Caribbean & Central America - November 2020

Costa Rica was already facing mounting fiscal problems, and the coronavirus (Covid-19) pandemic has worsened the situation.

Costa Rica’s GDP will contract by 5% in 2020 due to the impact of the pandemic, according to the country’s central bank (BCCR), which also forecasts that central government debt will reach 70% of GDP and the fiscal deficit 9% of GDP. The BCCR’s latest monthly economic activity index (Imae) for August 2020 showed a 7.7% decrease year-on-year, and on 9 October the national statistics institute (Inec) released new figures which show the national unemployment rate stood at 23.2% in the June-August 2020 rolling quarter. This represents an increase of 11.8 percentage points on the same period in 2019. 

While shocks to economic activity and the unemployment rate can be attributed to the impact of the pandemic, Costa Rica’s fiscal problems are longstanding. Indeed, the country passed a fiscal reform in 2018 aimed at relieving these fiscal pressures. In response President Carlos Alvarado made a number of proposals to cut the debt ratio and fiscal deficit and announced plans to begin negotiations with the International Monetary Fund (IMF) over a US$1.75bn three-year financial assistance programme.

The proposals, which the government claimed would reduce public debt by six percentage points, included public spending cuts and various temporary tax rises. These included an increase in taxes on individuals at higher income levels (earning over ¢840,000 [US$1,405] a month); a 0.25% increase in taxes on property; a new 0.3% levy on financial transactions for two years, falling to 0.2% for the following two years; and new taxes for business. Other proposed measures included selling the stated-owned liquor factory, Fábrica Nacional de Licores (Fanal), and the state’s share in the Banco Internacional de Costa Rica (Bicsa). These plans would allow for a fiscal adjustment of 24.02% of GDP in four years and reduce the debt-to-GDP ratio to 50% by 2034, according to an analysis by the Guatemala-based economic think-tank Instituto Centroamericano de Estudios Fiscales (Icefi) released on 1 October.

But the plans - or rather the mention of proposed tax increases - sparked widespread protests that forced President Alvarado to withdraw the proposals and launch a national dialogue to work out what comes next. His options are limited, however. The Alvarado administration is hamstrung by a weak presence in the legislative assembly, where the ruling centre-left Partido Acción Ciudadana (PAC) holds just 10 of the 57 seats, and opposition parties have ruled out supporting any tax increases. One alternative could be to remove tax breaks, which Icefi says could represent a minimum of 2.2% of GDP. Icefi also called for tougher measures on tax evasion. 

Another avenue open to the government is to cut public spending, and the 2021 budget proposal includes a ¢368bn reduction in spending compared with the 2020 budget - equivalent to 1.02% of GDP. It is also pledging to introduce further cuts of ¢150bn in public spending in January 2021. However, Icefi warns against spending cuts during a time of crisis and has called on the government to reconsider proposed sales of assets such as Fanal, arguing that it would bring in cash in the short-term but reduce long-term capacity to create revenue. One thing the institute does recommend is a plan to restructure the public debt, which is currently very expensive.  With opposition figures unwilling to budge on tax increases and Alvarado lacking the legislative seats to push measures through, it appears the country is at something of an impasse.

•  IMF help

At the end of August, President Carlos Alvarado hailed the legislature’s approval of a US$504m loan in emergency financial assistance from the International Monetary Fund (IMF) under its Rapid Financing Instrument (RFI), to support coronavirus-related health spending. According to the IMF, these funds will help Costa Rica meet the urgent balance of payments needs stemming from the pandemic. According to Alvarado, the loan will allow Costa Rica to save some US$50,000 on a daily basis, by exchanging expensive debt for cheaper debt, while US$50m will go on strengthening the national social security institute (CCSS).