In many aspects, Costa Rica is a success story in terms of development. It is considered an upper middle-income country, which has shown a steady economic growth over the past 25 years. This growth resulted from an outward-oriented strategy, based on the openness to foreign investment and gradual trade liberalization.
Costa Rica is also a global leader for its environmental policies and accomplishments, which have helped the country build its Green Trademark. The pioneering Payments for Environmental Services (PES) program has been successful in promoting forest and biodiversity conservation; making Costa Rica the only tropical country in the world to have reversed deforestation.
The combination of political stability, social contract and stable growth has resulted in one of the lowest poverty rates in Latin America and the Caribbean, where the proportion of the population living below the World Bank’s upper middle-income line (US$6.85 per person per day in 2017 Purchasing Power Parity - PPP) decreased from 15.6 to 13.7 percent between 2010 and 2019.
The success of the country in recent decades is also reflected in its strong indicators of human development, which have contributed to move the country up the global ranks, higher than the other countries in the region.
While these achievements are celebrated, the country faces fiscal and social challenges that have been intensified by the COVID-19 pandemic which has hit hard Costa Rica.
Fiscal consolidation efforts, launched in 2018, were interrupted as revenues collapsed amid increasing expenditures needed to mitigate the impact of the pandemic, bringing the public debt to 67 percent of Gross Domestic Product (GDP) in 2020. Unemployment rates nearly doubled -surpassing 20 percent in mid-2020- and family income declined despite the government’s emergency response. As a result, the poverty rate (US$6.85, in 2017 PPP) increased to 19.9 percent in 2020.
A strong economic performance in 2021 and 2022 and spending discipline enabled a faster than expected fiscal consolidation and allowed to improve labor market and social outcomes. GDP expanded 7.8 percent in 2021and 4.3 in 2022 after the largest drop in four decades in 2020. A strong rebound in manufacturing, particularly of medical equipment, and a gradual recovery in services and agriculture lifted GDP above pre-crisis levels. Fiscal consolidation efforts, enable a decline in the public debt in 2022 (to 63.8 percent of GDP), for the first time in 13 years. The poverty rate (US$6.85, in 2017 PPP) declined quickly to 14 percent in 2022 as the economy recovered.
However, new external pressures, including tighter financing conditions and lower growth in main trading partners, are starting to slowdown economic activity.
Growth surpassed expectations in the first half (H1) of 2023 (4.7 percent), supported by strong domestic and external demands. Inflation declined quickly from its peak of 12 percent in August 2022, returning to the targeted band by March 2023, and turning into a deflation in June (1 percent) and July (1.7 percent). This dynamic enabled the Central Bank to gradually cut the policy rate since March, boosting private consumption and investment. Manufacturing exports, especially medical equipment, tourism, and business services exports also expanded. However, global uncertainty and slower growth in key trading partners is expected to moderate external demand in the second half of 2023 and in 2024. Growth is expected to stay at 4.2 percent in 2023, given the strong performance in H12023, and decline to 3.3 in 2024.
As inflation stabilizes and labor market conditions improve, driven by growth in the services sector, the poverty rate is expected to decline to 13.8 percent in 2023 and then to around 13.5 percent in 2024. Poverty could be further reduced by implementing targeted social assistance measures to historically disadvantaged groups and to those living under the poverty threshold. Fiscal consolidation is expected to continue over the forecasting period, anchored in the fiscal rule, which limits the growth in spending, helping bring the debt-to-GDP ratio to around 60 percent by 2025.
Recent improvements in debt management should help lower Costa Rica’s financing costs. Additional reforms have been announced, including reductions in tax expenditures, income tax, and reduced fragmentation of social programs. These reforms are critical to reinforce fiscal consolidation and create buffers against shocks while protecting the poor.
This outlook faces downside risks. As a small, open economy, Costa Rica is highly vulnerable to external shocks, including global inflationary pressures, weaker global growth, and tighter financing conditions. Climate vulnerabilities, intensified by the El Niño, add to this uncertainty.
These challenges affect the basic pillars of the Costa Rican development model: inclusion, growth, and sustainability.
The government has strived to address these problems and is committed to an inclusive society that guarantees the welfare of its people, supported by transparent and accountable public institutions.
Last Updated: Oct 04, 2023