DOCUMENT OF THE INTER-AMERICAN DEVELOPMENT BANK

COSTA RICA

IDB COUNTRY STRATEGY WITH COSTA RICA, 2006-2010

FEBRUARY 2007

This paper was produced by a team from the Regional Operations Department 2 Country Division (RE2/OD3) and the Banks Country Office in Costa Rica (COF/CCR), coordinated by Fernando Straface (RE2/OD3) and consisting of Julin Caballero (RE2/OD3), Karla Enamorado (RE2/OD3), Miguel Loria (COF/CCR), Betsy Murray (COF/CCR), Alejandro Bernales (COF/CCR), Ana Silvia Aguilera (RE2/OD3), Ladislao Brachowicz (RE2/OD3), Ronan Le Berre (RE2/OD3), Federico Changanaqu (RE2/OD3), Cecilia Bernedo (RE2/OD3), Julieta Caunedo (RE2/OD3), Ramiro Ruiz del Castillo (RE2/OD3), and Roberto Machado (RE2/RE2). The team received inputs from the SC2, SO2, EN2, and FI2 Operations divisions, the Integration and Regional Programs Department (INT), the Research Department (RES), the Multilateral Investment Fund (MIF), the Private Sector Department (PRI), and the InterAmerican Investment Corporation (IIC). The paper was edited by Fernando Quevedo (RE2/OD3) and Manuel Agosn.

CONTENTS

EXECUTIVE SUMMARY MATRIX OF THE BANKS COUNTRY STRATEGY WITH COSTA RICA, 2006-2010 INTRODUCTION ............................................................................................................................I I. DEVELOPMENT CHALLENGES FOR THE COUNTRY AND THE GOVERNMENT'S PROGRAM 1 A. Chief development challenges..............................................................................1 1. Strengthening the macroeconomic framework and improving the quality of public spending............................................................................................2 2. Deepening the countrys growth and international positioning model ........5 3. Meshing social inclusion policies with the growth strategy.........................8 The governments agenda and medium-term macroeconomic prospects..........11

B. II.

PREVIOUS STRATEGIES AND PORTFOLIO: LESSONS FOR THE NEW STRATEGY ............14 A. B. C. Aligning programming cycles with country challenges.....................................14 Challenges in executing the programmed operations, and achievements..........15 Lessons learned and recommendations ..............................................................17

III.

THE BANKS STRATEGY WITH COSTA RICA FOR 2006-2010 ........................................20 A. Objectives and strategy focus .............................................................................20 1. Strengthening the macroeconomic and public expenditure management framework..................................................................................................21 2. Deepening the countrys growth and international positioning model ......22 3. Creating opportunities for inclusive economic growth ..............................25 Implementation of the strategy ...........................................................................26 1. Lending scenarios .......................................................................................26 2. The Banks exposure and its share of financing to Costa Rica ..................28 3. Country financing parameters and fiduciary risk .......................................29 4. Monitoring the strategy...............................................................................30 5. Engagement of other cooperation agencies ................................................30 6. Strategy implementation risks.....................................................................30

B.

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ANNEXES

Annex I Annex II Annex III Annex IV Annex V Annex VI Annex VII Annex VIII

Previous strategies and portfolio: Programming and approvals, 2002-2006 2007 lending program and work focuses, 2006-2010 lending scenarios 2006-2010 technical cooperation, MIF, and nonlending products programs Debt sustainability analysis Documents referenced in developing the Banks strategy with Costa Rica Strategy guidelines for support to Costa Ricas private sector Country financing parameters Millennium Development Goal indicators

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ABBREVIATIONS

AyA BCCR BCS-CR CABEI CACM CAF CCLIP CCSS CFAA CFPs CGR CNC COMEX CONAFIN CPAR CR DR-CAFTA FDI GEF HIPC ICE IDB IMF INEC ME MH MIDEPLAN MIF MINAE MIVAH MS MSMEs NLF NLP OVE PBL PDF-B PDL

Instituto Costarricense de Acueductos y Alcantarillados [Costa Rican Water and Sanitation Authority] Central Bank of Costa Rica The Banks country strategy with Costa Rica Central American Bank for Economic Integration Central American Common Market Corporacin Andina de Fomento [Andean Development Corporation] Conditional Credit Line for Investment Projects Costa Rican Social Security Administration Country Financial Accountability Assessment Country financing parameters Office of the Comptroller General of Costa Rica Consejo Nacional de Concesiones [National Concessions Council] Ministry of Foreign Trade Consejo Nacional de Financiamiento [National Financing Council] Country Procurement Assessment Report Costa Rica Dominican Republic-Central America-United States Free Trade Agreement Foreign direct investment Global Environment Facility Heavily indebted poor countries Instituto Costarricense de Electricidad [Costa Rican Electricity Authority] Inter-American Development Bank International Monetary Fund Instituto Nacional de Estadstica y Censos [National Statistics and Census Institute] Ministry of Education Ministry of Finance Ministry of Planning and Economic Policy Multilateral Investment Fund Ministry of the Environment and Energy Ministry of Housing and Human Settlements Ministry of Health Micro-, small, and medium-sized enterprises New Lending Framework Nonlending product Office of Evaluation and Oversight (IDB) Policy-based loan Project Development Facility Block B grant (GEF) Performance-driven loan

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PER PRI PRODEV PSE RPS S&T SIEPAC SMEs SWAp TC UNDP WDI WEF WTO

Public Expenditure Review Private Sector Department (IDB) Program to implement the external pillar of the medium-term action plan for development effectiveness Public social expenditure Red de Proteccin Social [Social Protection System] Science and technology Central American Electrical Interconnection System Small and medium-sized enterprises Sector-wide approach Technical-cooperation operation United Nations Development Programme World Development Indicators World Economic Forum World Trade Organization

