Country Report Costa Rica September 2008

Outlook for 2008-09

• The government will focus on passing the laws required to bring DR-CAFTA into effect and is confident this can be done well before the October deadline.
• The government will also prioritise a programme to cushion the poor from high food prices, and to encourage farmers to increase plantations.
• Our forecast for GDP growth to slow to 3.5% in 2008 and 2.5% in 2009 owing to a sharp deterioration of the external balance and the impact of high inflation on domestic consumption remains unchanged.
• We forecast that the Central Bank will manage a controlled real depreciation of the colon, following a spell of volatility. However, the currency may be subject to greater pressure to weaken, given a deteriorating external balance.
• The current-account deficit will almost double in 2008, owing to strong first-half demand, high oil imports and weakening export growth. With just 56% of the deficit forecast to be financed by FDI in 2008, reserves will fall. The current-account deficit will narrow in 2009 as the oil import bill decreases.

Monthly review

• The government has made cabinet changes in response to an investigation into alleged misuse of funds at the housing ministry.
• There has been further progress in the passage of laws to enable DR-CAFTA to come into operation, with the final telecoms bill passed in August. Only two laws now need to be passed before the deal can be implemented.
• Monetary policy has been tightened further, with the Central Bank reference rate rising by 1 percentage point in each of July and August, to 10%.
• Bank profits contributed to stronger government accounts over the first seven months, but customs and sales tax revenue growth appears to be slowing.
• The Central Bank has intervened to calm currency volatility, bringing about a 23% fall in foreign reserves between April and August.
• Prolonged high food and energy costs pushed inflation to an eleven-year high of 15.4% in August.
• In June economic activity slowed significantly in all sectors of the economy, including construction. Higher interest rates, a weak colon and the collapse in the US housing market are starting to have an impact on the sector.
• Private credit growth is still solid, although it is showing some signs of easing.
• As the colon continues its depreciation against the US$ and real interest rates are negative, investors move out of financial assets denominated in local currency at an increasing rate.