San José, Costa Rica, since 1956

Bad Economic Weather Moving In

The financial crisis sweeping the globe is creeping up on Costa Rica, with a dip in foreign investment leading a pack of problems prompting some of the country’s economists to predict a recession.

While Costa Rica’s banking system is relatively isolated from the ailing banks in the United States and Europe, the general lack of liquidity in the global markets means the country is seeing less direct foreign investment.

Costa Rica’s banks, reluctant to loan, are holding on to their dollars and granting less credit, at higher rates. This means business customers will have trouble restocking their stores, and other clients will struggle in repaying their loans, leading to a slowdown in commerce.

“There is going to be less money (for consumers) to spend and lower production and lower employment,” said Luis Mesalles, a former board member of the Central Bank and general manager of La Yema Dorada, a food manufacturer. “This is going to come, and people need to be prepared.”

A Balancing Act

Unlike in other Latin American countries, where a recent but now-halted commodity export boom allowed central banks to store up cash, Costa Rica has been running a trade imbalance for decades. In August, the trade deficit was nearly $3.9 billion (TT, Sept 26).

“A financial crisis is potentially more damaging for a Central American country than any other in Latin America,” said Mauricio Cárdenas, a senior fellow at the Brookings Institution think tank in Washington, D.C., and the former minister of economic development in Colombia. “In Central America, countries are running a (trade) deficit, which means that they have to access markets to finance that deficit. If the markets somehow get more illiquid, then this country will be in a situation where they eventually will have to use their reserves.”

Costa Rica’s Central Bank has about $3.77 billion in reserves, the lowest in nearly a year. It’s been spending rapidly in the past few months to keep the colón-to-dollar ratio within the boundaries it set in 2006, as the trade deficit puts pressure on the colón’s value.

“Construction investment has already started to shrink in some sectors last month, which implies that we don’t have all these dollars that we used to finance our deficit anymore,” said Eric Vargas, strategy director at the financial advising firm Aldesa. “We’re in a recession. It’s already started or it’s about to start.”

The economy is definitely slowing. In 2007, Costa Rica’s gross domestic product grew by 7.3 percent. The International Monetary Fund predicts it to grow about 4 percent this year, and only 3.5 percent in 2009.

Isaac Castro, chief economist at the finance company Interbolsa, said GDP growth could drop below 2 percent if the economic situation in the United States, Costa Rica’s largest export destination, worsens.

The delay of several major tourism projects, like the $800 million Cacique complex on the PacificCoast, has economists worried about the decline of foreign investment, especially in the real estate and tourism sectors.

Bye-Bye, Credit

But it’s not just big international projects that are unable to raise funds. Small- and medium-sized businesses in Costa Rica also are feeling the credit crunch.

Anselmo Sánchez, the president of the Association for Small and Medium Businesses (ASOPYMES), said businesses that rely on imported goods, like clothing stores, are the first to feel the pain of tightened credit.

“It’s going to affect small businesses really strongly,” Sánchez said. “The projects that they aren’t giving credit to aren’t going to go through.”

Vargas said the decrease in liquidity won’t be as “violent” as it is in the U.S. and Europe.

“But our impression is that the financial system is facing a big restriction of banks’ ability to give credit.”

To restore movement in the credit markets, Castro said, the Central Bank should inject some capital into banks, even at the risk of worsening inflation, which is predicted to be at 14 percent for the year. Banks are required to keep 15 percent of their deposits with the Central Bank, and Castro thinks that number should be lowered, so that more currency can begin moving around.

“This would have an impact on inflation, but we think that the danger right now isn’t so much inflation as businesses not being able to finance their normal operations,” Castro said. Banks are holding on to their money so that customers do not lose confidence and demand their savings back.

“The banks are keeping their money to be safer, even though it has heavy consequences on their profits, but that’s better than having people forming a line outside to take out their money,” said Danilo Montero, general manager of Interbolsa. “It would be great if we had a Central Bank that was more in the game.”

Bank Deposits Secure

Despite the slow-moving credit, there is no reason – at least not yet – to fear defaults in Costa Rican Banks.

State-owned banks, like Banco de Costa Rica, Banco Nacional and Bancrédito guarantee their deposits without limit 100 percent.

Private banks have a common reserve with the Costa Rican Bank Association, though its executive director, Maria Isabel Cortés, would not disclose the amount of money in that fund.

“There are some banks that invest abroad but mostly in foreign treasuries, so the impact (of the financial crisis) would be less strong,” Vargas said. “You can’t say it’s totally safe. They’re more isolated but still vulnerable.”

The Costa Rican banking system is also much less developed than that in the U.S. and doesn’t deal in the exotic financial instruments that sparked the crisis there, according to economists.

Cortés said the banks are safe. “There are no important risks that could generate any worries about the Costa Rican financial system,” she told The Tico Times.

“The banks will not feel, directly, the U.S. crisis. However, lines of credit that local banks have with U.S. banks could shrink.”

Cortés recommends caution before investing or taking on debt.

“In case of a profound crisis, public banks have support,” University of Costa Rica Professor Rudolph Lucka said. Public banks tend to have less invested abroad, he added, but also have lower interest rates than private ones.

“I think for the moment that we don’t have to worry about the money we have in the banks right now,” said former Central Bank President Eduardo Lizano said. But, he cautioned, “Keep an eye out, or even better, two eyes out.”

The Central Bank recently switched most of their reserves invested in North America to U.S. Treasury bonds, a safer investment, and raised their safety standards for investment in general, according to Héctor Ávila, the bank’s director of assets and liability.

Silver Linings

Two bright spots on the horizon are lower gas prices and an upcoming loan from the Inter-American Development Bank (IADB).

Gas prices dipped under $70 a barrel Thursday, a 52-week low, which could significantly help Costa Rica’s trade imbalance and inflation, said Eduardo Lora, the chief economist in the IADB’s research department.

A loan of $9.3 billion from the IADB and two other organizations will be divvied up among Latin American countries – no more than $500 million per country – for infrastructure and to help restore credit lines.

Costa Rica’s Legislative Assembly would have to approve the loan. The funds would most likely go to infrastructure projects.

A large infrastructure project would provide jobs, and better infrastructure might attract more foreign investment – both of which would be welcome relief if the economy contracts as severely as the experts are predicting.



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