EXECUTIVE SUMMARY

A number of positive factors set Costa Rica apart within the region and have underpinned the economic and social progress it has made over the past 20 years. The country has a long track record of political stability and institutional quality, a firmly established outward-looking growth model, and a social structure that includes a large middle class and low levels of exclusion relative to other countries in the region. The countrys generally good performance over the past two decades notwithstanding, its pace of growth has shown signs of slowing in recent years and its economic growth has been somewhat volatile. Moreover, since 1994 its growth has not been reflected in any substantive gains against poverty (which has stood at around 20% since that year), and income inequality is more acute than it was a decade ago, although recently it has been diminishing. Costa Ricas main development challenge is to speed up its growth and make it sustainable while broadening the platform for participation, bringing sectors still outside the mainstream into the economic life of the nation. This scenario involves an agenda composed of three major policy objectives for the new administration: (i) strengthen the macroeconomic framework and improve the quality of public spending; (ii) deepen the countrys growth and international positioning model; and (iii) mesh social policies with the growth strategy. The government agenda for 2006-2010, entitled Toward a Developed Costa Rica for the Bicentennial, ties these challenges to a set of policy priorities aimed at positioning Costa Rica more fully and more advantageously in the international economy. The objective of economic policymakers is to lock in macroeconomic stability by gradually lowering the inflation rate and cutting the fiscal deficit. To this end, the Executive has drafted a tax reform package designed to boost government revenues. The Government of Costa Rica will also work to bolster the countrys competitiveness by increasing investment in infrastructure and education (chiefly secondary education) and by providing the production sector with broader access to scientific research findings and technological developments. This process will be coupled with the design of a social safety net to ensure that the countrys poorest have access to quality education, health care, and core infrastructure services. On the external front, the authorities will work to strengthen the economys global positioning and attract foreign direct investment (FDI) by way of ratification of the Dominican RepublicCentral AmericaUnited States Free Trade Agreement (DR-CAFTA), deeper integration within Central America, and trade advances with the European Union, among other actions. The Banks country strategy with Costa Rica (BCS-CR) for 2006-2010 is the product of a dialogue between the Bank and the Government of Costa Rica regarding the major challenges facing the country, the new administrations policy priorities, and the Banks comparative advantages for action in specific areas. The BCS-CR has been enriched by a dialogue with the private sector maintained by the entire IDB Group.

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The BCS-CRs general objective is to help Costa Rica deepen economic growth and social progress. To that end, this paper sets out three strategic areas for Bank action that tie in with the Costa Rican governments policy challenges and priorities. It looks at each of these strategy pillars from a comprehensive IDB Group perspective, along with potential modes of lending and nonlending (technical assistance, research) support for the Costa Rican government and for the countrys private sector. 1. Strengthening the macroeconomic and public expenditure management framework. The focuses of Bank support will be a comprehensive review of public expenditure management, tax reform implementation, and macroeconomic scenarizing. 2. Deepening the countrys growth and international positioning model. The Bank will work with the country in its efforts to position itself within the global economy. Activities envisaged in this area include implementation of trade agreements and design of a complementary agenda under the Pro-Competitiveness Reform Program. The Bank also will provide support for the infrastructure investment plan (energy and highways) and various sector-level initiatives to help put the Costa Rican economy on a sustainable growth path. 3. Creation of opportunities for inclusive economic growth. The Bank proposes to focus its support efforts on the strengthening and reorganization of the countrys social safety net, improving the poorest sectors physical milieu, and upgrading the quality and extending the reach of secondary education and other forms of employment training. A cross-cutting challenge as the Bank follows that course will be to bolster the activity of its private-sector windows. Each action area proposed in the BSC-CR includes a number of private-sector work focuses, set out in the Strategy Guidelines for Private Sector Support (Annex VI) approved by the Bank in August 2006. With its new private-sector mandate the Bank can take a broader view in that sphere, reflected in the sectors being given priority in the aforementioned guidelines: infrastructure, financial system, agribusiness, sustainable tourism, and housing. To deliver this support effectively, coordination between the Private Sector Department (PRI), the Inter-American Investment Corporation (IIC), and the Multilateral Investment Fund (MIF) in their work with Costa Ricas producing sectors will need to be tightened. The IIC regional office in Costa Rica provides the physical presence necessary to move forward on that task, in coordination with all the IDB Group windows. The BCS-CR presents a base-case lending scenario fitted to the 2006-2008 work program, comprising operations that are high priorities for the Costa Rican government and could be approved in the current fiscal environment. Two operations totaling US$70 million were approved in December 2006 (Urban Poverty Alleviation and Tourism in Protected Areas), programmed during the preceding strategy cycle and endorsed by the current administration. The 2007 lending program calls for two operations totaling US$262 million, one of them a first US$250 million loan as phase one of a US$500 million conditional credit line for investment projects (CCLIP) operation to support the Costa Rican Electricity Authority (ICE). That operation figures in the ICEs externally funded investment plan. The

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second loan would supply US$12 million for a project to strengthen the Ministry of Environment and Energy (MINAE), requested by the new administration at the start of its term. In 2008 the Bank could process for approval a global operation to further development of the Chorotega, North Hutar, Pacific, and Brunca regions, which would complete the regional support line that currently takes in the Atlantic Hutar and Sixaola regions. Prospects for that loans approval in 2008 would depend on progress in securing parliamentary ratification and disbursement eligibility of the projects already approved. The estimate of total Bank lending to Costa Rica in the base-case scenario is aligned to the overall fiscal capacity of the countrys public sector, projected from the macroeconomic outlook discussed in section I. Net lending flows in that lending scenario would be negative in 2006 and 2007, slightly positive in 2008, and increase moderately in 2009. A shift from the base-case lending scenario to a high-case scenario will depend, first, on the creation of greater fiscal capacity to carry through the countrys priority investments in a manner consistent with the Costa Rican governments stated debt sustainability objectives. Potential work focuses to configure a high-case lending scenario have been envisaged as beginning only in 2008. At that time, the Bank and the government, as part of a midterm review of the BCS-CR, will analyze the state of the public accounts and the feasibility of enlarging the investment account in connection with new Bank support operations. Second, the approval of new loans to comprise a high lending scenario would hinge on progress made in securing congressional ratification and disbursement eligibility of Bank-approved projects that are awaiting ratification and of the four operations that could be approved in 2006 and 2007. Decisions on the possibility of adding new loans to the pipeline will be made in the course of programming exercises as from 2008. The Costa Rican government is devising a set of action lines that could help make up a high lending scenario, including modernization of the government procurement and contracting system, road infrastructure finance, support to expand the nations social safety net, and secondary education improvements. The structuring of a quick-disbursing loan to help supply the governments 2008 or 2009 borrowing requirements is one potential future action focus.

