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Results of a technical analysis of the country’s fiscal situation were presented by the Organisation for Economic Co-operation and Development (OECD) at the request of Costa Rican Finance Minister Helio Fallas.
The OECD’s director of economics, Álvaro Santos Pereira, summarized the agency’s conclusions last week to the Costa Rican Legislative Assembly’s finance committee. Also in attendance were the heads of the different political parties represented in the assembly, and the Costa Rican Union of Chambers and Associations of the Private Business Sector (UCCAEP).
Santos Pereira, Portugal’s former Economy and Employment Minister, started his presentation by saying fiscal reforms are necessary to reduce the debt burden faced by Costa Rica,
“The price of inaction is too high. Without fiscal reforms there is a very high probability that a serious fiscal crisis will unfold in the near future, with disastrous consequences for growth, welfare and social stability in Costa Rica.”
While the OECD commended the Costa Rican government for its recent efforts to reduce the deficit, without fiscal reforms, the country will not achieve further reductions by using the same cost-cutting measures.
Santos Pereira said the country’s large public debt affects business investment, and also that the large and growing fiscal deficit will mean stricter financial conditions as investors request high-risk premiums to finance the public debt:
“Costa Rica is playing with fire … Without reforms, the country’s fiscal situation could become a threat … it is urgent to stabilize the public accounts. Costa Rica has much to lose if the reforms that are currently in congress are not approved.
“Weak fiscal performance can hurt foreign direct investment (FDI) inflows. It has been shown that FDI inflows are highly sensitive to internal conditions. Therefore, further deterioration of Costa Rica’s fiscal situation could undermine its comparative advantage vis-a-vis other emerging countries in attracting and even maintaining FDI, potentially weakening its successful growth model,” explained the international economist.
Also, because Costa Rica is a small open economy, it is more vulnerable to the consequences of external macroeconomic shocks or natural disasters. Increased debt service payments will divert resources from investment in education, health, infrastructure, and security, said Santos, making the country less resilient in the face of potential future regional or global crises.
“An eventual debt crisis would jeopardize the great achievements made so far and amplify the effects of any negative shock to the economy. It would also force Costa Rica to make detrimental cuts and freeze the welfare system, potentially increasing poverty, inequality and, ultimately, social instability. In addition, it would mean postponing once again the much needed improvement of public infrastructure. In addition, it could require cuts in the costs of law enforcement and lead to an increase in crime, drug trafficking and endanger the safety of citizens, with the risk of triggering a strong political reaction from society,” explained Pereira.
The Costa Rican government successfully reduced the budget deficit by about 0.5 percentage points of its gross domestic product in 2016 by using existing fiscal regulations within its power, and also managed to increase revenue through actions to combat tax evasion, noted Santos Pereira. But, the country has basically exhausted the measures it can take to control the public deficit. And the OECD said fiscal reform measures are needed to allow for a reduction in the budget deficit by 3 percent of GDP to stabilize the country’s foreign debt.
The OECD has offered its technical expertise to aid in drafting a fiscal reform package for Costa Rica.
In the absence of such new legislation, the international agency said the country can undertake other types of measures including strictly controlling salary increases and pensions, halting all new public hiring, and modernizing the tax agency’s technology to better detect tax evasion, as well as utilizing debt management instruments to improve relations with international and domestic lenders.
“While these [alternative] measures are too small to boost public finances to a sustainable trend, they will reduce the deficit somewhat, and improve credibility, and thus demonstrate a willingness to address Costa Rica’s worrying fiscal trends,” concluded the OECD analysis.
