Tue | Mar 19, 2024

Walter Molano | Costa Rica: Paradise lost

Published:Friday | November 6, 2020 | 12:15 AM
AP
Street view of San José, the capital of Costa Rica.
AP Street view of San José, the capital of Costa Rica.

In theory, Costa Rica should be one of the best credits in Central America.

It is a well-diversified economy, with agriculture, manufacturing and tourism, giving it a much more stable trajectory than most of the other countries in the region. It is a relatively wealthy country, with a GDP of about US$60 billion, a population of about five million, and an annual per capita income of about US$12,000.

During the past six years, Costa Rica averaged a GDP growth rate of 3.2 per cent year-on-year. This was significantly higher than the annual population growth rate of 0.9 per cent, thus resulting in a 2 per cent improvement in per annum income.

This year, the economy is expected to contract 3.3 per cent, due to the onset of COVID-19. Fortunately, the pandemic has not had the same ravaging effect as in other countries. This could be partially due to its impressive healthcare system, but it has not been cheap.

The annual fiscal deficit through the first half of the year was 7 per cent of GDP, and it is expected to close the year at 9 per cent of GDP. The government has persistently suffered from poor fiscal performance due to mandated entitlement programmes and the atomisation of the political parties which, in turn, led to gridlock.

At the end of 2018, the government enacted a thorough fiscal reform which transformed the sales tax into a value-added tax, added new tax brackets for high wage earners, and introduced a fiscal rule that limited increases in spending to 75 per cent of the average nominal GDP growth rate over the past four years.

The measures were supposed to stabilise the debt-to-GDP ratio by 2023. However, it was announced before the onset of COVID-19, and since then the fiscal picture has deteriorated further.

To this end, the Costa Rican government is requesting a US$1.75-billion Extended Fund Facility from the International Monetary Fund, IMF, which, unfortunately, was postponed. Not surprisingly, Fitch lowered its credit rating for Costa Rica to B from B+ in June. The rating agency cited the high fiscal deficit, as well as the steady increase in the debt load.

External debt as a percentage of GDP has soared more than 50 per cent since 2014, going to 46 per cent of GDP in 2019 from 30 per cent of GDP in 2014. Moreover, international reserves cover only a quarter of the debt, leaving the country highly exposed.

Transformation at high cost

One of the market’s major concerns is the government’s electricity/telecoms giant, Instituto Costarricense de Electricidad, or ICE. Although the government does not explicitly guarantee the highly leveraged conglomerate, it is its sole owner and there seems to be an implicit commitment that is not reflected in the government’s balance sheet.

One of the main reasons ICE is so leveraged is that it went on a huge investment spree, building a series of large hydroelectric plants. This converted the country into an environmental paradise, allowing it to claim that 98 per cent of its electricity was generated from renewable sources. Still, the transformation carried a very high price.

Costa Rica is often praised for its well-diversified external sector, particularly in tourism, but the onset of COVID-19 made it more of a liability. The Central Bank of Costa Rica reported a deficit of US$260 million in the current account balance during the second quarter of this year, after reporting a surplus of $9.8 million in the first quarter.

Part of the decline in tourist receipts was offset by the fall in oil prices, but the country also lacks the remittance inflows of most of its regional peers

Given its relative prosperity, not many Costa Ricans emigrate. On the contrary, many migrants, particularly from Nicaragua, move to Costa Rica for better opportunities.

While Costa Rica may be considered to be a modern-day democracy, its political stability has been deteriorating over the last two decades. Up to 2002, two dominant political parties, the Social Christians Unity Party, SCUP, and the National Liberation Party, NLP, controlled the political system. However, the rise of a third party, the Citizen’s Action Party, CAP, broke the two-party hegemony and led to an eventual fragmentation of the system.

The process has accelerated as evangelical missionaries from the United States pushed local congregations towards conservative political values, particularly in regard to marriage, reproductive rights and gender identity.

In 2018, President Carlos Alvarado Quesada, of the CAP, won against Fabricio Alvarado Munoz, of the National Restoration Party. Munoz, an evangelical pastor and Christian pop star, ran on the issues of same-sex marriage, abortion and gender rights.

Advised by many of the same groups that drive the conservative agenda in the US, the new political parties and players have been urged to block the legislative process unless the government gives into their social issues. The result has been the formation of a political gridlock, which has led to the deterioration of the country’s macroeconomic indicators and given rise to a situation of paradise lost.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com