THE BANKS STRATEGY WITH COSTA RICA, 2006-2010 COUNTRY STRATEGY MATRIX
General BCS-CR objective for 2006-2010: Help deepen Costa Ricas economic growth and social progress Macro variables: GDP growth: Baseline (BL): 4.1% (2001-2005 average) // 2010 target: 4.8% (2006-2010 average) Poverty (% households): BL: 20% (2006) // 2010 target: 16% Strategy focus I. Strengthening the macroeconomic and public expenditure management framework Country objectives Improve the effectiveness and efficiency of public expenditure Actions of other agencies European Union Municipal strengthening, e-government World Bank E-government Areas of IDB intervention I.1 Institutional and technical capacity building to improve public expenditure management IDB actions Portfolio* TC -Public Financial Management Improvement Program (PRODEV-A) 2006-2008 work program ** NLP -Public Expenditure Review (PER) with World Bank TC -Management for Results and National Public Investment System (PRODEVB) Pipeline NLPs -Fiscal risk management strategy for natural disasters -Evaluation of the decentralization process and policy proposal -Loan to modernize the government procurement system Country indicators relating to the IDB program -% Central government budget capital expenditure/GDP BL 2006: 1.1 Target 2010: average: 1.5 (Ministry of Finance) -% of central government capital expenditure incorporated into National Public Investment System BL 2006: 0 Target 2010: 100 (Ministry of Finance) -National Public Investment System implemented (Ministry of Finance) - Procurement system redesigned in 2010 (Ministry of Finance) - (%) Tax revenues/GDP (Ministry of Finance) BL 2006: 13.7 Target 2010: 17.2 -Primary surplus (%) (Ministry of Finance) BL 2002-2005 average: 1.4

Increase tax revenues by implementing tax reforms

CABEI Modernization of public finances (55 MM)

I.2 Support for tax reform implementation and macroeconomic scenarizing

Loan -Regularization of Cadastre and Property Registry (50.7 MM)

NLP -Technical assistance in the design and execution of tax reforms -Macroeconomic consistency model

-Loan to help fund borrowing requirements during transitional phase of tax reform implementation

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General BCS-CR objective for 2006-2010: Help deepen Costa Ricas economic growth and social progress Macro variables: GDP growth: Baseline (BL): 4.1% (2001-2005 average) // 2010 target: 4.8% (2006-2010 average) Poverty (% households): BL: 20% (2006) // 2010 target: 16% Strategy focus Country objectives Actions of other agencies Areas of IDB intervention IDB actions Portfolio* 2006-2008 work program ** -Debt sustainability study Pipeline Country indicators relating to the IDB program Target 2006-2010 average: 2.3 -(%) Public debt/GDP (Ministry of Finance) BL 2005: 56.7 // Target for 2010: 50 -% of cadastral surface area incorporated into Regional Information System BL: 0 // Target for 2010: 60 (National Property Registry) -Effective installed electrical capacity (MW, ICE) BL 2006: 1,937 Target 2010: 2,529 -(%) Paved roads in good condition with pavement roughness below 3 BL: 20 Target 2010: 30 (Ministry of Public Works and Transport) -Projects under concession BL 2005: 2 Target 2010: 4 (CNC)

II. Deepening the countrys growth and international positioning model

Renovate and expand the countrys infrastructure

CABEI -Road infrastructure loan (170 MM) World Bank -Loan: Port of Limn (35 MM) -Technical assistance and possible loan in the telecommunications sector

II.1 Support for the Infrastructure Development Plan

Loan SIEPAC (33.7 MM)

2007 loan -Electric Power Development IV (CCLIP-ICE) (250 MM) PRI/EN2 -Investment in public utilities in Heredia (without sovereign guarantee) (28 MM) MIF -Support for the National Concessions System

PRI -San JosCaldera highway -San JosCartago highway -Loan for road rehabilitation and expansion -Veraguas hydroelectric project (PPP)

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General BCS-CR objective for 2006-2010: Help deepen Costa Ricas economic growth and social progress Macro variables: GDP growth: Baseline (BL): 4.1% (2001-2005 average) // 2010 target: 4.8% (2006-2010 average) Poverty (% households): BL: 20% (2006) // 2010 target: 16% Strategy focus Country objectives Actions of other agencies Government of Japan -Water supply and sanitation in metropolitan area (127 MM) -Bridge rehabilitation Promote industry linkages, boost SME productivity, and create an investmentfriendly environment II.2 Enhancement of competitiveness and promotion of industry linkages Loans Competitiveness Reform Program (116.8 MM) Agricultural development (12.5 MM) TCs -Development of a national environmental strategy -Water resources management Areas of IDB intervention IDB actions Portfolio* 2006-2008 work program ** TC -Supplementary studies for the Boruca-Veraguas hydroelectric project Pipeline Country indicators relating to the IDB program

2007 loan -Enhancement of environmental management capacity (12 MM) TC - Support for negotiation and implementation of trade agreements NLPs -Strategy guidelines for support to Costa Ricas private sector -The rural economy and CAFTA -Workshops on integration and trade challenges

MIF -Business incubator -SME development in environmental service payment schemes -Internet for SMEs -Development of SME equity market -Digital signatures -Public-private partnerships in subnational governments

WEF Growth Competitiveness Index BL 2005: 3.72 Target 2010: 4.0 (+10%) -Domestic purchases by freezone enterprises (COMEX) BL 2004: US$79 MM // 2010 target: US$103 MM (+30%) -Export growth (%) (COMEX) BL 2000-2005: 4.2 average 2006-2010 target: 10 average -MINAE restructured in 2010

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General BCS-CR objective for 2006-2010: Help deepen Costa Ricas economic growth and social progress Macro variables: GDP growth: Baseline (BL): 4.1% (2001-2005 average) // 2010 target: 4.8% (2006-2010 average) Poverty (% households): BL: 20% (2006) // 2010 target: 16% Strategy focus Country objectives Actions of other agencies Areas of IDB intervention IDB actions Portfolio* 2006-2008 work program ** MIF -Assistance for SMEs in gaining access to CAFTA (R) -Appellation of origin for Central American coffee (R) -Development of national franchising TCs -National Emergencies System -PDF-B Management of marine and coastal resources in Puntarenas -Priority and design of ASP investments GEF grant Puntarenas (6 MM) Pipeline Country indicators relating to the IDB program

