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AmericasNovember 4 2004

Opposition stalls Costa Rica’s economic reforms

Can Costa Rica – traditionally stable compared with its central American neighbours – preserve its tradition of consensus building and move ahead with liberal economic reforms? Jane Monahan reports.The question mark over Costa Rica’s economic future came into sharp focus when the finance minister, Alberto Dent, resigned on September 3, at a time of mounting opposition to his package of economic reforms.
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His successor, Federico Carrillo, a lawyer and economist, has vowed to continue Mr Dent’s reform programme. But Mr Carrillo’s appointment has already been questioned, mainly because of his lack of experience of the public sector and his personality, which is deemed too strong.

Political difficulties

The build-up to the cabinet crisis began in August. State electricity workers and state health employees took the unusual step of joining a truck drivers’ strike, partly in protest against Costa Rica’s signing of the Central American Free Trade Agreement (Cafta) with the US. Well-entrenched labour organisations in state-owned electricity and telecommunications companies vigorously oppose such an agreement because it requires that, over the next four years, state holdings and monopolies in the electricity, telecommunications, health and insurance sectors must be privatised.

Brian Brady, general manager of Scotiabank de Costa Rica – a subsidiary of Scotiabank, Canada’s leading international bank, and one of 15 private banks now operating in Costa Rica – told The Banker: “There are various factions in the country. Some factions want to open up the market and support Cafta. Others, including powerful trade unions, want more protection for the status quo.”

But Francisco de Paula Gutiérrez, president of Costa Rica’s central bank, counters: “Financial reform has been going on at a slow but continuous pace since the 1980s. But Costa Ricans value their state-owned companies. There is no support for privatisation.”

Certainly, no privatisations are on the cards for the banking sector, even though Costa Rica still has three state-owned commercial banks; one state-owned mortgage bank; Banco Popular, which is owned by a workers’ cooperative; and BICSA, a private bank owned by state banks located in Panama. BICSA was created to give the public banks greater flexibility so that they could establish offices outside the country to finance trade and take a share of offshore banking.

Private banking in Costa Rica has become more varied in the last two decades, reflecting a switch from an agriculture-based economy to an industrial one that is increasingly open and international. The country’s industrial exports now represent about 50% of GDP, up from 30% in 1980.

Foremost among the country’s exports are high-tech goods, such as microchips and medical equipment – high-tech manufacturers benefit from Costa Rica’s proximity to the US and Canada. Tourism, where Costa Rica made its name by practically inventing eco-tourism, is also important.

Strong opposition

However, opposition to economic reform is evident on Costa Rica’s streets, and there has also been resistance to proposals by President Abel Pacheco’s government in parliament, where the ruling party has only 19 of the 57 parliamentary seats and where there are seven political parties.

The government has proposed fiscal reforms to bring down the budget deficit and reduce the country’s public debt – government debt and the debt of state-owned companies combined amounts to $6.5bn, or 48% of GDP. When these fiscal reforms are implemented, it will be possible to make the public debt sustainable, Mr Dent claimed a few months ago, because the country’s tax base would be broadened, tax loopholes would be eliminated and expenditure contained – by reducing the degree of indexation of civil servants’ wages, for example. But although the fiscal reforms were submitted to parliament in April 2002, debate on them only began very recently, and the long delay was one reason for the former finance minister’s departure, government officials say.

The last major banking reform, which allowed private banks into retail banking for the first time, was in 1996. Since then, the banks have been making up for lost time. By 2003, according to central bank statistics, private banks had a 24% share of the deposit market and around a 50% share of the credit market.

But private banks continue to operate at a disadvantage compared with their public peers. One major problem is that, when private banks first enter the retail banking market, they have to place the equivalent of 17% of their deposits in public banks at below market rates for use in state-directed investments. Furthermore, while the deposits in private banks are not insured, deposits in public banks are covered by a blanket government guarantee.

International financial experts in Washington say these asymmetries have increased the differences between the deposit and credit markets by inducing private banks to rely more heavily on dollar-denominated deposits and debt as a source of their funding.

Also Costa Rica’s inflation, which has ranged between 10% and 30% a year for the last 20 years, has made the colon, the local currency, depreciate in value, providing another incentive for banks to carry out transactions in US dollars.

Dollar risk

But the dollarisation of the Costa Rican economy – highlighted by the sharp rise in the foreign currency deposits of private banks in recent years, to the point where these now account for half of all these banks’ deposits – carries risks, as the International Monetary Fund recently pointed out.

A principal danger is that many dollar-denominated loans have been granted to non-dollar earners. As a result, if there is any sudden or large depreciation of the colon, this could well affect the capacity of borrowers to repay their loans, leading to a deterioration in the quality of loan portfolios.

Against this background, Costa Rica’s central bank has prepared sweeping financial reforms that will help level the playing field between private and public banks and make both more competitive.

According to Mr Gutiérrez, with this reform, rigid hire-and-fire laws at public banks will be relaxed and red tape that now slows down a public bank’s acquisition of goods and services, such as computers, will be simplified.

At the same time, the percentage of deposits that private banks now have to place in public banks, as a toll for entering the retail banking market, will be cut and a new Deposit Guarantee Fund will be established, insuring the deposits of all banks.

But how long it will take for these new financial measures to be implemented is debatable. Costa Rica’s financial reforms have been languishing in a special parliamentary committee for over a year, and before he resigned, Mr Dent said: “I would be surprised if the reform gets to the floor before next year.”

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