa Elnagar
Phone: +1 202 623-7100Email: [email protected]