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General BCS-CR objective for 2006-2010: Help deepen Costa Ricas economic growth and social progress Macro variables: GDP growth: Baseline (BL): 4.1% (2001-2005 average) // 2010 target: 4.8% (2006-2010 average) Poverty (% households): BL: 20% (2006) // 2010 target: 16% Strategy focus Country objectives Strengthen border area growth Actions of other agencies Areas of IDB intervention II.3 Regional development capacity building IDB actions Portfolio* Loans -Sustainable development of binational Sixaola River Basin (9.2 MM) -Sustainable development of Atlantic Hutar region (15 MM) 2006-2008 work program ** 2006 loan -Tourism in protected areas (20 MM) (2006) 2008 loan -Support for development of Chorotega, North Hutar, Central Pacific, and Brunca regions (45 MM) TC -Development strategies for Chorotega and North Hutar regions Pipeline MIF -Development of cultural and educational tourism Country indicators relating to the IDB program (%) Open unemployment, by region (INEC) 2006-2010 target: declines in each region I. Chorotega BL: 5.8 II. Brunca BL: 5.9 III. Central Pacific BL: 8.5 IV. Atlantic Hutar BL: 6.8 V. North Hutar BL: 5.9 - 50% reduction in the number of families living in informal neighborhoods and slums BL: 39,739 families Target for 2010: 19,127 families (MIDEPLAN) -Access to child care and health services for adolescent mothers in urban areas (%) BL 2005: 33 Target 2010: 55 (MIDEPLAN)

III. Creation of opportunities for inclusive economic growth

Ensure access to social and core infrastructure services for the poor

European Union Poverty, migration, social spending

III.1 Amelioration of physical milieu in high-poverty urban centers

Loan -Regularization of cadastre and property registry (50.7 MM)

2006 loan -Urban poverty alleviation (50 MM) TC -Heritage preservation and urban development

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General BCS-CR objective for 2006-2010: Help deepen Costa Ricas economic growth and social progress Macro variables: GDP growth: Baseline (BL): 4.1% (2001-2005 average) // 2010 target: 4.8% (2006-2010 average) Poverty (% households): BL: 20% (2006) // 2010 target: 16% Strategy focus Country objectives Actions of other agencies Areas of IDB intervention III.2 Support for the launch of a social safety net Work toward universal secondary education World Bank Equity and efficiency in education (30 MM) III.3 Improving access to secondary education and employment training and heightening their relevance IDB actions Portfolio* Loan -Development of the health sector (4.2 MM) 2006-2008 work program ** TC -Design of social safety net and Conditional Transfers Program NLP -Analysis of the Costa Rican labor market Pipeline Loan pipeline -Support for social safety net Country indicators relating to the IDB program - Number of families covered by the new social safety net BL: 0 Target 2010: 40,000 (IMAS) -Number of students benefiting from conditional cash transfers (MIVAH) BL: 0 // 2010 target: 130,000 -Annual dropout rate in secondary school (MEP (%) BL: 12.5 // 2010 target: 10.5

-Support for secondary education and employment preparation

* Figures in parentheses are undisbursed balances (in millions of dollars). ** Figures in parentheses correspond to the preliminary operations design (millions of dollars). Abbreviations: MIF: Multilateral Investment Fund NLP: Nonlending product PRI: Private Sector Department TC: Technical-cooperation operation R: Regional

INTRODUCTION
The Banks strategy with Costa Rica (BCS-CR) for 2006-2010 is the product of a dialogue between the Bank and the Government of Costa Rica regarding the major challenges facing the country, the new administrations policy priorities, and the Banks comparative advantages for action in specific areas. On 25 May 2006, a policy dialogue was held between the Bank and the Costa Rican government in San Jos, Costa Rica. During this meeting, the country authorities outlined the broad development blueprint for the present administrations term and the Bank presented the main findings of the Policy Dialogue Paper.1 After this meeting, sector-specific workshops and missions were carried out to delve more deeply into each subject area and explore ways in which the Bank might make a contribution. The BCS-CR was enriched by a dialogue with Costa Ricas private sector held before the presidential elections. This entailed an exchange of views on visions and support prospects between the countrys private sector and all arms of the IDB Group, including the Private Sector Department, the Inter-American Investment Corporation, and the Multilateral Investment Fund. Out of this dialogue came strategy guidelines for support to Costa Ricas private sector (Annex VI), which informed the development of the Bank intervention strategy focuses set out in strategy paper. In line with the Banks ongoing country strategy reformulation exercise, the BCS-CR identifies Bank intervention areas and strategy pillars. Determinations on specific operations beyond the outset of the strategy period will be made as part of the programming process over the strategys life span. The programming work will be aligned with the action parameters set out in this paper and with the scenarios and triggers devised.

This paper summarizes a series of studies and analytical thematic notes that were prepared as a contribution to the dialogue.

I.

DEVELOPMENT CHALLENGES FOR THE COUNTRY AND THE GOVERNMENT'S PROGRAM

A.
1.1

Chief development challenges

A number of positive Table 1. GDP growth (%) and poverty (% of households) institutional, economic, and 1991-1995 1996-2000 2001-2005 CR 5.5 5.0 4.1 social factors set Costa Rica GDP growth LAC 3.4 3.2 2.4 apart within the region and CR 3.0 2.8 2.1 Per capita GDP growth have underpinned the LAC 1.7 2.0 1.1 CR 25.0 20.6 20.5 economic and social Poverty LAC 45.2 43.2 43.3 progress it has made over CR: Costa Rica LAC: Latin America and the Caribbean the past 20 years. However, Source: IMF, World Bank, and MIDEPLAN in recent years there have been signs of a gradual slowing of economic growth and a measure of economic volatility.2 Moreover, since 1994 the countrys growth has not translated into any substantive gains in the struggle against poverty, with poverty rates holding at around 20% since that time (Table 1). Meanwhile, although income inequality has recently diminished, it is greater than it was a decade ago. Costa Ricas main development challenge is to speed up its growth and make it sustainable while bringing sectors currently outside the mainstream into the economic life of the nation. While it is true that the countrys economic growth rates have outpaced the Latin American average, its real growth potential would appear to be substantially greater than its actual performance.

1.2

1.3

The principal reason for Costa Ricas modest growth has been the difficulty of forging linkages between its most dynamic sectors (tourism, electronics, services, technology) and the rest of the national economy, primarily small and medium-sized enterprises (SMEs). Factors playing a part in this situation include the productivity differentials between the more dynamic firms and the rest of the economy, the lack of the infrastructure needed to link up industry enclaves (a consequence of low public and private investment), asymmetries in the business environment for domestic firms in comparison to ventures operating in free trade zones or under other special regimes, and the high cost of local-currency production finance for small businesses. The internationalization and modernization of the dynamic sector of Costa Ricas economy has not been effectively coupled with a commensurate change in the available supply of human capital. As a result, there is a widening gap between demand on the countrys more dynamic labor markets and the education systems ability to turn out qualified workers for those markets. This has direct implications for income distribution and the perpetuation of poverty in sectors that have been left out of the economic mainstream.

