Latin America Advisor

A Daily Publication of The Dialogue

How Serious Have Costa Rica’s Fiscal Problems Become?

Costa Rica’s finance minister, Rodrigo Chaves, recently said the government will sell state assets in order to lower its debt level. // File Photo: Costa Rican Government. Costa Rica’s finance minister, Rodrigo Chaves, recently said the government will sell state assets in order to lower its debt level. // File Photo: Costa Rican Government.

Costa Rican Finance Minister Rodrigo Chaves announced this month that the government is planning to sell state-owned liquor distillery Fanal and a public bank in a bid to lower expenditures and use savings to pay down debt. The announcement came the same day as Moody’s Investors Service downgraded the country’s long-term issuer and senior unsecured bond ratings from B1 to B2. Standard & Poor’s credit rating for Costa Rica stands at B+ with a negative outlook, the same as Fitch’s latest rating. Why are ratings agencies taking a dim view of Costa Rica’s finances? Are the government’s plans to sell some of its assets financially significant, and what else should it do to manage the country’s ballooning deficit? What factors are driving Costa Rica’s growth, and what headwinds will the economy face in the period ahead?

Eli Feinzaig, economic consultant and chairman of the Liberal Progressive Party (PLP): “At 7 percent of GDP, Costa Rica’s fiscal deficit exceeded the government’s own projections by 0.8 percentage points in 2019, despite a 1.1 percentage-point jump in tax revenues due to the implementation of the December 2018 fiscal reform. The primary deficit jumped to 2.8 percent from 2.2 percent in 2018. Finance Minister Rodrigo Chaves’ announcements lacked credibility for the same reason that the deficit ballooned: the government has shown no taste for fiscal discipline. His proposed action plan is lacking in detail. His promise to cut tax evasion in half within two years depends on a highly unlikely timetable of events, and no particulars were provided as to how that goal could be achieved. Although the minister’s plan to concession the state-owned liquor distillery and sell a public bank are a welcome policy change, success is not guaranteed in a highly divided congress. Furthermore, with public debt hovering near 60 percent of GDP, the government is expected to raise no more than $200 million from both transactions, barely 0.5 percent of outstanding debt. With the full impact of the tax increase on economic growth to be felt only in 2020, current expenditures growing 50 percent faster than revenues, a weak economy growing well below its full potential and unemployment (12.4 percent) at its highest in four decades, the government’s plan to close the budget gap by selling relatively minor assets and tightening tax collection efforts will further erode consumer and producer confidence, which already stand near historic lows. It is precisely the opposite of what is needed at this juncture.”

María Inés Solís, chief of the Christian Social Union Party (PUSC) faction in Costa Rica’s Legislative Assembly: “In recent days, several items of bad news roiled the Costa Rican economy. We were informed and surprised by news that the fiscal deficit was higher than what political authorities expected, reaching nearly 7 percent of GDP. Subsequently, it was announced that Moody’s lowered Costa Rica’s rating, from B1 with negative outlook to B2 with a stable outlook. Following those announcements, the government proposed a series of measures, including the sale of Fábrica Nacional de Licores (Fanal) and the International Bank of Costa Rica (BICSA). Although they are necessary actions, they are not enough. We must take measures that can really affect the Costa Rican economy, including a plan for structural reforms. The sale of these two institutions would only contribute 0.03 percent to GDP in the case of Fanal and 0.04 percent in the case of BICSA. It is a pity that the Alvarado administration did not decide to sell two institutions that would significantly provide resources to the state, such as the Bank of Costa Rica (BCR) or the telecommunications sector of the Costa Rican Institute of Electricity (ICE). It is also urgent for Costa Rica to pass other laws that can contribute to reducing the government deficit, such as the constitutional fiscal rule and the public employment law. It is an opportune time to start talking about state reform, one that would allow eliminating existing redundancies of state enterprises, as well as merging or closing down public entities. With the implementation of such measures, we would contribute to a cleansing of state finances.”

