Costa Rica - Current economic position and prospects

R E S T R I C T E D FILE COPY R e p o r t N o. W.H. 54-A This report was prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT CURRENT ECONOMIC POSITION AND PROSPECTS OF COSTA RICA February 18, 1957 Department of Operations Western Hemisphere  CURRENCY EQUIVALENTS Official Rate U.S. $1.00 = g 5.615 (colones) i $ 0.178 1 million = $ 178,000 Free Market Rate U.S. $1.00 = / 6.65 The official rate applies to most exports, to a few invisible receipts, to imports of goods consid- ered most essential (about one-half of imports), to Government expenditures abroad and to students' remittances. The free market rate applies to a few exports (principally cacao), and to all imports and non-trade payments which do not come under the official rate. Since 1952 the free rate has been stabilized by the Central Bank at the level of 6.65.  TABLE OF COI'TTE:ITS Page No. BASIC DATA 1MAP S UP1ARY i CURPCiNT ECONONIC POSITION -.ND PROSPECTS OF COSTA RICA I. Background 1 II. Economic Growth 2 Rate of Growth 2 Investnent 3 Agriculture 4 Industry 5 Oil 5 Prospects 6 III. IKonetary and Fiscal Position 6 7cocnomic Stability 6 Government Finances 7 Prospects 9 IV. Creditworthiness 11 APPENDIX I - Balance of Payments' Outlook 13 APPENDIX II - IPonetary Situation 21 STATISTICAL APP1DIX Table 1 - Summary of External Public Debt 23 Table 2 - Service on the External Public Debt 24 Table 3 - Indices of Economic Activity 25 Table 4 - Main EXports (Value, Volume and Prices) 26 Table 5 - Production, Cons-ziption and Exports cf Coffee 27 Table 6 - Export and Import Prices and Terms of Trade 28 Table 7 - Composition of Imoorts 29 Table 8 - Exports and Imports by Regions 30 Table 9 - Balance of Payments 31 Table 10- Foreign Exchange Reserves 33 Table 11- Government Finances 34 Table 12- Summary of Government Finances and of the Position 37 of the Government with the Banks and the Private Sector Table 13- Goverrnment Ordinary Revenue 39 Table 14- Government Expenditures by Functions 41 Table 15- Internal Public Debt 42 Table 16- Changes in Money Supply and their Origin 0 Table 17- Credit Ceilings for Coy,.ercial Banks and Central 4 Bank Rediscounts Table 18- Commercial Bank Loans by Purpose 5 Table 19- Indicators of Savings 5 Table 20- Domestic Prices and Wages 46  BASIC DATA Area 51,000 square kilometers Population - 1956 1 million National Income - 1955 Approximately i280 per head Exports - 1955 478.9 million (gross value) Imports - .1955 S'77.7 million (f.o.b.) Principal Exports and Imports - 1955 Exports % Imoorts % Coffee 47 Food and beverages 15 Bananas (gross) 42 Fuel and lubricants 6 Cacao 8 Chemicals 15 Other 3 Machinery and transport equipment 27 'Various manufactures 36 Other 1 Gold and Foreign Exchange December 31, 1956 Approximately $16 million In relation to 1956 imports Approximately 20% Internal Public Debt - August 30, 1956 Iillions of colones Consolidated 187 Floating 21 208 External Public Debt - July 31, 1956 036.9 million  N I C A R A G U A * - -S.-. Q'E A N& C A S ET... S.AN[ CAR:LOS , . 7 . ............... . .:. .:::A R E A '\ Reveo STANDAFD FRUIT POWER. PL comPANr's NE,w 8ANVANA PLANrTA- TION'S C POS TA REN IC AAt PT I EXPLOrAION < 31 7 .. ILSIDRO 0 25 50 75 R00 KM. I A JANUARY~~~~~~~~~~~~~~~~~~~~~~ 195 IB 0 COSTA RICA LFT MAIN RAILWAYS INTER-AMERICAN HIGHWAY- INTER-AMERICAN HIGHWAY, PROJECTED BANANA FUI OR IN CONSTRUCTION PLANTrATIONS EACH RED DOT REPRESENTS 100 INHABITANTS JANUARY 1957 IBRD-307  SUi'!|ARY 1. Costa Rica is a country of high educational standards and democratic traditions. Its population of one million is largely concentrated in the small Central Plateau, while the settlement and cultivation of the outlying parts is just beginning. Soil and climate offer excellent conditions for agriculture; lands are on the whole appropriately used and there are no serious problems of soil erosion and forest destruction. The Inter-American Highway, the southern part of which is now being constructed, provides a basic artery from north to south, while railroads link the capital with both oceans. 2. In recent years Costa Rica's economy has grown rapidly. This progress has been brought about by adoption of better agricultural methods and high investments in agriculture and industry. The investments have to a large extent been financed from the earnings created by good coffee prices. In 1956 economic growth was interrupted by serious crop failures caused by heavy rains and floods. However, crop prospects for 1957 are excellent. 