1.4

GDP did rebound somewhat in 2005, however, and the 2006 estimates are promising.

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1.5

6 65 These factors are Figure 1. Deficit and debt of consolidated public sector partly a 5 60 consequence of macroeconomic 4 55 circumstances that 3 have, in recent 50 years, weakened the 2 States ability to 45 1 finance investments, reduced the avail0 40 ability of coln 1998 1999 2000 2001 2002 2003 2004 2005 production finance and raised its cost, and restricted policy options for curbing inflation. The persistence of fairly large fiscal and quasi-fiscal deficits, the result of a low tax burden and expenditure rigidities, has narrowed the scope of policy options open to successive administrations and poses a threat to the future sustainability of public finances (Figure 1).
Debt (% of GDP)
Public debt Consolidated public sector deficit BCCR deficit

1.6

The challenges facing Costa Rica involve an element of strategic timing, given the prospects opening up to better position itself in the global marketplace through the various treaties that are now awaiting approval and/or being negotiated. The following sections take a closer look at these challenges, which can be summed up as follows: (i) strengthen the macroeconomic framework and improve the quality of public spending (ii) deepen the countrys growth and global trade engagement model; and (iii) mesh social inclusion policies with the growth strategy. 1. Strengthening the macroeconomic framework and improving the quality of public spending

1.7

Over the past 15 years Costa Rica has built up a series of macroeconomic imbalances that have limited successive administrations policymaking latitude. If the country can reduce these imbalances it can free up resources that are now being paid out to service the public debt and use them to increase social expenditure and investment and lower inflation. There are three main macroeconomic challenges to be addressed: (i) reduce fiscal imbalances (chronic fiscal and quasi-fiscal deficits; (ii) lower inflation, and (iii) keep the public debt sustainable. On the public spending side, some expenditure-line rigidities and weak areas in the expending of public monies diminish the quality of public spending. From 1992 to 2005, the combined public-sector deficit averaged 3.2 points of GDP and trended up throughout most of the decade, peaking at 5.4% of GDP in 2002 (Figure 1). The operating losses of the Central Bank of Costa Rica (BCCR) have been a chronic problem since 1992 and are part of the reason for a quasi-fiscal deficit averaging 1.4% of GDP. Because the shortfall is so large, the public debt stock has been mounting. Measured in terms of GDP, the debt passed the 50%

1.8

Deficit (% of GDP)

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mark in the late 1990s and peaked at 61% of GDP in 2004. The stubborn quasifiscal deficit is also one of the main reasons why inflation has been so high in Costa Rica over the past decade. During this period the inflation rate has not dipped below about 10%, and it reached 13% in 2004 and 14% in 2005. 1.9

To balance the public finances the country would urgently need to boost tax revenues, currently on the order of 13% of GDP. Agosin and Machado (2005) estimate that, given Costa Ricas per capita income levels and pattern of income distribution, its tax ratio should be close to 21% of GDP. The following factors explain the difference: (a) the tax systems structure and design, which is laden with exemptions and preferential-treatment provisions, and (b) the way in which the tax system is administered limits the governments ability to ensure tax revenue collection. The need for more public revenues is all the more important in light of the new administrations resolve to channel more resources into education, help finance infrastructure works, and move toward capitalizing the BCCR as a first step to rein in inflation. To manage this challenge the government is sending a tax reform package through Congress which, according to IMF calculations (Article IV), could boost tax revenue intakes by about two and a half percentage points of GDP.3 The BCCR quasi-fiscal deficit poses a further challenge that needs to be addressed with some urgency. There are three options for capitalizing the BCCR: its debt could be transferred to the government; the Ministry of Finance could transfer funds to the BCCR to erase the debt; or some combination of these two approaches. A reduction in the chronic fiscal and quasi-fiscal deficits would also help counter one of the countrys inflation drivers, paving the way for the inflationtarget system that the BCCR plans to move steadily toward.4
At the moment the public debt is not so high as to create a crisis in the short run,5 but it does restrict the authorities latitude to borrow for sectors where investment is needed and heightens the countrys external vulnerability. The debt challenge is to bring the debt stock below 50% of GDP and set it on a long-term downward trend. Different analysts (BCCR, IMF, IDB) concur that a primary surplus of at

1.10

1.11

1.12

Tax reform is a top priority for the Costa Rican government, which has split its draft legislation into nine separate bills, three of whichincome tax, value-added tax, and tax on high-end real estatewould yield the bulk of the new tax revenues. The other bills call for changes to the tax code, tax bases, and some smaller levies. In addition, given the WTO requirement to equalize, by 2009, corporate income tax rates for all companies operating within the country, including companies operating in the free trade zones, in the medium term the country would need to reassess its free-zone investment incentives, which to date have offered an important tax exemption component. The exchange-rate band system introduced on 17 October 2006 is an intermediate step toward greater exchange-rate flexibility. In its latest review (July 2006), Moodys Investor Services upgraded its Costa Rica debt outlook from negative to stable. It did not, however, revise the countrys Ba1 rating for local- and foreign-currency bonds.

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least 2.5%-2.8% of GDP will be needed in order to achieve the above-mentioned objectives (Annex IV). 1.13

