IMF Executive Board Concludes 2019 Article IV Consultation with Costa Rica | WPN World People News

On March 27, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Costa Rica.

Costa Rica has made great strides converging towards OECD living standards, and its accession process to the OECD was opened in 2015. Moreover, over the last four decades the export sector has transformed itself from being agricultural-based to high-value-added manufacturing and service-oriented, helped by trade openness and strong FDI inflows. Nevertheless, unemployment and income inequality remain elevated, and the persistently high fiscal deficit and rapidly rising public debt continue to pose vulnerabilities. The new government recognizes the challenges and passed a fiscal reform bill—after nearly two decades of gridlock—into law last December. It is also planning a broad array of reforms, including those required for OECD accession.

Reflecting the impact of a public-sector strike against the fiscal reform, developments in Nicaragua, tighter global and domestic financial conditions, and the uncertainty surrounding the fiscal reform that eroded consumer confidence, growth slowed markedly in 2018 to 2¾ percent, falling below potential and closing the output gap. Inflation remains low, and inflation expectations are converging toward the mid-point of the target range. External sector performance continues to be solid. The banking system is sufficiently well-capitalized to absorb sizable shocks.

Fiscal consolidation and tight financial conditions are expected to keep growth moderate in 2019-20 (around 2¾-3 percent), notwithstanding a pickup in public investment, base effects associated with the 2018 public-sector strike, and improving terms of trade. In the medium term, positive confidence effects and progress with structural reforms, including those related to OECD accession, should lower risk premia and boost investment, pushing growth up towards its potential of 3½ percent. Inflation is expected to remain within the target range. Despite the fiscal reform, the government faces sizable financing needs in the near term and central government debt is expected to reach above 60 percent of GDP in 2023, after which it will gradually decline.

The outlook is subject to downside risks, including partial implementation of the fiscal reform, an escalation of global trade tensions, and a sharp tightening of global financial conditions.

Executive Board Assessment

Directors commended Costa Rica for the significant progress made in improving living standards and reducing poverty. Directors noted that while the medium-term outlook is generally positive, it faces downside risks. Directors encouraged the authorities to continue their efforts to address fiscal and financial vulnerabilities, strengthen the economy’s resilience, and advance structural reforms to foster inclusive growth.

Directors commended the recent fiscal reform, which is important for restoring fiscal sustainability. They called for full and timely implementation of the fiscal reform to improve market confidence and rebuild fiscal space to manage potential shocks and major contingent liabilities, especially pensions. While being mindful of the current political constraints, Directors generally considered that further front-loaded measures might be needed to reduce financing pressures and improve debt dynamics. Directors underscored that given the relatively low tax-to- GDP ratio, any further adjustment, if needed, should be underpinned by well-designed revenue measures while protecting the poor. To allow fiscal policy to better contribute to growth and equity, they highlighted the importance of improving public spending efficiency and debt management, ensuring better targeting of social assistance, and implementing a medium-term expenditure framework and fiscal council.

Directors welcomed the passage of the bill safeguarding the central bank independence and greater foreign exchange flexibility. They considered that monetary policy should continue to remain data dependent and balance downside risks to inflation stemming from slower activity and upside risks to inflation arising from tighter global financial conditions. Directors noted that transparency could be further improved by publishing the calendar of monetary policy meetings and their corresponding meeting minutes, helping further anchor inflation expectations.

Directors observed that the banking system is sufficiently well-capitalized to absorb shocks. They saw need for continued efforts to monitor and tackle financial vulnerabilities related to high dollarization, sizable net foreign liabilities of banks, sharply growing household borrowing, and significant sovereign exposure. Directors welcomed the authorities’ plans to push ahead with the FSAP/ FSSR recommendations and encouraged their rapid implementation and adoption of Basel III standards.

Directors welcomed the authorities’ efforts to implement structural reforms in line with the OECD accession process, to boost competitiveness and inclusive growth, and to continue pursuing green development and the objectives of the Paris Agreement. They viewed promoting female labor force participation, tackling youth unemployment, and addressing weaknesses in transport infrastructure as key priorities. Directors supported the OECD’s recommendation to undertake an in-depth review of key sectors (e.g. electricity) exempted from the competition law, and measures to increase banking competition and reduce high interest rate spreads.

Source: International Monetary Fund