3. On the whole the economic growth of recent years was achieved without disrupting economic stability. There have been no significant price increases, and foreign reserves kept growing up to the end of 1955. However, from 1953 an important change was taking place in the fiscal situation as Government expenditures for investment, welfare and administration expanded rapidly. Government revenue, although also increasing, was not sufYicient to meet these expenditures as well as the substantial amortizations of Government debt. Not being able to sell any great amount of bonds to the public, the Government had therefore to utilize bank resources increasingly by reducing its deposits with the banks and by selling them bonds. Zerious consequences from these developments were averted in 1954 and 1955 through more rapid increases in such bank resources as capital and reserves, savings deposits and proceeds from, the sale of bank bonds, and through restra.nts in bank credit expansion. However, when in 1956 the effects of the crop failures were added, a heavy loss of foreign reserves resulted. 4. High coffee prices and good crops presently offer Costa Rica an excellent opportunity to build up its external reserves and strengthen its position for the eventuality of future price falls. In order to utilize this opportunity, Government finances would have to be balanced and credit expansion stopped in 1957; in subsequent years bank credit expansion as well as Government use of bank resources would have to be kept within narrow limits. There are good reasons to expect that this could be achieved through some adjustments in government expenditures, together with judicious use of external credits and a continuation of the Central Bank's firm control of bank credit. 5. Costa Rica's external public debt is principally composed of old bonded debt and Export-Import Bank loans for the construction of the Inter- American Highway. In addition there are some suppliers credits and a recent  ii `j3 million IBRD loan. '.'hen the service of all the old bonds is resumed, total debt service would in 1957 reach a level of betaJeen "4 and 0 million, where it would remain until 1961. This is about 6% to 7% of prospective export earnings (less income transfers of the banana companies). 6. Costa Rica's land resources are abundant and mostly within easy reach of communications. There are great possibilities to increase production by better methods and good ability to utilize these methods quickly. The prospects for the countryls continued economic growth would therefore be excellent, if it were not for the likelihood of a serious drop in export prices. In spite of the outlook for falling coffee prices, it would be justifiable for the country to incur further external debt for well considered purposes. A sizeable increase in external debt would not be justified, however, unless economic stability were maintained and foreign exchange reserves built up.  I. BACKGROUND 1. Costa Rica is in many respects an advanced country. Its standard of education is high, political democracy is firmly established and per capita income is at least one third higher than in the other Central American countries. A class of small holders is the backbone of the nation, and extremes of wealth and poverty are not spectacular. There are no standing military forces and education and welfare have long received major attention from the Government. Soil and climate offer excellent conditions for agriculture and in recent years economic progress has been rapid. 2. In spite of these advantages, Costa Rica with an income per head of less than $300 is still a poor country. Its fortunes are highly dependant upon world markets of two crops, coffee and bananas; and its economic growth is hampered by the small markets for industrial and agricultural products that itself and its neighbors can offer. 3. The population of Costa Rica, mostly European in origin, is clustered in the Meseta Central, a small plateau of an elevation of 3,000 to 6,000 feet. From the volcanic soil of the Meseta comes the high quality Costa Rican coffee, most of the sugar and a good part of the cereals produced in the country. The higher part of the Mieseta is Costa Rica's most important dairy country. Bananas are now grown principally in the tropical lowlands of the southern Pacific coast while cacao production is concentrated on the atlantic side. To the northwest the wide and relatively dry plain of Guanacaste offers excellent agricultural conditions, while in the northeast humid forest plains stretch towards the Atlantic. 4. It is only in the Meseta Central that available lands are fully cultivated. Even there increases in production are being obtained through improved practices. In most other parts of the country, outside the banana areas, settlement and cultivation is just beginning. Some coffee is now being planted in the valleys towards the Pacific, in Guanacaste and in the San Carlos area on the edge of the northeastern plains. Grain, cotton and cattle production is increasing in Guanacaste. However, this area is still little developed and this is even more true of the northeast. Throughout the country lands are on the whole appropriately used (except for the sugar cultivation on the Hieseta) and soil erosion and forest destruction is nowhere a serious problem. Compared with the present population of 1 million, land resources are ample and will continue to remain so for a long time to come in spite of a population increase which presently is one of the highest in the world (3.5% annually). 