As for quality of public spending, severe expenditure rigidities make it difficult to improve resource allocation, and curtail the level of resources that can be put into public investment.6 Earmarked expenditures amounted to nearly 190% of current revenues in 2005 (Ministry of Finance, 2005). In their efforts to bolster the countrys fiscal position the authorities have focused mainly on containing the small portion of non-entitlement expenditure, which includes public investment.7 Improved efficiency, transparency, and targeting of public expenditure would heighten the legitimacy and impact of the fiscal reforms that the Costa Rican government intends to pursue. One priority thus is to enhance the transparency of the different fiscal scenarios and provide guidance for priority-setting by adopting a multiyear budgeting approach. One move in that direction would be a look at the set of earmarkings and the expenditure rigidities they entail. That in turn should be associated to a National Public Investment System to concentrate investment initiatives of all Costa Rican government departments and bodies, including public enterprises and decentralized agencies. Specifically, capital spending plans and goods or services provided by State enterprises that carry a significant subsidy should be explicitly identified in the government budget submitted to Congress. Meanwhile, to make the budget go further, administrative requirements and procedures would need to be streamlined in order to lower decentralized agencies transaction costs in dealings with the central government.
Government procurement system challenges In recent years the central government has developed the CompraRed [Purchasing Network] initiative as a core technology platform to underpin a decentralized procurement system. But this initiative covers only 6% of Costa Rican public sector procurement: 92% of procurements are concentrated in a handful of autonomous agencies which do not answer to the central executive and over which Congress has no oversight authority. The main consequence of this situation is that procurement processes become fragmented and there are no uniform quality standards. The Office of the Comptroller General (CGR) performs ex ante and ex post checks of procurement and contracting processes, particularly in the case of the autonomous agencies that have the bulk of the spending power, thereby driving up the associated transaction costs. The result is a set of incentives for procurement officials to take an extremely cautious approach involving protracted consultations and backtracking in each procurement operation. Open tendering processes take an average of 240 days, limited bidding processes 255 days, and sole-source procurement 62 days.8

1.14

6 7

This situation also heightens the countrys fiscal vulnerability to natural disasters. Capital expenditures shrank by 0.4% of GDP between 2002 and 2004, while their share of total expenditure fell from 8.4% to 6.8%. On occasion this prompts bidders to inflate prices for goods and services sought by the government in a bid to cover costs that may be occasioned by delays in contract finalization, and thus offset the heavy associated transaction cost (CPAR, 2005).

-5-

1.15

In regard to other branches of government that have public-expenditure responsibilities, in recent years Costa Ricawith support from the Bankhas moved ahead with a successful reorganization and modernization of its justice system. There are a number of issues regarding the operation of Congress to address, to equip that body to tackle a parliamentary agenda that will be key to the reforms the country plans to pursue in the coming years. Some specific concerns are: (i) limitations in congressional advisory service delivery, procedures, and methods; (ii) human resource management systems; (iii) constraints for Congresss relations with public institutions and its interaction with civil society; and (iv) some poor physical facilities that make it difficult to work and impossible to ensure employee privacy, safety and security, and health.

2. Deepening the countrys growth and international positioning model9

1.16 Costa Ricas growth strategy is an outstanding factor in assisting it to position itself in the global economy (DR-CAFTA, a possible accord with the European Union, and deepening of the Central American Common Market (CACM)). In order for the country to take full advantage of integration movements and of increased competition, however, it will have to sustain and deepen the foundations of that growth model and forge linkages between its most dynamic export-oriented sectors and the rest of the economy. This would call for a combination of cross-cutting and sector-specific interventions to make the Costa Rican economy more competitive and prepare the various sectors for the new opportunities and challenges that come with integration. Costa Rica has a number of challenges ahead to leverage the positive impact that its growth sectors can have on the economy at large. High on the agenda of crosscutting actions would be measures to: (i) increase investment in infrastructure, in view of the modest rate of physical capital formation registered in the 1990s;10 (ii) upgrade the human capital stock (see subsection 3); (iii) strengthen the financial sectors capacity to supply funding for the production system, especially SMEs; and (iv) enhance the climate for science and technology investment and innovation.

1.17

1.18

One pressing challenge will be to improve Costa Ricas infrastructure. Because investment levels have been so low over the past 20 years the country will have to surmount a number of obstacles. Its road network is underdeveloped and is severely deteriorating: according to a Ministry of Transport survey, only 28% of roads and highways are in good repair. Day by day the nations ports are losing market share to competitors in the subregion because of shortfalls in their facilities physical service-delivery capacity and high costs. Costa Rican airports operating capacity is too limited to meet air traffic demands. Electricity and fuel demand is

9 10

For an in-depth discussion of these issues, see chapter III of the Policy Dialogue Paper. The overall investment rate averaged 19% of GDP between 1991 and 2005, far below the 25% that international experience suggests is necessary to achieve a sustained growth rate of over 5% (Agosin and Machado, 2005).

-6-

forecast to rise around 5% annually, so investments in new ventures and to expand current installed capacity are a must. In addition to these concerns, there are severe housing and sanitation service deficits in various areas of the country. New operating modalities are required in order to expand public utilities coverage.11 As a result of these problems, pollution levels in some rivers and coastal areas are jeopardizing future tourism development in Costa Rica, and infrastructure shortcomings threaten to heighten the impact of natural disasters. 1.19 Approximately US$3.9 billion in investment is needed over the next four years for transportation and energy infrastructure expansion and maintenance US$1.5 billion for transportation, the rest for energy. The nations port, airport, and telecommunications infrastructure is in need of investment as well. For this to happen, mechanisms will have to be devised to encourage private investors to participate. One important focus will be the strengthening of the concessions system.12 Measures to that end should go hand in hand with moves to strengthen the institutional capacity for oversight and regulatory functions of public agencies such as the Ministry of Public Works and Transport, Ministry of the Environment and Energy, the ICE, the Public Utilities Regulatory Authority, the Costa Rican Water and Sanitation Authority (AyA), and local governments.

1.20

The slide in physical capital formation is also related to the financial sectors limited capacity to supply funding to the production sector. Total credit to Costa Ricas private sector in 2004 came to 42.5% of GDP, behind countries like El Salvador (50%) and Chile (70%). The credit supply for micro, small, and medium-sized enterprises (MSMEs), in particular, is extremely limited, representing only 16% of total financial system lending. This is attributable, in part, to the marked segmentation existing in the market between local- and foreigncurrency borrowing terms and conditions. Moreover, an underdeveloped secured transactions system, together with the regulatory requirements of the Superintendency for Financial Institutions (SUGEF), inhibits MSME demand for production loans and raises that markets entry barriers. A final, albeit not decisive, factor that should be mentioned is the existence of certain incentives for the financial system to lend to the State to finance the deficit and the ensuing crowding out of lending to private-sector segments that cannot tap the international capital markets. The countrys underdeveloped money and securities markets are a further constraint. In order to deepen the securities market, steps are needed to remove existing obstacles to private debt paper issues and the creation of new vehicles

1.21

11 12

Particularly solid waste removal and wastewater treatment. For a detailed analysis of Costa Ricas concessions system, see the sector note (Policy Dialogue Paper) on challenges facing that system (IDB, 2005). This note underscores four major challenges the country would have to manage in order for its concessions system to function well: (i) a shortfall in systemic infrastructure planning capacities in the country; (ii) the risks encountered in procurement processes due to the presence of multiple actors with partial veto powers; (iii) implementation risks owing to the dense bureaucracy involved in securing authorization for works contracts; and (iv) shortcomings in the legal and technical framework for expropriations.

