By
Jonathan Lemco
Costa
Rica is something of an enigma. Long before it became
fashionable for the large majority of poor emerging market
countries to adopt democratic practices, Costa Rica was
the exception. Despite a substantial degree of economic
inequality, it has long been in the forefront of political
democracies. It has also been able to avoid all of the
turmoil that engulfed many of its Central American neighbors
in the 1980s. Indeed, it has had only two brief periods
of violence since the late nineteenth century. Of course,
Costa Rica has long benefited from support from the United
States. Also, it has not had a standing army within memory.
But its ability to retain its largely democratic character
over a long period of time is admirable and unusual by
any measure.
Like its neighboring countries, Costa Rica remains dependent on agricultural
exports as its primary industry. This is problematic, as low coffee prices
and an overabundance of bananas have hurt. But unlike its neighbors, it
has cultivated a vibrant tourist industry and a fairly strong technology
sector as well. Land ownership is now reasonably widespread, and there
is a small but growing middle class. Poverty is still readily apparent,
but it has declined over the past fifteen years and a strong safety net
has been put into place. According to World Bank figures, headcount poverty
declined from 27% in 1990 to 21% in 2000. Access to healthcare and primary
education is nearly universal.
From an investment perspective, Costa Rica’s democratic character,
its attractive industries, and its reasonably well-educated population
are obvious attractions. The government is, however, faced with the twin
challenges of reducing a large deficit and a growing internal debt. Costa
Rica’s domestic fiscal problems are cited by the credit ratings agencies
(Moody’s and Standard & Poor’s) as particularly troublesome
for fixed income investors. They both rate the sovereign in the “BB” range
with negative outlooks. The government continues to have trouble curbing
expenditures and investors should expect a budget deficit of about 3.0%
in 2004. Fortunately, Costa Rica’s external debt burden is not particularly
odious. The external Debt/Exports ratio is forecast at 58.1% for 2004.
In addition, the government has had difficulty passing legislation that
would modernize the state-owned electricity and telecommunications sectors.
This stalled reform effort has hampered economic growth.
Investors should also pay particular attention to inflationary pressures.
Over the past twelve years inflation has averaged 12%, which is second
only to Honduras in the Central American region. As of January 2004, it
is in the 10.5% range. Also, the monetary and exchange rate regimes promote
dollarization, which in turn, limit the scope for relative price adjustments.
But the economy is now improving. Boosted by the manufacturing, construction
and financial services industries, Costa Rica’s monthly index of
economic activity expanded by 5.4% in the twelve months through June 2003
at 5.3%. This is the highest level since July 2000. The latest government
forecast, which we regard with skepticism, puts real GDP growth for 2003
at 5.3%. (We expect it to be more in the 4.0% range for 2004). Meanwhile,
export earnings increased by 22.4% in the first seven months of the year
compared with the same period in 2002. A pending free trade deal with the
United States may also help the trade balance. Costa Rica is also a prime
beneficiary of the positive disposition that investors have towards all
sovereign credits offering decent yields. Its recent issue of US dollar
denominated bonds in January was substantially oversubscribed.
Costa Rica is not without its problems. But relative to many other emerging
market sovereigns, its economy is open and diversified. More striking is
the fact that amidst economic reversals, it has remained a democratic stalwart.
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