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### Viewing cable 09SANJOSE85, COSTA RICA AND THE FINANCIAL CRISIS: SO FAR, SO GOOD, BUT

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
09SANJOSE85 | 2009-02-10 12:12 | 2011-03-21 16:04 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Embassy San Jose

`

    VZCZCXYZ0000
    PP RUEHWEB

    DE RUEHSJ #0085/01 0411259
    ZNR UUUUU ZZH
    P 101259Z FEB 09
    FM AMEMBASSY SAN JOSE
    TO RUEHC/SECSTATE WASHDC PRIORITY 0478
    INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE PRIORITY
    RHEHNSC/NSC WASHDC PRIORITY
    RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY

` `

    UNCLAS SAN JOSE 000085

    DEPT FOR WHA, WHA/CEN, WHA/EPSC, EEB/IFD/OMA AND EEB/IFD/ODF;
    PLEASE PASS TO TREASURY: SSENICH

    SENSITIVE
    SIPDIS

    E.O. 12958: N/A
    TAGS: ECON EFIN EIND EINV PGOV PREL CS
    SUBJECT: COSTA RICA AND THE FINANCIAL CRISIS: SO FAR, SO GOOD, BUT
    CLOUDS ON THE HORIZON

    ¶1. (SBU) SUMMARY:  Costa Rica's conservative financial system has
    served it reasonably well thus far during the current global
    financial crisis, but 2009 will likely be difficult.  The GOCR knows
    it must act intelligently as some fundamentals begin to deteriorate;
    the Arias administration does not want its final year in office to
    be colored only by the crisis.  In the current account, the greatest
    worries are (1) a deterioration of exports (which grew only four
    percent in 2008 while imports increased 18.6 percent); (2) a slump
    in tourism (which hit a record two million in 2008, but has been
    dropping on a year-by-year monthly basis); (3) a likely drop in
    Foreign Direct Investment (FDI), which thus far has helped to fill
    some of the trade deficit; and (4) a reduction in foreign credit
    lines (which have begun to tighten).  The drop in petroleum prices
    has been good news; in addition, the GOCR's countercyclical spending
    helped fund a USD 117.5 million liquidity package to strengthen the
    national banks in December, along with the "Shield Plan" announced
    in January to assist the disadvantaged, labor, small business, and
    the Central Bank.  An IADB loan of USD 500 million should also help
    the Central Bank, but the need to fund liquidity and to make credit
    available on the one hand, while managing Costa Rica's high
    inflation rate (nearly 14 percent for 2008) on the other, is an
    ongoing source of economic tension.  END SUMMARY.

    ---------------------------
    NOT YOUR FATHER'S RECESSION
    ---------------------------

    ¶2.  (U) In discussing prospects for the immediate future, Costa
    Rican experts and businessmen often refer back to the country's
    financial meltdown in the early 1980's.  The comparisons are largely
    quite positive.  Since then, the Costa Rican economy has benefitted
    greatly from globalization, with the export and banking sectors
    becoming more efficient and diversified.  Around the region in
    general, consistent macroeconomic policy, self-designed rescue
    packages, a competitive edge with commodities, and relatively strong
    consumer demand positioned many economies -- including Costa Rica's
    -- to better weather the current storm.  Such globalization also
    implies great vulnerability to problems originated elsewhere in the
    world, however, and blaming globalization for "imported" problems
    could again become a flash point issue for the opposition, as the
    body politic continues to recover from the bruising fight to
    institute CAFTA-DR.

    --------------------------------------------- -
    2008:  MIXED RESULTS; 2009:  MORE OF THE SAME?
    --------------------------------------------- -

    ¶3.  (U) The current picture is a mixed one, however, based on the
    Central Bank's monthly index of economic activity.  Overall
    performance improved steadily in 2007 only to flatten at year's end,
    and then, starting in March 2008, incrementally decrease. Not
    surprisingly, the sectors associated with tourism and resort
    development declined the most.  The hotel sector posted a decrease
    of 3.8 percent in 2008, while construction declined 6.2 percent.
    Manufacturers fared the worst, with a drop of 8.4 percent.  In
    contrast, agriculture, which tailed off in 2007, experienced a
    recovery in 2008.  The service sector held its own in 2008 mainly as
    a result of outsourcing professional services from other countries.
    Hence, the net overall effect was a slight decline in economic
    activity.