-7-

(mortgage securitization, mortgage bonds, and launch of an equity market) to channel financial-sector liquidity to the production sector. An analysis of financial system regulation would be important as well, with a view to striking a balance between risk mitigation needs and promotion of the sector. 1.22

Though Costa Rica is one of the most advanced countries in the region in terms of science and technology development, only 6% of Costa Rican businesses are engaged in activities related to the patenting or adoption of new technologies. To turn this situation around, various actions would be called for: (i) development of a science and technology (S&T) strategy to coordinate the sectors stakeholders and resources; (ii) strengthening of the institutional capacity and incentives system to support SME innovation; (iii) incentives for new business startups through venture capital formation and other instruments; and (iv) linkages between the business sector and S&T-generating elements in academia. The DR-CAFTA opens up an array of opportunities for some sectors and poses transition and realignment challenges for others. The launch of trade negotiations with the European Union also is opening the way for Costa Rican exports and the attraction of foreign direct investment (FDI). Measures aimed at strengthening Central American integration and the operation of the Central American Customs Union are essential pieces in the countrys effort to achieve its growth and global economic integration objectives. This backdrop should be taken into account as a second stage of the complementary agenda is developed, to include programs to assist growth sectors and support realignment efforts in those that are facing the stiffest challenges.13 Such programs should be coupled with a broad modernization effort in spheres of government associated with business development in the country and initiatives to level the playing field in terms of business development conditions for all companies operating in the country, including those based in preferential industry enclaves.14 Some areas warranting special attention are registration and certification procedures and environmental, construction, and sanitation and health permitting requirements, which pose a stiff obstacle to national competitiveness and could open the way for influence peddling.

1.23

13

14

The launch of talks with the European Union and strengthening of Central American integration and the operation of the Central American Customs Union are key steps in achieving the countrys growth and global trade engagement goals. An analysis of Costa Ricas business climate reveals the following major impediments: (i) there are stiff bureaucratic entry barriers for business startups; (ii) regulations governing construction, environmental, and sanitation or health permits are excessive; (iii) doing business with the State is extremely complicated and in some cases the process is discriminatory with respect to domestic firms; (iv) the judicial system is inefficient in handling civil and commercial disputes; and (v) the public safety situation is deteriorating.

-8-

3. Meshing social inclusion policies with the growth strategy15

1.24
Figure Social indicators indicators Figure 3.2. Social Costa Rica has a broad 25 0,44 array of institutions 20 0,42 that are working to promote the transfer of 15 0,40 assets to the countrys 10 0,38 poorest. This institu5 0,36 tional fabric has served as a platform 0 0,34 1997 1998 1999 2000 2001 2002 2003 2004 2005 for universal policies Poverty Extreme poverty GINI coefficient which, in combination Source: MIDEPLAN (SIDES) with a series of http://www.mideplan.go.cr/sides/social/index.htmlMIDEPLAN selective interventions, made substantive inroads against poverty up until the mid-1990s (Table 1, page 1).
Poverty (%)

1.25

The fact that poverty levels have barely budged since then poses a challenge for policymakers to put the country back on the road to social progress (Figure 2). There also are regional economic and social disparities across the country: poverty is greater in border areas than in the central region, with rates nearing 50% in the Brunca and Chorotega regions. Measured in terms of unmet basic needs, there also is more poverty in these areas than in central Costa Rica (Figure 1). Income distribution is also more uneven in border areas than in the central zone.16 The challenges facing the country in order to return to a path of social progress are to: (i) achieve high economic growth rates and sustain them over time (see section C); (ii) increase the capacity, efficiency, and effectiveness of public social expenditure in order to heighten the impact of public policies targeting the most vulnerable groups and help more of the population into the economic mainstream; and (iii) upgrade the nations human capital by raising basic secondary education graduation rates and supplying the production system with workers who possess the requisite technical skills and competencies.
Figure 1. Percentage of extremely poor households, by region

1.26

Region Central Chorotega Brunca Atlantic Hutar Northern Hutar Central Pacific

2003 11.0 19.7 21.5 12.3 16.1 19.8

2004 13.5 23.1 26.8 18.0 17.5 17.7

Source: MIDEPLAN-INEC. The darker the color, the higher the rate of extreme poverty.

15 16

For a more in-depth discussion of these issues see chapter IV of the Policy Dialogue Paper. In addition to regional demographics, poverty in Costa Rica is associated with gender-related factors (single mothers), ethnicity (Costa Ricans of African descent and indigenous people), and nationality (Nicaraguans).

GINI coefficient

-9-

1.27

Public social expenditure (PSE) rose 3.8% annually, on average, between 1990 and 2003, but in 2004 per capita PSE was 20% lower than it had been prior to the 1982 crisis.17 Furthermore, real PSE declined in 2003 and 2004 as the economys growth slowed, fiscal strictures tightened, and inflation rose.
From a functional standpoint, the PSE trend reflects an increase in restrictive policies, which tend to be regressive, and a decline in selective policies, which have traditionally been more progressive. Social security was the sector in which PSE rose the most during this period (4.9% a year, on average) and, within that category, the sharpest increase was in contributory pension programs (5.3%). In contrast, in real per capita terms, funding for programs to aid vulnerable groups has remained constant, and such programs share of the resources devoted to the sector as a whole and of overall social expenditure has declined. In the education sector, the largest increase has been for preschools (11.9%) and open-learning modalities, whereas increases for postsecondary education trail the population growth rate. Allocations for stay-in-school incentives have also shrunk, and this is showing up in higher secondary-school dropout rates. The Ministry of Healths lead-agency capacity has been strengthened (19.6%) and primary healthcare funding has risen (4.9%), but this has been accompanied by a reduction in budgets for nutrition programs and services for the preschool population (-3.6%).