5. Costa Rica has ample water resources suitable for power production. Electricity is widely used for cooking and power consumption is high. An ambitious expansion program of a publicly owned power agency (I.C.E.) as well as some expansion by the local subsidiary of the American and  - 2 - Foreign Power, is putting an end to present power shortages. No ore deposits of significance have been found in the country, and while it is likely that petroleum can be found, explorations have not yet given important results. Snall scale manufacturing industries produce consumer goods for the domestic market. 6. With the completion of the Inter-American Highway in a few years, Costa Rica will have basic arteries of transportation from north to south and from coast to coast. Coming from Nicaragua the Inter-American Highway already connects the lowlands of Guanacaste with the capital and other population centers of the Meseta Central; over rugged country its continuation towards Panama will connect the Yl'eseta with the valleys and coastal plains on the southern Pacific side. Since the beginning of this century the Meseta has been connected with both oceans through railroad lines; the one to the Atlantic (San Jose-Limon) is owned by a British company, and the one to the Pacific (San Jose-Puntarenas) by the Government. Both railroads have been reasonably well kept up, and are presently being modernized, while the wharfs and warehouses of the ports of Limon and especially Puntarenas have in recent years become inadequate. Puntarenas is linked to San Jose by the Inter-American Highway, but there are no roads reaching the Atlantic coast. In addition to the basic arteries, a well developed road network covers the Meseta Central, While most of these roads are paved, and have been well maintained, they are too narrow and winding for present day traffic. A new international airport, El Coco, has recently been opened, although the terminal building is still incomplete. II. ECONOMIC GRJITH Rate of growth 7. In the last seven years, Costa Rica's economy has grown rapidly. No comprehensive national product estimates have been prepared that could measure this growth, but all the economic indicators point the same way. Production of most agricultural and livestock products has increased by between 4 and 12% per year since about 1950. The important exceptions are bananas and corn, which did not increase. No figures are available on industrial production, but general observations indicate substantial growth. Freight traffic on the railrcads increased by 7% per year and power generation in the San Jose area by 10%. The volume of sales in San Jose as well as that of imports increased by 11% per year, while money supply, adjusted for price changes, expanded by an annual average of 9% from 1950 to 1955. On the whole, it seems likely that real national product has during this period grown at a rate of no less than 5 to 6% per year. Even with an annual population increase of  3.5%, this is a satisfactory rate of growth, and a higher one than was obtained during the same period by any of the other Central American countries, except Nicaragua. 8. This rapid economic growth was interrupted at the end of 1955 when heavy rains damaged the banana plantations, and greatly reduced the coffee, corn and bean crops. In 1956 banana exports declined to 7 million stems, compared with 10 in previous years, the coffee crop was reduced to 548,000 quintalsli compared with 736,000 thle year before and it becane necessary to import corn and beans. However, in 1957 Costa Rica again looks fonrard to an excellent year with good food crops and an estimated coffee crop of almost 800,000 quintals, the largest in its history. Banana production is expected to have recovered by 1958. Investment 9. The economic growth of recent years has been brought about by high investments in agriculture and industry and by adoption of better methods, especially in agriculture. Since 1954, public investment has also been high and increasing, but most o' it has been in projects which have not yet greatly in- fluenced production. Nbo calculations of private or public investments have yet been completed in Costa Rica, but preliminary estimates indicate a ratio of gross investment to gross national product of almost 20% in 1954-55. Public investment expenditures financed by the Government approached 5% of gross national product in 1955. In addition to this came investment expenditures financed by Government agencies from credit or from their oTwn revenue. Another indicator of high and rising investment is the increase in imports of machinery and transport equipment by over 150% from 1950 to 1955. 