The Big Idea
Costa Rica | IMF staff summary
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The International Monetary Fund’s latest summary on Costa Rica focuses on whether the country’s fragile balance of high growth and deflation will persist through a protracted cycle of foreign exchange appreciation. This balancing act needs to be carefully monitored. There are downside risks to growth and fiscal accounts, and ultimately the country’s trajectory towards an investment grade rating.
The IMF’s latest statement on Costa Rica opened the debate about monetary policy. The central bank sees the policy rate as neutral while the IMF sees it as restrictive. The debate is the reference rate for inflation. It’s interesting that inflation expectations remain consistent at 2% despite what the IMF described as the “tenth consecutive month of deflation and 34 months below the BCCR’s 2-4 percent tolerance range.” Inflation expectations are still below the midpoint of the 2% to 4% inflation target band. The central bank points to mostly temporary shocks on food prices, though the IMF emphasizes lower prices across services and the CRC appreciation as deflationary factors.
There is clear agreement about the liquidity buffer with strong foreign exchange reserve accumulation. Costa Rica now has one of the highest relative foreign exchange reserves in the region (10 months import coverage). This accumulation has been exclusively through direct purchases from the government after the large EUR domestic auctions with a priority to raise external liquidity through the recent uncertainty (well-timed considering recent external volatility). The central bank suddenly switched tactics last month with direct foreign exchange intervention ($259 million) to interrupt the renewed pace of appreciation. This provided only temporary relief.
The IMF statement argues against foreign exchange intervention and instead prioritizes additional rate cuts. There is a clear contrast between the central bank’s assessment of a neutral policy rate versus the IMF assessment of a restrictive policy rate at 3.25% (likely based on actual versus inflation expectations). “With the real policy rate now further above IMF staff estimates of the neutral level, additional rate cuts would support domestic demand and prevent inflation and inflation expectations getting stuck below the central bank’s target range. Continued efforts to reduce dollarization and market frictions and modernize central bank communications would strengthen monetary policy transmission.” The central bank gradually adopted 3X25bps in rate cuts last year with fewer policy options against the newest phase of foreign exchange appreciation (and below US policy rates).
The real effective foreign exchange appreciation has not yet translated into acute imbalances with strong headline GDP growth estimated at 4.6% in 2025 and estimated at 3.8% in 2026 with high real wages and two-speed exports on still strong external demand for higher value-added exports. The current account deficit remains low at 0.7% of GDP (strong export growth from the free trade zone and still positive growth from traditional exports) with still large inflows on the capital account (high FDI inflows). The fiscal rule reinforces spending restraint against the deceleration in lower nominal (deflationary) revenues with low debt service improving the nominal fiscal deficit.
The IMF policy recommendations do not carry any conditionality with no formal program and already agreed precautionary credit line. The latest shock in commodity prices may erode the external position with Costa Rica an energy importer at 17% of imports. However, the strong fundamentals of the supportive external liquidity/above trend growth and favorable technicals offer a buffer against other Central American countries (specifically the Dominican Republic). The still net positive credit momentum from an active reform agenda should discourage against risk reduction while illiquidity on the Eurobonds should reinforce low market beta. Our base case view remains for relative outperformance relative to investment grade credits (Costa Rica/Paraguay convergence trade) on the positive rating momentum later this year.
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