The Central Bank of Costa Rica (BCCR) estimates that the national economy grew 5.1% in 2023, while the country’s economic growth by 2024 and 2025 will be on average 4%, which would be driven mainly by domestic demand, in particular by investment and household consumption.
The pace of growth in external demand would moderate from 2023, due to the expected slowdown in economic activity of our main trading partners.
Economic cojuncture
The international environment continues with significant challenges to the performance of the world economy and therefore for our country. War conflicts seem far from a solution and rather in some, such as the armed confrontation between Israel and the Hamas group, the risks of its expansion and transformation into a regional conflict have been increasing.
Added to this are events that generate uncertainty, such as high indebtedness in many countries and the results of the electoral processes to be carried out this year in some countries.
One of the concerns surrounding these events, especially wars, is that they may cause a significant increase in the price of raw materials, especially oil, which slows or even reverses the progress made by central banks in controlling inflation.
However, while the price of this raw material rose at the beginning of the conflict between Russia and Ukraine, it subsequently decreased and the impact of the attack on Israel so far has been more limited. This allowed inflation to continue the slowdown process that began since mid-2022, although the adjustment has been slower than initially anticipated.
On the other hand, despite the difficult environment, the world economy has shown strength because, although its growth has slowed, it did not enter recession, as expected months ago, with significant differences between countries.
The slower-than-expected adjustment in global inflation and the relative strength of the world economy has led central banks to maintain the restrictive tone of monetary policy, although advanced economies are expected to begin downward adjustments in their benchmark interest rates in 2024, a process that emerging economies have begun since last year.
In Costa Rica, during the fourth quarter of 2023, as in the previous quarter, general year-on-year inflation was negative (deflation), although in three of the last four months of that year the monthly variation in the Consumer Price Index (CPI) was positive. On the other hand, year-on-year underlying inflation remained at positive, but relatively low (lower than 1%).
Both indicators were below the lower limit of the tolerance range around the inflation target (3.0% to 1 percentage points or p.p.). In particular, in December the year-on-year variation of the CPI was -1.8% and that of the average underlying inflation indicators of 0.2%.
The reduction in inflation, with negative values since June 2023, has been determined, to a greater extent, by the reversal of external supply shocks and restrictive monetary policy.
On the other hand, in the fourth quarter of 2023 economic activity moderated its rate of growth compared to the previous one, although it remained relatively high. In this period, the Gross Domestic Product (GDP) in volume grew at an annual rate of 5.3% (0.1 p.p.) less than in the third quarter, which at the end of the year recorded a variation of 5.1%, higher than that of 2022 (4.6%).
Particularly, in the outcome of the fourth quarter, they highlight, by components of expenditure, the acceleration of private consumption, the increase in investment and moderation in export growth, while, by economic activity, the recovery in agriculture and construction, as well as the acceleration in manufacturing, stand out.
By type of trade regime, the greatest contribution to the acceleration of economic activity in 2023 came from the definitive regime, reflecting the recovery of the above-mentioned activities, in addition to trade.
In line with production developments, labour market indicators continued with signs of improvement, resulting in lower unemployment and underemployment rates, an increase in the employment of some groups of workers and the recovery of real income. However, there are medium-term challenges associated with structural factors that restrict labour participation, as they condition the production and growth capacity of the economy.
As of November, the public finances maintained its good performance, already for several years, which supports the objective of ensuring its medium-term sustainability. While both the financial and primary results showed a deterioration from a year ago, it mainly responds to the record of extraordinary income in 2022 by the application of Law 9524 and, to a lesser extent, the negative net effect of the appreciation of the national currency and the growth of interest expenditure.
The good fiscal results are evident in several respects, including the decline in debt to GDP ratio (1.5pc compared to December last year) and increased confidence of savers about the Government’s ability to meet its obligations, which has led to a reduction in the marginal cost of debt and a lower premium per risk per country.
Operations with the external sector also improved in 2023. In that year, the current account deficit in the balance of payments amounted to 1.4 per cent of GDP (2.3p less than the previous year). This is the result of the increase in international terms of trade, mainly due to the decline in external commodity prices, as well as the good performance of receptive tourism and exports of companies attached to the free zone regime. In this period, Costa Rica maintained access to external savings at sufficient levels to finance the current account gap and strengthen the reserve asset pool.
Credit to the private sector grew 6.7 per cent in 2023, with further boosting foreign currency trading. In addition, the BCCR estimates that the behavior of monetary aggregates in the fourth quarter of 2023 will not generate higher inflation in this year or next year and, although the prize in colones remains around zero, there is no definitive evidence of a dollarization of financial savings.
BCCR policy actions
From March 2023 to January of this year, the Board of Directors of the BCCR reduced the Monetary Policy Rate (TPM) seven times, by a cumulative 325 basis points (p.b.). These reductions were based on an analysis of the behaviour of inflation, the expected evolution for this variable and its determinants, as well as the assessment of existing risks, on the basis of which the Board considered that there was room for a less restrictive monetary stance.
It should be noted that in September last year the process of reducing the MPC was slowed down with the aim of providing the space required for the previously applied reductions to be transmitted to the other interest rates in the financial system. However, at the monetary policy meetings in October and December of that year, as well as in the January of the present year, gradual downward adjustments to that indicator were resumed.
The Board of Directors of the BCCR has repeatedly stated that changes in the MSA must be gradual and prudent, in order to react in a timely manner and in the appropriate direction, if macroeconomic conditions and risk assessment so require. In addition, it has outsourced its willingness to continue the path towards monetary policy neutrality in the medium term, provided that circumstances permit.