10. Costa Rica has not gained any significant improvements in its terms of trade since 1950, except briefly in 1954 when coffee prices skyrocketed. On the other hand, the great gain in terms of trade that resulted from the increase in coffee prices in 191i9 has been an important, if not the most important, factor in the country's economic progress in recent years. In the first place good coffee prices stimulated planting of new trees and better care of existing trees. In the second place the high profits from coffee earnings financed to a large extent the agricultural and industrial investments on which economic growth has been founded. Although thlese profits have in part been taken out of the country, and in part have found their way to residential construction and luxury consump- tion, there is no question that they have been substantially utilized for productive investments in agriculture and industry. in addition -the banks have supported agricultural and industrial investments with an expansion of their loans to the private sector of rnore than V30 million per year in 1951 to 1955. A substantial part of these loans has been made under special programs for imports of capital goods, for improvement of coffee and cacao plantations, and for other development purposes. On the other hand, it has been official policy not to encourage new coffee plantations through easy credit, considering that new planta- tions might run into diffAculties -hen coffee prices declined. New foreign private investments were not of rmuch importance until 1955 when the Banana Company started substantial investments for the rehabilitation of its damaged plantations. More- over, investments for oil exploration have been significant in the past two 1/ 1 quintal - approx. 100 pounds  years, and the Standard Fruit Company is starting a major investment program. Several other foreign investors have also recently shown interest in industrial investment opportunities in Costa Rica. Agriculture llo Adoption of imoroved agricultural methods is greatly facilitated in Costa Rica by the high level of education, the predominance of ownership by the farmers themselves and the generally economic size of holdings. Nluch has been done to utilize these opportunities. The Inter-American Institute of Agricultural Affairs in Turrialba carries out basic research while agencies of the M4inistry of Agriculture and STICA take care of applied research. Adequate extension services are provided by the iMinistry of Agriculture. In addition, the National Production Council through crop purchases and storage has created price stability for domestically consumed products, and the banks give satisfactory credit facilities for crop financing, purchase of machinery and farm betterment. 12. Coffee research has demonstrated that through use of fertilizer and insecticides, yields on coffee farms can be increased greatly, or from 5 to 10 times on farms wqhich previously had poor yields, and up to 2 times on farms which already had good yields. STICA estimates that these advanced methods have been adopted on about 20% of the coffee area in the last 4 to 5 years. Similar results can be obtained in cacao production, and several centers have been established in the cacao regions to furnish farmers with necessary material and advice to carry out improvements. Good results have been obtained from experiments with improved varieties of corn, and some extension work has started along these lines. Through imports of cattle, selection of local breeding stock and artificial insemination, Costa Rican livestock has already been greatly improved, and research and extension services are at present mainly directed towards improving pastures and feedin. 13. Like in other Central American countries, the Panama disease has caused many difficulties for Costa Ricats banana industry. However, the Pacific coast where production is now located has been free of disease, and production was stable at around 10 million stems from 1950 to 1955, Heavy rains and winds damaged plantations in late 1955 and in 1956, reducing production to 7 million stems in 1956. Production is expected to recuperate to a level of 9 million stems in 1958 but the Banana Company (subsidiary of the United Fruit) has no plans for further expansion. On the other hand, the Standard Fruit Comoany is starting operations in Costa Rica for the first time. It will plant disease resistant bananas in a new area on the Atlantic coast; total investments will amount to $17 million over a ten year period, and production is estimated to reach 2 million stems by 1960 and 4 million by 1965.  Industry 14. The lack of current industrial statistics makes it difficult to appraise recent developmerts in industry. Ho-wever, there are clear indications of substantial industrial investments in new plants and in expansion of old ones, and of increases in production. There have not been any spectacular developments, but rather a continued expansion of small industries producing consumer articles for the domestic market. It is likely that the new and more protective tariff which came into effect in 1954 has helped to stimulate industrial output. 