    ¶4. (U) Economic worries continued to figure prominently in survey
    results.  In the January 2009 CID-Gallup poll, three of ten
    questioned cited employment, the cost of living, and the economy in
    general as their key concerns.  Four in ten reported the high cost
    of living as their biggest worry, fueled by the inflation rate,
    which crested at 14.4 percent in November 2008 and then eased to a
    year-end-rate of 13.9 percent. (For comparison, the rate in 2006 was
    9.4 percent and 10.8 percent in 2007, marking an upward trend.)  As
    for the future, noted banker Luis Liberman gloomily told the weekly
    financial publication "El Financiero" there would be near zero
    economic growth in 2009, with the current doldrums lasting up to two
    years.  The Central Bank recently ratcheted downward its 2009 GDP
    growth projection to 2.2 percent.  Though less negative than
    Liberman, the Bank offered its recent statement on lowered
    projections with much caution due to the uncertainty in export
    markets, notably to the U.S.

    ----------------
    ARIAS HAS A PLAN
    ----------------

    ¶5.  (U) In a national address on January 29, President Arias noted
    the "devastating dimensions" of the global financial crisis and
    announced the "Shield" Plan to provide social protection and a
    stimulus to the economy.  Stressing four key beneficiaries --

    families, labor, small business, and banking -- Arias outlined a
    program of government assistance designed to "shield" the Costa
    Rican economic and monetary system from worsening:

    -- For families:  institute measures to expand existing programs
    that benefit poorer families and workers.  Individual pensions under
    a special system for disadvantaged families will be increased by 15
    percent.  The school-lunch program will be expanded to cover some
    children and members of their families during weekends, and the high
    school scholarship program that provides basic expenses to poor
    students will likewise grow incrementally.  The National Training
    Institute will offer scholarships in coordination with companies to
    provide additional training to workers who would otherwise be
    released.  In addition, the GOCR requested the state-owned banks
    (all of which are run by Boards of Directors) to reduce the interest
    rates of their smaller housing loans by two percent; one bank has
    officially agreed and the others are expected to follow.

    -- For labor:  reform the labor laws (with legislative approval) to
    liberalize the requirements on the number of hours per day and days
    per week worked.  The objective is to maintain employment levels,
    but allow for a reduction in hours through greater work flexibility.

    -- For small business:  request the state banks and Banco Popular to
    consolidate business debt, particularly for credit-dependent
    organizations such as cooperatives, and to reduce interest rates by
    two percent for loans targeted at micro, small- and medium-sized
    businesses (PYMES).  One bank has taken this measure and the others
    are expected to follow.

    -- For the general economy:  secure an IADB loan of USD 500 million
    in order to bolster the Central Bank in its role of backing the
    state banks.  Also secure a set of loans from international
    institutions (para 12 below) to finance infrastructure.  The Arias
    administration estimates that 10 percent of the monies could be
    spent in the next year.

    -----------------------------------------
    HEY MR. BANKER. . . CAN YOU SPARE A LOAN?
    -----------------------------------------

    ¶6. (U) The next several months will reveal if credit tightening
    threatens the Costa Rica economy.  Costa Rica's public banks are the
    biggest in the market, largely buffered from tightening in foreign
    credit because they only derive about four percent of their
    resources from foreign sources.  Private banks, on the other hand,
    were recently reported to derive 22 percent of their resources from
    overseas.   One contact at Citibank told us that headquarter banks
    were cutting the flow of funds to subsidiaries in countries such as
    Costa Rica and advising subsidiaries to look to other sources for
    funds.  Moreover, many private firms rely to one degree or the other
    on foreign credit lines which have disappeared or become more
    expensive.

