VZCZCXYZ0000
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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
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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