Monetary policy actions also consider short-term liquidity conditions. Both in 2023 and the current year, the national financial system showed a loose liquidity condition that has been increasing, largely due to monetary expansion due to the purchase of dollars by the BCCR.
This purchase took place within a framework of greater availability of foreign exchange in the foreign exchange market, determined to a large extent by real sector operations. This result is consistent with the evolution of economic activity, the marked performance of exports of goods from the free zone regime, some agricultural activities (which are recorded as part of the definitive regime) and the rebound in receptive tourism, which is also part of that regime.
The high availability of foreign exchange has allowed the Central Bank to participate in the foreign exchange market as a net claimant and, with this, to meet the requirements of the Non-Bank Public Sector (SPNB) and strengthen its reserve position. Given the above, the balance of net international reserves (NRI) was levelled as at 29 January of the current year at the equivalent of 140 per cent of the appropriate value under the IMF ARA methodology.
This high foreign exchange availability has also manifested itself in a fall in the nominal exchange rate, despite the active participation of BCCR as a net claimant. As of January 30, 2024, the average exchange rate weighted in Monex stood at 517.06, which means an annual variation of -6.8% and accumulated of -1.0% compared to the end of 2023.
Projections and future monetary policy actions
International financial agencies estimate that by 2024 and 2025 global economic activity would have moderate growth (about 2.8 per cent on average), below the pre- pandemic average (3.8 per cent in 2000-2019). They also expect inflation to be around the central bank target by 2025, particularly in the case of advanced economies. For this reason, they believe that restrictive monetary policy should be maintained in those countries until there is clear evidence that inflation is controlled.
The behaviour of global economic activity would be influenced by the slowdown in major economies, slow growth in international trade, geopolitical conflicts and restrictive financial conditions, which maintain high debt costs mainly in developing economies.
The price of oil, which is critically important to Costa Rica, due to its import status, would continue a downward trend in the biennium, associated with the weakening of its global demand and the increase in crude oil production. This fact, coupled with the expected evolution in the price of our country’s exports, would lead to a gain in international terms of trade in both years.
As indicated above, for the national economy, after growing 5.1 per cent in 2023, the BCCR estimates an average growth of 4 per cent in the biennium 2024-2025, which would be driven mainly by domestic demand, in particular by investment and household consumption. The pace of growth in external demand would moderate from 2023, due to the expected slowdown in economic activity of our main trading partners.
The current balance of payments deficit would be on average 1.8 per cent during the biennium, an increase of 0.4 p.p. compared to 2023. This is mainly due to the expected increase in the property deficit and primary income. In both years, the deficit would be more than financed by medium- and long-term external flows, which would allow the balance of reserve assets to be kept within the range deemed appropriate according to the above-mentioned IMF methodology.
Financial savings and credit to the private sector would increase in line with real economic growth, the inflation target and the highest degree of financial deepening the country has experienced. In particular, the increase in credit, mostly from placements in national currency, since it is assumed to contain the relative dollarization process of the credit observed in 2023.
According to preliminary estimates by the Ministry of Finance, public finances would continue on the path to sustainability, with positive primary results of 1.9% and 2.3% of GDP and financial deficits of 3.1% and 2.4% of GDP in 2024 and 2025, respectively. If these projections were met, the Central Government’s debt to GDP would decrease, compared to 2023, both in 2024 and 2025, which would put this ratio below 60% in the last year.
Overall inflation and the underlying inflation are expected to return to the tolerance range around the target in the fourth quarter of 2024. The former would remain in negative year-on-year values during the first quarter of this year, although with less and less negative values.
The revision of the projections of the main macroeconomic variables presented in this report incorporates the best information available at the moment, but is subject to risks that, if materialized, could divert inflation upwards (risks upwards) or down (risks downwards) from the central value estimated in this report.
From the upward risks, the intensification of geopolitical conflicts, particularly in the Middle East, the fragmentation of world trade and the effects of climate change, stand out. The downside risks stand out for possible below-than-expected growth in the global economy and more widespread domestic deflation than predicted in this financial year.
The Board of Directors of the BCCR reiterates its commitment to price stability as a necessary condition for macroeconomic stability and, consistent with this, maintains the inflation target at 3%, with a tolerance range of 1 p.p.
As it has so far, its monetary policy will be based on a prospective analysis of inflation and its determinants, as well as the risks whose materialisation could divert inflation from its central trajectory. Based on this analysis, it will make the necessary adjustments to the reference interest rate, to induce inflation to be placed at near-goal values over the horizon of its macroeconomic programming. To this end, it will also make the necessary efforts to reduce monetary excesses, in order to prevent their persistence from generating inflationary pressures, for which it will actively manage liquidity in the money market.
In the area of exchange rate policy, the BCCR will participate in the foreign exchange market to meet its requirements and those of the SPNB, as well as to mitigate violent fluctuations in the exchange rate.
In addition, it will continue with the analysis of possible operational changes that ensure the best functioning of this market and contribute to the price formation process.
Finally, consistent with efforts to improve their communication with the general public and markets in particular, it will provide information and explain the relevant elements of the economic situation and the fundamentals of monetary policy, exchange and financial system decisions, in order to contribute to an informed process of building expectations that facilitates the convergence of inflation to the inflation target.
This article has been translated from the original which first appeared in El Mundo