    ¶7. (U) The public banks haven't helped matters since September 2008,
    when they declared that they were too close to the 10 percent
    equity/asset ratio required under Costa Rican law and therefore
    adopted the policy of only lending funds paid in from outstanding
    loans.  Nonetheless, Alberto Dent, President of the GOCR's financial
    services regulator (CONASSIF), shared with us that Costa Rican banks
    were relatively well-capitalized, as the typical equity/asset ratio
    in Latin America is eight percent.  With respect to loan costs, the
    premium above LIBOR increased from 50 basis points to 600 basis
    points, Dent observed, greatly raising the percentage rate charged
    to customers, which expands profit margins but strangles growth and
    results in less liquidity.

    -------------------------------
    BANK SPENDING. . .THE SOLUTION?
    -------------------------------

    ¶8.  (U) Preceding the Arias announcement of the "Shield" Plan, the
    GOCR injected capital into the public banks.  The Legislative
    Assembly (legislature) quickly passed a bill in December granting
    USD 117.5 million to the three public banks (BNCR, BCR, BanCredito)
    with the explicit understanding that they would then be able to lend
    up to USD 1.175 billion relying on the expanded equity base.  The
    GOCR instructed public banks to dedicate the new resources to
    housing and "productive" credit.  The investment strategy was not
    written, and thus could be modified as circumstances change.  The
    banks received these fresh resources in the last week of 2008.
    However, this recapitalization may be less than meets the eye, as it
    was made with non-coupon paying inflation-linked bonds that are not
    marketable.  While these bonds will add to the state banks'
    regulatory capital, allowing more lending without violating the law,

    they do not provide any actual liquidity.  The banks' two percent
    reduction in loan rates (see para 5, above) may encourage use of
    those funds.

    ¶9. (U) A countertrend (and source of tension) to the need to create
    liquidity is the Central Bank's tight credit policy due to
    inflation.  Facing the third worse inflation in Central America, a
    weaker currency, and falling reserves, the Bank continues to raise
    interest rates.  President Arias' request to the state banks to
    lower rates will provide only very modest relief, as the benchmark
    "tasa basica" has risen from four percent to 11.50 percent since the
    currency moved off the bottom of the currency exchange band in mid
    ¶2008.

    -------------------------
    UNEMPLOYMENT EDGES UPWARD
    -------------------------

    ¶10.  (U) From 2001 through 2006, unemployment in Costa Rica was 6.0
    percent or higher.  During the Arias Administration, the rate fell
    to 4.6 percent in 2007.  For 2008, the rate inched upward to 4.9
    percent.  The construction sector has clearly slowed down and laid
    off large numbers of workers in recent months as a result of a
    pullback in Pacific resort development.  However, we are not aware
    of any major lay-offs outside of the construction and tourism
    industries.  As recent as early 2008, Costa Rican officials were
    quite concerned with major shortfalls in labor in the construction
    and agricultural sectors.  Both rely heavily on foreign labor,
    largely Nicaraguans.  Now, the GOCR predicts a labor surplus,
    especially in northern Costa Rica, as Nicaraguans (and other foreign
    workers), many undocumented, flee the economic uncertainty in their
    own countries.

    --------------------------------------------
    RUN UP THE DEBT; BUILD UP THE INFRASTRUCTURE
    --------------------------------------------

    ¶11.  (U) In addition to a focused expansion of the money supply, the
    GOCR stated its determination to engage in countercyclical spending
    on infrastructure projects.  A recent article in "El Financiero"
    proclaimed "The Government's New Goal is to Contract More Debt".
    The GOCR can reasonably aspire to do so, since Costa Rica's current
    external debt of USD 3&GnFOQQg programs,

    external credits may have little immediate impact since there is a
    long lag between contract signing and project implementation.
    External debt is indeed low, but this year the GOCR needs to
    refinance a Eurobond that matures in May.  Also, until very
    recently, the doJnLRT2\Xanging its marketing
    strategy:  issuing short-term domestic currency and
    dollar-denominated securities which resulted in a much better
    response to its debt auctions.  Nonetheless, funding for government
    spending will remain challenging until monetary policy is relaxed.

