Costa Rica Economic Outlook - Interview with Abelardo Medina, Senior Economist at Icefi

In early September, authorities tabled the 2021 draft budget for Costa Rica, amid high uncertainty due to the Covid-19 pandemic. The 2021 budget bill included an increase in the fiscal deficit to 9.9% of GDP from 9.3% this year. To delve deeper into the budget and its implications for the economy, we spoke to Abelardo Medina, head of Icefi’s macro-fiscal analysis department.


 

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Abelardo Medina Bermejo

Abelardo Medina, PhD in taxation, is in charge of macro-fiscal analysis at Icefi. Before joining Icefi, he worked for 14 years in the Superintendency of Tax Administration (SAT) in Guatemala. He was also director of the economics course at the Rafael Landívar University and coordinator of the program in Central Banking Economics financed by Banguat.

 


 

  • What is your assessment regarding the economic outlook for the year ahead?

The outlook is uncertain both domestically and internationally, as even though strict lockdown measures have been lifted in many countries, there is still the risk of spikes in cases, and no vaccine is expected to be available in the near term. Due to these factors, as well as the fiscal and social crisis, we expect a slow rebound in 2021, more a product of inertia following a crisis rather than an improvement in economic agents’ confidence, with growth of 2.0% to 3.0%, which is well below potential.

  • How will the 2021 budget affect the economy?

Despite containing measures to tackle Covid-19, the budget is austere, with total spending 1.7% below 2020, and a 22.8% decline in real investment. Even though unemployment had doubled by August in annual terms, spending on public sector wages will only rise 3.7%. There will also be a notable regression in terms of social welfare, as social spending will fall from 14.7% to 13.4% of GDP. However, public debt payments will rise from 11.5% to 13.5% of GDP. In addition, 54.9% of the budget is to be funded by borrowing. This means that until external financing is secured, the government will have to rely on domestic financing, which could crowd out private investment.

  • Are the assumptions upon which the budget is built realistic?

The budget bill was prepared under assumptions built on the macroeconomic outlook prepared by the Central Bank, although it is still early to estimate what lies in store for the economy by 2021, given the changing dynamics in recent months. The budget tables fairly optimistic figures, if we consider the significant declines shown by key indicators, and the fact that the Central Bank foresees a greater economic contraction in the second half of 2020, and a 5.0% drop in national production in 2020 as a whole. The health situation remains uncertain, while the country was already slowing economically prior to 2020.

Another assumption is that the country will sign an agreement with the IMF to negotiate and postpone debt payments to the Fund, and to arrange new disbursements under more favorable conditions. However, in order to achieve this, the country needs to boost confidence in its ability to meet its obligations.

  • Do you think Costa Rica and the IMF will reach a bailout agreement?

It is not very feasible in the current climate, as even though the country’s public finances need restructuring to avoid serious fiscal sustainability issues, the conditions of the IMF agreement could deepen the social crisis the country is currently going through. The most appropriate way forward, before any fiscal changes, would be for a participative and universal discussion covering the government’s obligations and solvency, as well as society’s willingness to pay more taxes. It is imperative to discuss the effective implementation of a progressive and broad-based tax system, which seems to be one of the main areas of disagreement currently.

  • What will be the implications of the budget for the country’s credit rating?

In an effort to contain public spending and meet the high cost of servicing the debt accumulated in recent years, the authorities have proposed a budget with few or no economic implications. While there are proposed increases in resources for some tourism-oriented activities, some education items and some healthcare services, the rest of the budget shows significant reductions, including in investment expenses and transfer spending. In the absence of measures to increase its own revenues, the country will be forced to borrow to finance more than half the budget. Under this scenario, the major credit rating agencies, which have already downgraded the country’s credit rating in recent years and have consistently raised the alarm regarding deteriorating public finances and the lack of diversification of funding sources, are likely to see increased risk. This will worsen Costa Rica’s credit profile even further relative to its peers.

  • What is your outlook on the fiscal situation?

Without a serious discussion on the country’s fiscal situation, public debt will keep rising, and could reach close to 80% of GDP, far above the levels recommended by the IMF for emerging economies with access to financial markets. Unfortunately, revenue generation will remain low—below 13 % of GDP—despite the recent tax reform, due to the absence of an effective strategy to fight evasion, tax fraud and illicit capital flows. As such, the government will remain focused on restraining spending, which could generate social conflict.

  • Could Costa Rica suffer a public debt crisis?

It is possible in the medium term. It is clear that the country needs to rollover its debt, but it must also create new sources of revenue to meet previously incurred obligations. Although managing the debt structure seems to be a secondary issue, it is also appropriate to move towards a restructuring process now.

  • The 2021 budget anticipates a fall in public investment. Does the government have a plan to attract foreign investment?

The external situation is causing FDI to fall around the world due to elevated uncertainty. Even though Costa Rica has fiscal issues, which imply financial and exchange rate risks, many economic fundamentals remain intact, and as such the country is still considered the second most attractive destination in Central America for FDI (after Panama). However, there are still areas to improve, chiefly when it comes to fiscal and macroeconomic sustainability, improving transparency, upgrading infrastructure and boosting public sector efficiency.

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Author: FocusEconomics

Date: November 3, 2020

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