15. A mechanized shoe factory has recently entered production. Two plants, one producing paints and varnishes and the other baking yeast, have been expanded to the extent that they can now supply the entire Central American market and are being recommended to come under the Central American industrial integration scheme. Two other plants, one for welded tube and the other for glass bottles, are being planned with the view of coming under the scheme. An interesting enterprise is the aircraft repair shop (SALA) which services airplanes from neighboring countries (including U.S. military planes) as well as Costa Rican planes. This company is owned and operated by a U.S. citizen, but its personnel is entirely Costa Rican. The most important industrial project now being prepared is a cement plant with a capacity of 75,000 metric tons per year. The possibilities of aluminum production are being looked into by several foreign companies, but nothing is knowJn about the result of their investigations. 16. Efforts to increase industrial productivity are being made by the Department of Industry of the Miinistry of Agriculture with the aid of U.S. Point IV. The Department gives technical and management advice to industries and conducts training prog-rams. It also acts as advisor to the banks in the processing of industrial loans. In addition to credit for working capital, the banks have in recent years been granting medium term loans to industries under the capital goods import program. Electric Power 17. Costa Rica has for many years suffered from shortage of electric power. This shortage was in part relieved by the construction in 1954 of a 10,000 kw. steam plant by the power and Light Company (a subsidiary of American and Foreign Power) and a 12,000 kw. diesel plant in 1956 by ICE (the Government power agency). The large hydroelectric project, La Garita, on which ICE has been working for several years is also nearing completion, and is expected to be in production early in 1958. The plans of ICE then call for the development of thle Rio Macho, to be completed by 1960 (24,000 kw.), and the second stage of La Garita, to be completed by 1965 (30,000 kw.). The most important hydroelectric potential in Costa Rica is to be found in the Rio Revantazan, the development of which would come at a later stage.  -6- Oil 18. Since 1951 the Union Oil Co. of California has had an exploration concession for the entire area of the departmients of Limon and Guanacaste. Tlhe concession expires in 1957 when the company has the right to select 150,000 hectares of the area for development. Explorations have been concentrated on the Atlantic slope not far froni the Panamanian border, and have so far indicated the likelihood of oil in significant, although orobably not very large quantities. As a matter of fact one well produced high quality oil for some time. It is expected that the explorations will lead to definite conclusions regarding oil deposits in this area during 1957. If oil is found and developed the Costa Rican Government would receive about 50% of the net profits. Prospects 19. Costa Rica's prospects for contilued rapid economic growth would be excellent but for one reason: The likelihood of a serious drop in export prices. Land resources are abundant, the possibility to increase production by better methods is great and so is the ability to utilize these methods quickly. Furthermore, there is no apparent need for heavy investments in transportation or other basic facilities in order to make production increases possible. However, if prices of coffee fall substantially, and they as well as cacao prices long remain at low levels, the prospects of economic growlth will be seriously impaired. In the first place, there would be less inducement to increase production of these crops. In the second place, and this is probably more important, one of the principal sources of financing private investment would be eliminated. The result would either be a reduction in investment with a decline in growth following or serious balance of payments difficulties if en effort was made to keeo up investmenlt through bank credit expansion or fiscal deficits. 20. However this may be, Costa Rica can presently look forward to a period of from one to three years with good coffee prices. If there are no crop failures during this period, and crops will at least be good in 1957, an excellent opoortunity will be offered to prepare for future adversities. These preparations can be made in two ways; by improving production methods so that more can be produced at lower costs, and by ouilding up strong foreign exchange reserves which can take the initial blow of the price fall. The first is being done, the second will depend on the conduct of fiscal and monetary policy. III MONETARY AID FISCAL POSITIOF Economic Stability 21. On the whole economic stability prevailed in Costa Rica from 1950 to 1955. Money supply was increasing at an average of 9% per year. Although this was a faster rate than the increase in real income, retail prices increased little, or only by 5% from September 1950 to September 1956. The  - 7 - increase in money supply reflected, therefore, prL-arily the need of tile economy for greater means of payment at const-nt prices. At the same time foreign reserves were increasing, except for a minor drop in 1954. 