COSTA RICA: PRUDENT DEBT MANAGEMENT

UNCLAS SAN JOSE 000811 SENSITIVE SIPDIS DEPT FOR WHA, WHA/CEN, WHA/EPSC, EEB/IFD/OMA AND EEB/IFD/ODF; PLEASE PASS TO TREASURY: SSENICH E.O. 12958: N/A TAGS: ECON EFIN EIND EINV PGOV PREL CS SUBJECT: COSTA RICA: PRUDENT DEBT MANAGEMENT ¶1. (U) SUMMARY: The Arias administration has increased spending on infrastructure, education, health, support for workers, and the judiciary, not only in absolute terms, but also as a percentage of the total budget. As spending in these line items increased, they were offset by a decline in the percentage of the budget spent on debt payments. Despite the economic crisis and former Finance Minister Zuniga's request for 20 percent across the board budget cuts, international financial institution (IFI) representatives from the International Monetary Fund (IMF) and Inter-American Development Bank (IDB) expect spending in priority areas to continue, albeit at a slower pace. The decline in debt payments is likely to stall however, as the crisis has compelled the administration to take on more debt as revenues fall. End Summary. -------------- INVESTING IN SOCIAL AND PUBLIC WORKS PROGRAMS -------------- ¶2. (U) An analysis of the government of Costa Rica's (GOCR) 2007-2009 period reveals a notable increase in spending on infrastructure, education, health, support for workers, and the judiciary as a percentage of the total budget. The increases are remarkable when compared to budgets of the previous administration (2003-2006 budgets) and in light of the fact that an estimated 90 percent of the budget consists of mandated expenses and debt payments. Ministry or Percent of total budget Difference Budget Item 2003-2006 2007-2009 (average) (average) Education 19.7 24.6 4.9 Public Works 3.5 5.3 1.8 Judiciary 3.7 4.6 0.9 Health 1.7 2.4 0.7 Labor 1.1 1.9 0.8 Finance 1.1 1.7 0.6 Public Debt 50.4 38.3 -12.0 ¶3. (U) In education, the greatest increases came in funding for university education, followed by secondary education, and auxiliary and general education services. Over the same time period, spending on non-university post-secondary education dropped by almost three percentage points as the emphasis switched to university education. This change began in 2006 with the last budget prepared by the Pacheco administration and continued through the Arias administration. ¶4. (U) For public works, capital expenditures for highways posted the largest increase. The pattern of increasing expenditures is expected to continue through at least 2010 since the IDB's USD 850 million infrastructure loan was recently approved. The 2009 extraordinary budget, presented to the National Assembly on August 31, includes individual road projects from the loan. ¶5. (U) Increases in health, labor, finance, and the judiciary flowed mostly to general services in each of the ministries. A further breakdown showed the increase funded mostly wages and salaries in the judiciary, goods and services in finance, and public sector transfers in health and labor. -------------- THE RATIO OF PUBLIC DEBT DECREASES. . . -------------- ¶6. (U) The decrease in the percentage allocated to public debt payments cannot be wholly attributed to the Arias administration, as it is partially the result of less borrowing during previous administrations. Although debt had been declining as a percent of the budget and as a percent of GDP through 2008, it was not possible for the administration to maintain the trend in the face of sharply declining revenues. -------------- . . .AS DEFICITS INCREASE -------------- ¶7. (U) In a presentation to market participants in August, Director of Public Credit Juan Carlos Pacheco Romero noted that revenues declined by 8.3 percent in the first half of 2009 (1H2009) compared to 1H2008, while expenditures increased by 22.1 percent in comparison to the same time period. This resulted in an accumulated deficit of USD 350 million, which has been entirely financed through domestic debt issuance. Pacheco estimated that domestic debt would finance the combined public sector 2009 budget deficit (4.8 percent of GDP, 19 percent of the budget),but that the country will have to draw on a USD 500 million loan from the World Bank to finance not quite half of the 2010 budget deficit. -------------- -------------- INTERNATIONAL FINANCE INSTITUTIONS SIGNAL APPROVAL -------------- -------------- ¶8. (SBU) The IMF's mission chief for Costa Rica Andreas Bauer stated that he encouraged the GOCR to draw on the World Bank loan, as the increased domestic debt issuance was likely to begin to strain the domestic market. Bauer noted that although spending increased by 22 percent, this was lower than the 30 percent increase called for in the 2009 budget. A main risk to economic recovery was the continued under-execution of the 2009 budget, especially continued under-execution of investment expenditures. He noted that the increase in expenditures was due largely to current expenditures, particularly to increased public salaries. Such salary expenditures will be difficult to reverse once the crisis abates. He said the IMF expected a combined public sector 2009 deficit of 4.8 percent of GDP, assuming that spending on capital expenditures would increase in 2H2009. ¶9. (SBU) IDB resident representative Fernando Quevedo noted that the IDB's 2006-2010 country partnership strategy's priorities had not been revised based on the economic situation. Although he expressed some disappointment with the length of the process to gain National Assembly approval on loans, he stated that operations were relatively on track and the GOCR still placed a high priority on infrastructure improvements. -------------- 2009 AND 2010 BUDGETS -------------- ¶10. (U) The Finance Ministry presented the extraordinary 2009 and the regular 2010 budgets to the National Assembly on August 31 and September 1, 2009. The administration plans to fight the economic slowdown through explicit deficit spending as the Finance Ministry requests the National Assembly's approval of debt financing for ordinary expenses as well as approval of the 500 USD million World Bank loan. The extraordinary 2009 budget revision confirms the under-execution evident in 1H2009, but partially balances that with additional infrastructure spending in the port city of Limon financed by the World Bank. The 2010 budget deficit, projected to be 20 percent of the budget and 5 percent of GDP, is similar to 2009's budget deficit. The budget itself represents a 12.23 percent increase in local currency terms over 2009. While continuing to emphasize social and infrastructure spending, it also contains a notable 26.7 percent budget increase for public security. BRENNAN