    ------------------------------
    REAL ESTATE (AND FDI) SLOWDOWN
    -----------------------------

    ¶13.  (U) The real estate sector, which is concentrated along the
    Pacific coast and which accounts for about one third of Costa Rican
    FDI, has suffered an abrupt reduction in activity.  Due to a lack of
    potential buyers (largely U.S. citizens looking for vacation or
    retirement homes), projects have slowed or been suspended.
    Companies looking to invest in Costa Rica have likewise placed their
    decisions on hold.  FDI reached USD 2.048 billion in 2008, but is
    highly likely to drop in 2009, according to our sources.  No one is
    willing to predict the extent of the decline, however.

    ------------------------
    A (DOWN) TURN IN TOURISM
    ------------------------

    ¶14.  (U) The two-millionth tourist to Costa Rica in 2008, a member
    of a family of seven from New Jersey, arrived to great fanfare in
    the third week of December.  While tourist numbers hit new records
    last year, however, the year-on-year monthly number has been
    declining since August 2008.  The economic downturn in the US is
    mainly to blame; 54 percent of Costa Rica's tourists each year are
    American.  The Costa Rican Institute of Tourism (ICT) is expecting
    2007-2008 to show an increase of about seven percent, compared to an
    increase of 12 percent 2006-2007.  The Costa Rican Chamber of Hotels
    (CCH) reports that three in ten hotels have already had
    cancellations for 2009 of between five and forty percent of
    reservations.  At the opening of a new J.W. Marriott resort in the
    prime beach destination of Guanacaste, Marriott officials commented
    that the hotel occupancy rates in this region had sunk to about 25
    percent.

    --------------------------------------------- --
    PETROLEUM PROGNOSIS: LOWER PRICES ARE GOOD NEWS
    --------------------------------------------- --

    ¶15.  (U) The recent precipitous drop in fuel prices has been a
    bright spot, representing major foreign-exchange savings for the
    country and a savings for the national budget.  Statistics from 2008
    indicated that, for every USD 10 drop in the petroleum price, Costa
    Rica spent USD 197 million less on importing the product.  While
    Costa Rica produces most of its electricity from renewable sources
    (more than 80 percent), the transportation sector is completely
    dependent on fossil fuels, and Costa Rica has no fossil fuels
    production at all.  CONASSIF's Alberto Dent told us that the GOCR's
    fuel cost planning for 2008 changed drastically from a projected USD
    2.4 billion in June-July to USD 1.0 billion by the end of the year.
    (COMMENT: Such a drop also greatly undermines the GOCR's original
    stated rationale for joining Petrocaribe.  Membership was still
    pending at the end of 2008.  END COMMENT.)

    ---------------------------------
    COMMENT: WHAT DOES THIS ALL MEAN?
    ---------------------------------

    ¶16.  (SBU) To date, Costa Rica has weathered the crisis better than
    most countries, in spite of its close economic ties to the U.S.
    (Costa Rica's GDP is approximately $30 billion and the two-way trade
    relationship is valued at $8.5 billion.)  Cultural conservatism and
    a stricter financial regulatory environment have combined to provide
    a natural buffer to most of the problems emanating from the ailing
    U.S. economy.  (Financial instruments such as mortgage-backed
    securities and credit default swaps simply do not exist in the Costa
    Rican financial system.)  The coming year will reveal the
    effectiveness of the GOCR's countercyclical spending programs, how
    close of a "cause and effect" relationship Costa Rica has with the
    U.S., and the result of the Central Bank's tight credit policy in an
    environment hungering for credit liberalization.  Government
    officials, economists and most Ticos expect things to get worse, but
    no one is sure precisely when, and how quickly.  Here as everywhere
    else, economics remains both a science and an art.

    CIANCHETTE

`