San José, Costa Rica, since 1956

Economy Saw Reforms

Outgoing President Abel Pacheco boasted economic growth and fiscal stability as he stepped down from the presidency and handed the country’s reins to free-trade advocate Oscar Arias this year.

Under the new Arias administration, the economy saw a key reform with the Central Bank’s implementation of a new exchange rate system. Arias also introduced his own version of fiscal reform, after Pacheco’s attempts to overhaul the tax system flopped, and tried to wrangle the Central American Free-Trade Agreement with the United States (CAFTA) through Congress (see separate stories).

Under Arias, Costa Rica’s continued economic growth was accompanied by a tightening of the fiscal belt, as the country’s trade deficit grew and the tourism sector’s growth slowed a bit.

Though Costa Rica enjoyed growth reaching nearly 7%, the annual State of the Nation report brought into question whether the country’s growth – driven by expansions in tourism, mobile telecommunications and exports – is something that trickles down to Costa Rica’s nearly one million residents living in poverty.

As in years past, the report suggested that the gap between rich and poor continues to grow in Costa Rica, despite the fact that the poverty rate dropped slightly, hovering at just above 20%, and unemployment dipped to 6%.

The booming construction industry, driven by expanding real estate along the central and northern Pacific coast, saw investment growth skyrocket more than 100% and help Costa Rica’s job market. But construction and real estate growth remained disorganized in much of the country, as municipalities lacked resources to enforce regulations and ministries tried to regulate from their desks in San José.

Though construction boomed along with the agriculture, export and industrial sectors, the tourism industry saw slowed growth this year, which tourism officials attributed to higher fuel prices, Costa Rica’s bad roads and competition for tourists with the World Cup soccer event in Germany.

Costa Rica’s high inflation rate remained a rock in the economy’s shoe – though by updating inflation rate indicators and implementing a new exchange rate regime, the country saw last year’s 14% inflation rate drop this year to about 10%.

The economy’s biggest change was the implementation of a new exchange rate regime, in which the country left behind its decades-old system of mini-devaluations to let the colón’s price against the U.S. dollar be determined by supply and demand – semi-regulated by Central Bank intervention. The new currency band system bred uncertainty in the highly dollarized economy, though by yearend the exchange rate had stabilized after a dip when it was implemented in mid-October.

Though the liberalized exchange rate system is meant to give the Central Bank more power in controlling inflation, the country’s inability to pass fiscal reform may restrict that power. Fiscal reform would give the Bank the funds it desperately needs to crawl out of its $2 billion debt and efficiently manage inflation.

As the Central Bank celebrated the implementation of its new system, the National Stock Exchange celebrated its 30 years of existence.

An October report from the credit agency Fitch Ratings concluded that Costa Rica’s banking sector remained weak this year. The Costa Rican banking system is partially state-owned, highly dollarized and has a largely unsupervised offshore banking system.

The assembly introduced legislation in August that would help regulate offshore banks and give banking laws more teeth, but at year-end it had not advanced.

The Fitch report said the recent acquisition of large local private banks – such as the June $293 million buyout of Banco Interfín by the Canadian Scotiabank – is likely to reduce risks associated with offshore banking activities.

Costa Rica’s fiscal deficit decreased 37% from January to October this year compared to the same period last year. Though government spending was on the rise, officials also collected more taxes.

Many high-tech firms expanded this year, promising to create thousands more jobs in Costa Rica, news that the government applauded. Intel received a special pat on the back by the government and President Arias for the jobs, training, and investment the U.S. company has brought to the country in its nearly 10 years here, while Hewlett-Packard quietly became the country’s largest employer in the services sector.

Foreign investment continued to grow, the majority of which came from the United States, including the world’s biggest retailer, Wal-Mart, which bought out some of the nation’s biggest supermarket chains early in the year.

The nation’s free zones, where nearly half the country’s $861 million in foreign direct investment lands, were shrouded in uncertainty at year’s end. The administration’s fiscal reform plan would strip the free zones of their tax incentives by 2010 – as is required under World Trade Organization mandate.

Business and government leaders alike continued brainstorming to find new ways for Costa Rica to become more attractive to foreign investors.



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