OECD Economic Outlook, Volume 2021 Issue 2

Costa Rica

GDP will grow by 3.9% in 2022 and 2.9% in 2023. Strong external demand will drive growth, with the tourism sector also gradually rebounding. Consumption will strengthen more gradually, supported by a progressive improvement in the labour market and accelerating vaccination. Private investment will rebound strongly, boosted by improved economic prospects. Inflation will increase gradually, but will likely stay below the 3% target rate as sizeable domestic spare capacity remains.

Fiscal policy should continue to reallocate spending towards social protection to support the recovery, while implementing the public employment reform and increasing fiscal revenues to ensure debt sustainability and improve public sector efficiency. Monetary policy should remain accommodative as long as inflation expectations remain well anchored and inflation remains below the target rate of the central bank. Phasing out remaining exemptions to the competition law would boost productivity and lower prices. Shifting part of the tax burden from social security contributions to property taxes and reducing the cost of setting up firms would boost formal job creation.

The employment recovery lags behind economic activity

The recovery of economic activity is progressing fast and in September 2021 it was 2.6% above the pre‑pandemic level, driven by strong external demand for manufacturing, business services and agricultural products, including activities in both the free trade zone (medical equipment, processed food) and the traditional sector (plastic and metal products). The increase in imported commodity prices, especially energy commodities, and a slight depreciation of the exchange rate have contributed to higher consumer price inflation, which reached 2.5% in October, above the low end of the inflation band target of the central bank (2-4%). Market expectations for inflation in 3 years and 5 years time remain well anchored, and wage pressures are contained.

Costa Rica: Economic activity, labour market and inflation indicators

1. The horizontal black line indicates the pre-pandemic level (February 2020).

2. Economic activity is measured by the monthly index of economic activity (IMAE).

3. Headline, core and producer indicate, respectively, the headline consumer price inflation rate, the core consumer price inflation rate and the producer price inflation rate. The core consumer price inflation rate measures consumer price inflation excluding food and energy components.

Source: Banco Central de Costa Rica.

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Costa Rica: Demand, output and prices

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Two waves of contagions since April, the last one peaking in late September, have put hospital capacity under considerable pressure and slowed the reopening of the economy. This has particularly affected labour intensive sectors (hotels and restaurants, face-to-face services sectors), moderating the recovery in employment. The progress in the vaccine campaign, with just over 73% of the entire population having received at least one dose as of early November, should allow more restrictions to be lifted in the next months.

Public spending reallocations and low interest rates support the recovery

Despite limited fiscal space, Costa Rica is supporting the recovery by reorienting public spending towards health and social programmes. The fiscal situation has recently improved thanks to strong revenue performance and expenditure restraint in line with the fiscal rule. The projections assume that the public employment reform will be implemented and additional measures increasing fiscal revenues will be approved. However, planned measures to increase revenues remain unlegislated and they are key to meet the government’s fiscal plan to achieve the primary surplus target of 1% of GDP by 2023 and put the public debt-to-GDP ratio on a downward path. Similarly, the approval of the public employment bill is critical to increase public spending efficiency and ensure that a higher share of public spending supports the most vulnerable. The central bank’s credit facility programme, amounting to around 2.3% of GDP and aimed at providing liquidity to the private sector, was finalised last June. It has been almost entirely used to renew existing credits at lower interest rates, involving largely households and micro and small enterprises that received around 70% of the total amount. The central bank is also supporting the recovery by maintaining interest rates at historically low levels, and should continue to do so as long as inflation expectations remain well anchored and inflation remains below the 3% target. An independent central bank, focused on maintaining low and stable inflation, is vital to navigate potential episodes of uncertainty and financial volatility.

Domestic demand will strengthen gradually

Exports are driving growth, with domestic demand strengthening gradually as remaining economic restrictions are lifted in the first half of 2022 and the successful vaccination campaign progresses further. The gradual reactivation of tourism throughout 2022-23 will support the recovery in labour intensive sectors, improving employment. The public finances are expected to continue improving, with spending remaining contained, in line with the fiscal rule, and revenues benefiting from higher economic activity. However, political gridlock that delayed the approval of the additional fiscal measures underpinning government fiscal plans would hinder public debt sustainability, with potential negative repercussions on financial markets and the exchange rate. Inflation is projected to reach 2.4% in 2022 and 2.9% by end 2023, increasing gradually in accordance with the pace of recovery of domestic demand and labour market conditions, and as large idle domestic resources get slowly absorbed. The high degree of dollarisation of Costa Rica’s economy exposes the country to risks associated with sharp exchange rate movements, which could stem from an unexpected tightening of global financial conditions. A higher-than-expected recovery in the tourism sector would boost exports and the labour market recovery.

Continuing reforms would strengthen the recovery

Continuing the implementation of the structural reforms initiated during the OECD accession process would strengthen the recovery and ensure that more Costa Ricans benefit from it. Reinforcing the childcare network would allow more women to access formal jobs and help reduce large educational inequalities. Strengthening the governance and performance of state-owned enterprises would benefit the economy as a whole, as they play a dominant role in many key sectors, such as electricity and banking. The high administrative burden to start a company could be reduced by establishing virtual one-stop shops, where all administrative requirements can be met at once and online. Phasing out remaining exemptions to the competition law would boost productivity and lower prices. Costa Rica is advancing in the implementation of the National Decarbonisation Plan that aims to achieve the goal of net-zero emissions by 2050. Initiatives undertaken include, among others, increasing the share of zero‑emission vehicles in the public transport fleet and maintaining the 100% share of electricity produced from renewable sources.