Silvia Hernández, chief of the National Liberation Party (PLN) faction in Costa Rica’s Legislative Assembly: “The Finance Ministry’s measures to combat the weight of debt interests and Moody’s ratings downgrade have as a common denominator the adjustment process for public finances as well as doubts regarding the sufficiency and terms of that process. The downgrade comes because of doubts as to whether the reform is sufficient, and above all, whether the executive branch will be capable of carrying out the adjustment, especially when it comes to expenditures. The reform’s tax component has been resolved, so the question now is whether the fiscal rule will be applied correctly, and whether it will be enough to recover sustainability of the public debt. The problem Costa Rica faces to generate credibility and confidence is not just an economic problem, but also a political one, since the state doesn’t feel it is part of the necessary adjustment. This is why external actors increasingly don’t get their hopes up. In the current fiscal adjustment process, doubts have arisen because of the adjustment’s size and its effects on the debt, but above all, because a political calmness is perceived, as if the problem were already solved. A greater emphasis on trying to make adjustments and trying to achieve concrete results quickly is missing, as well as clearer results, beyond programs or plans—results aimed at reducing the primary deficit and at showing that we are handling public finances more ably. New measures seeking to reduce debt, the primary deficit and access to external financing cannot be just to save time and make the adjustment process more digestible. There is a fear that there will be no emphasis on the structural reforms needed, and that we will end up with more debt and closer to a scenario as recent and terrible as that of 2018, which was very traumatic for the country.”

Gabriel Torres, vice president and senior credit officer at Moody’s Investors Service: “Costa Rica’s main credit challenge is its high fiscal deficits, averaging more than 6 percent of GDP since 2015. These large deficits have in turn pushed debt increasingly higher, and we expect it will reach 63 percent of GDP this year. On Feb. 10, Moody’s downgraded Costa Rica’s sovereign rating to B2 based on these elevated deficits and deteriorating debt metrics. In 2018, the government passed a fiscal consolidation law, but we expect the adverse fiscal trends will likely continue since the reform will be gradually implemented, and the government has found it difficult to maintain fiscal discipline. Last year Costa Rica’s fiscal deficit reached 7 percent of GDP. Despite an 8-percent increase in overall revenues last year, the government deficit was considerably wider than the authorities’ original target, driven by increased interest costs and higher capital spending. Based on current trends, we expect debt will continue to rise, approaching 70 percent of GDP by 2022. Further fiscal reform will likely be required to bring the deficit down to levels that stabilize the debt. One-off measures, including selling government assets, can reduce the debt, but lowering the deficit will require more permanent measures. Costa Rica remains vulnerable to external shocks, but it has historically shown an ability to adapt and has even managed to create a high-tech export sector, uncommon among other countries in the region. We expect the economy to grow close to 2.5 percent in 2020, below its long-term potential but higher than in 2019.”

Ottón Solís, Costa Rica representative at the Central American Bank for Economic Integration and former presidential candidate for the ruling Citizen’s Action Party (PAC): “Costa Rica has strong fundamentals for growth and stability. Ratings agencies do not confer weight to literacy levels or access to electricity, communication services and clean water, nor to low crime, political stability, respect for human rights and environmental sustainability, which are the factors driving Costa Rica’s growth. Fortunately, private capital does. That is why foreign direct investment continues to grow, central bank foreign reserves stand at record levels, the colón currency is fully stable against the dollar, and inflation averages that of the most advanced economies. Privatizing noncore businesses and using surpluses from successful government enterprises to extinguish debt is a major and significant step toward limiting its growth. The primary deficit is under control. It would have fallen but for some once-and-for-all expenditures that required budgeting in 2019, related to the strong pruning and altogether closing of government entities. Most importantly, that deficit increased also as a result of a very welcome boost (of half of a percentage point of GDP) to infrastructure expenditure. The core of the deficit problem for Costa Rica lays on the interest payments bill. It is urgent to complement actions already undertaken and others just unveiled, with a restructuring of public debt, extending maturity and lowering interest rates. It was expected that after the painful and comprehensive revenue and expenditure reforms of 2018 that Washington multilateral banks would be forthcoming toward reshaping Costa Rican debt. That has not been the case. Therefore, the government is seeking that funding from other sources.”

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