22. During this time, however, an important chlange was taking place in Government finances. From 1950 to 1953 the Government lhad been receiving more money from the private sector than it paid out. This surplus, which was substantial, went over to the banks in the form of increased Government deposits and purchases of Government bonds held by the banks. In addition, "exchange profits" during these years were used by the Central Bank to buy Government bonds, probably mainly from banlks. (These profits arise when the Bank solls at the free market of 6.60 foreign exchange bought at 5.60). These increased resources made it possible for the banks to expand their loans substantially at the same time as foreign exchange reserves were growing rapidly. Beginning late in 1953, however, the Government began to pay more to the private sector than it received. This happened in spite of a. continued Government surplus (net of amortization) in 1954, and only a small deficit in 1955. The explanation is primarily thlat the Government was amortizing debt with the private sector without being able to sell new bonds in substantial amounts outside the banks. In ordcr to meet all the payments to the private sector tlae Government had, therefore, first to draw doi,m its deposits with the banks, and then to sell to them increasing amounts of bonds. At the same time the exchange profits were increasingly being used to buy new bond issues of Government agencies instead of old bonds held by the banks and the public. 23. Why did this utilization of banlc resources by the Government not upset economic stability in 1954 and 1955? The answer is principally that during these years bank resources in the form of capital and reserves, savings deposits and returns from bond sales, increased more rapidly than before, ihile at the same time expansion of bank loans continued at the previous rate. Nevertheless, foreign exchange reserves increased much less in 1954 and 1955 than previously. This was primarily the result of the change in the fiscal situation. 24. Under the conditions that thus had been created, thle crop failures of 1956 were sufficient to upset stability. As the result of lower income, monetary circulation was reduced. At the same time the Central Bank considered it necessary early in the year to permit an increase in bank loans in order to reduce the effects of the crop failures on the private economy. Later in the year the prospects of a large coffee crop made it necessary to permit an increase in coffee loans compared with previous years. As a...r6sult bank loans increased from September 1955 to September 1956 by almost 060 million, twice the average inc-rease of previous years. In addition the Government continued to sell substantial amounts of bonds to the banks and to reduce its deposits. The overall result was a reduction in foreign reserves of no less than t13 million from September 1955 to September 1956.  -8- Government Finances 25. In recent years Government revenue and expenditures have increased rapidly, and in all probability more rapidly than national product. The increase in revenue from V191 million in 1952 to V277 million in 1955 was the result partly of high imports and partly of an increase in income tax rates from a maximum of 15% to 30%. The latter especially increased the tax payments of the Banana Company. Moreover, revenue was temporarily increased in 1955 when the Banana Company not only paid the tax for 1954, but also the 1955 tax in advance. In spite of the increase in income tax rates, indirect taxes on exports, consumption and above all imports, remain as high a part of revenue as ever before, or about 70% of the total in 1955. 26. It was the policy of thie administration which came into office at the end of 1953 to utilize the increase in Government revenue for the expansion of public works. A ten year program of power development was started by ICE, the Government power agency, a low cost housing institute was established, and expenditures for road construction and other public works expanded. The power program has been partly financed from the "exchange profits"., and there has also been some financing of public works by internal credit and by foreign supplierst credits. Nevertheless, the bulk of the increase in public works has been financed directly by the Government. In 1952 Governrment expenditures (excluding debt amortization) had amounted to