The Costa Rican Flag
The blue colour is said to stand for the sky, opportunity, and perseverance; white denotes peace, happiness, and wisdom; while red represents the blood shed for freedom, as well as the generosity and vibrancy of the people. The shield contains 3 volcanoes, 2 ships on water (representing the Pacific and Caribbean coasts), and 7 stars (representing each of Costa Rica’s provinces). The central red stripe was added in 1848 when, in response to revolutionary activity in Europe, it was decided to incorporate the French colours into the national flag.
Costa Rica: At a glance
Structure of the economy
Costa Rica is the most prosperous of the Central American Common Market’s five countries, where it has reached upper middle-income status via stable economic growth over the last 30 years. This success story has been largely underpinned by Costa Rica’s commitment toward trade openness which has attracted foreign direct investment. Over this robust period of development for the country, where GDP per capita has tripled, the economy has broadened beyond its dependence on agriculture, diversifying into tourism, electronics, medical components and IT services. As such, Services (70% of GDP) dominate the economy, followed by Industry (19% of GDP) and Agriculture (4% of GDP). Costa Rica has a strong export focus (40% of GDP); its main export products are optical/technical medical apparatus (32% of total) and its main trade partner is the United States (42%). Costa Rica is also a global leader in its commitment to sustainability; it is one of the few countries which has succeeded in reversing deforestation and also stands out internationally as one of the first nations to establish the target of achieving zero net emissions of C02 by 2050. Likewise, Costa Rica is a regional trailblazer when it comes to social care; the universal healthcare system has resulted in the highest life expectancy in Latin America.
Despite the rapid economic achievements in Costa Rica over recent decades, the country faces significant challenges in the wake of the pandemic. The economy suffered badly last year, slipping into a sharp recession, where GDP contracted -4.8% in 2020. While the economy is expected to rebound over the next two years, with IMF GDP forecasts of 2.6% in 2021 and 3.6% in 2022, the recovery is likely to be sluggish. The economy faces a number of headwinds, including; tough fiscal consolidation, rolling pandemic disruptions and a slow recovery in the tourism sector.
In response to the pandemic, the Central Bank of Costa Rica (BCCR) cut its policy rate to a record low of 75bps in June last year. The BCCR left policy rates unchanged at this level in at the recent meeting in July, opting to insulate the nascent economic recovery. The central bank is in no rush to tighten policy while inflation remains subdued; inflation at 1.44% in July remains at the lower bound of the 2%-4% target band. Over recent weeks, the central bank has updated its economic forecasts, upgrading the growth outlook for this year to 3.9% from 2.9%, citing a recovery in manufacturing activity and vaccination progress. The BCCR also marginally upgraded the growth outlook for 2022, where it now expects GDP at 3.7% compared with the previous estimate of 3.6%.
The economic damage wrought by the pandemic has brought a reckoning for Costa Rica, after years of mounting debt used to finance its comprehensive social welfare system; ambitious fiscal reforms which commenced late-2018 came too late to insulate the economy from the crisis. The contraction in the economy and the emergency pandemic response measures pushed the debt to GDP ratio to 70%; the minister of finance has estimated that 42% of the $19bn national budget would be allocated to debt repayments and interest payments. As such, Costa Rica was forced to open negotiations with the IMF for economic support. In September last year, the government announced the terms of the $1.75bn IMF loan under the Extended Fund Facility (EFF), which required tax reform, public sector wage freezes and the sale of some state assets. In sum, Costa Rica pledged to eliminate the primary deficit by 2023 and bring the debt down to 50% of GDP by 2035, which requires a series of unwelcome adjustments totaling 4.75% of GDP.
Alongside Chile and Uruguay, Costa Rica has one of the strongest democracies in Latin America. That said, over recent months, Costa Rica has not been immune to the political tensions that have been troubling neighboring countries. The political backdrop in Costa Rica has traditionally been dominated by two parties; the left leaning National Liberation Party (PLN) and center-right Social Christian Party (PUSC). Both have suffered splits over recent years, forming two breakaway groups, the Citizens Action Party (PAC) and the National Integration Party (PIN). There was barely a winner following the 2018 election, with current president Quesada (PAC) attaining a razor thin majority. As a result, the country has become increasingly difficult to govern, with the much-needed fiscal reforms often blocked in congress. At the same time, social unrest has flared in response to news of the IMF deal, resulting in months of protests and strikes. Public cynicism stems from the damaging experience in the 1980s, where the IMF mission was expelled by conservative, center-right, Carazo Unidad administration. Following months of negotiations, lawmakers finally voted to approve the IMF agreement just last month, paving the way for an initial disbursement of $292m; the balance of the debt will be paid over the next three years.
Bottom line: Silver medal
We are cautiously optimistic when it comes to the outlook for Costa Rica. From a bottom up standpoint, while downside risks remain, the recovery is likely to gather momentum over the next two years, reflected by the constructive IMF outlook over that horizon. At the same time, the domestic rebound continues to enjoy support from the BCCR; muted inflation pressure has facilitated ongoing policy easing to insulate the recovery. That said, we do note that challenges remain in terms of the fiscal backdrop, however, the approval of the IMF package in congress signals a commitment to reform, which will be underpinned by international support.
From a structural perspective, as noted in our Roadmap for Q3 and Beyond, we believe that the current backdrop is complicated for emerging markets. That said, in our view, there are selective opportunities to extract alpha from EM. Why? As noted under our investment theme – Sticky Inflation, Structural Headwinds – we stick to our longstanding view that recent price pressures are transitory. As such, we believe that the Fed will introduce a controlled normalisation of monetary policy under the AIT framework, which will encourage selective carry positions; we believe that with the recovery likely to gather pace in the coming years, Costa Rica represents a solid opportunity in this respect.
1. United Nations;
3. The World Bank.
Olympics data: Olympiandatabase.com
All other data is ESLJ, 2021.
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