1.28

1.29

Furthermore, PSE is distributed proportionally across the population, which runs counter, in some cases, to the principle of progressivity. Between 1990 and 2003, public social spending rose in all quintiles, but the increase was somewhat steeper at the two ends of the spectrum. The poorest 20% of the population (the first, or bottom, quintile) received 20% of total PSE in 1990 and 22% in 2003. The more modest second-quintile gain (less than 1%) nonetheless helped raise the portion of total PSE received by the poorest 40% of the population from 39% in 1990 to 41% in 2003. The wealthiest quintile saw a marginally above-the-mean increase, so its share of the total remained unchanged at nearly 23%, which is larger than the proportion of the population this group represents. The share received by the countrys middle-income strata edged down slightly but is still close to 20%, which helped maintain a generally proportional PSE distribution pattern. Given the nature of PSE patterns and trends in poverty (and extreme poverty, especially in some regions), social policies clearly have had mixed success in recent decades. On the one hand, the social sector has succeeded in supplying core assets to Costa Ricas poorest over the last 15 years, chiefly by means of universal policies. However, the fact that extreme poverty rates have remained largely unchanged (5.6%) for a decade shows that the reach of universal policies has been insufficient and that the country still faces a challenge in terms of its selective policies. The Social Development and Family Allowances Fund (FODESAF) is the

1.30

17

Petrei et al. (2005).

- 10 -

main government vehicle for funding these types of policies, but in recent years its impact has been weakened by inefficiency and targeting problems. 1.31 The heads of chronically poor households in Costa Rica generally have not gone beyond primary school and a sizable share are economically inactive. A large percentage of these households are headed by women (this is especially true among economically inactive heads of household). Bringing these sectors into the production mainstream therefore calls for increased investment in human capital in such areas as early stimulation, secondary education, and job skills training. In addition to substantially improving childrens future chances of academic success, an expansion of early childhood services will help parents, and particularly mothers, to join the labor force and/or obtain training/education. One vehicle to invest in human capital in vulnerable and poor sectors of the population and halt the intergenerational transmission of poverty is the conditional cash transfers program which the Government of Costa Rica plans to implement.18

1.32

In order for the country to transform its production patterns in the coming years, its social sector must be capable of meshing social policies with the national economic growth strategy. The social inclusion strategy should focus on changing the profile of the asset portfolios being made available to disadvantaged sectors in such a way as to ensure that they receive the kinds of assets they need to be able to join the economic mainstream. As labor markets adjust to changes in the countrys production structure, those sectors chances of escaping poverty will depend on their access to educational endowments that can ready them for that marketplace.19 Education policy should be directed toward creating a labor supply that can meet the demand for more highly skilled workers. This will entail more equitable access to a secondary education, lower dropout and repeater rates, and readier access to higher education. Demand-side measures (targeted subsidies) to help people finish secondary school could complement the necessary supply-side investments (the experiences of Argentina, Brazil, and Mexico). Given the demand in booming sectors of the economy, consideration might also be given to improving English-language instruction and learning, to come up to international secondlanguage proficiency standards. Given the countrys relatively sophisticated job market, it would be well to consider modernizing the national training system, developing a system to certify training providers and permitting businesses to use their National Training Institute (INA) contributions to pay certified providers for training activities.

1.33

1.34

18

19

As one of its first actions, the administration created the Conditional Cash Transfers Program, which has three main components: cash transfers; improving education services for adolescents living in poverty; and incentives for more advanced students to save so that they can continue their studies after they pass the programs age threshold. Average real wage patterns reveal a widening gap between the various levels of educational attainment. In 1990 the mean wage for highly educated workers was 3.5 times the low-skill wage; by 2004 the proportion had risen to 4.

- 11 -

B.
1.35

The governments agenda and medium-term macroeconomic prospects

The governments 2006-2010 plan entitled Hacia la Costa Rica Desarrollada del Bicentenario [Toward a developed Costa Rica for the bicentennial] plots out the main strategic lines of action for the four-year term of the Arias administration. The common thread running through the administrations platform is the resolve to position Costa Rica more fully and more advantageously in the international economy while at the same time creating greater opportunities for the various sectors to share in the countrys economic progress. The governments national competitiveness agenda calls for increased investment in infrastructure, strengthening of employment training policies, and streamlining of procedures and regulations governing business activity. A high priority will also be placed on investment in education and in science and technology research and development. The government regards these fields of endeavor as key for improving production and the foreign investment climate. Work in these areas will be complemented by actions in the spheres of public safety and protection of property rights. Concurrent environmental policy measures will emphasize conservation of the nations water, forest, and marine and coastal resources and will further its strategy to encourage the use of renewable energy sources.

1.36

The social sector is one of the new administrations prime action targets. Measures will focus on sustainable reductions in current poverty rates and providing the rural and urban population with greater access to public health, housing and, especially, education services. The Costa Rican government proposes to reduce the proportion of poor households by one percentage point per year, raise the education budget from 6% to 8% of GDP, and do away with 50% of the countrys informal settlements.
The authorities economic objective is to lock in macroeconomic stability by gradually reducing inflation and the fiscal deficit. To this end, the Central Bank will move toward a more flexible exchange-rate policy with a view to adopting an inflation-target system. As they tackle the current fiscal challenges, the authorities understand that the policy of containing expenditure by restricting social and capital investment programs is not sustainable, given the countrys huge physical infrastructure gaps and mounting social demands. The Executive Branch has drafted a tax reform package aimed at boosting revenues by approximately two and a half percentage points of GDP. These proposals include income tax amendments, conversion of the sales tax to a value-added tax (VAT), and a new tax on luxury dwellings. On the external front, the authorities will concentrate on positioning the country in the global economy and attracting foreign direct investment. Passage of the DR-CAFTA, movement toward a free trade agreement with the European Union, the deepening of Central American integration, and devising of a new framework for attracting investment are key actions in this area.

1.37

1.38

- 12 -

Macroeconomic outlook20
1.39 Medium-term forecasts put the Costa Rican economys growth rate slightly ahead of the long-term trend rate (4.5%). Inflation is expected to come down, the real exchange rate to remain stable, and the fiscal deficit to gradually narrow (Table 2). This scenario assumes an active policy set designed to maintain an investmentenabling macroeconomic climate that will include the furthering of integration, approval of tax reforms and a resulting increase in the tax ratio, movement toward more flexible monetary management, and transfer of Central Bank (BCCR) losses to the Ministry of Finance.21 This policy package would be designed to preserve the investment-friendly climate that the country has offered over the past two years, thereby stimulating and attracting both domestic and foreign investment. The adoption of a more flexible currency regime, a reduction or erasing of the Central Banks operating losses, and a gradual narrowing of fiscal imbalances would enable the country to bring down inflation. The current account is likely to remain in deficit, given the national savings rate and the fiscal deficit, but the improvement in public accounts and the continuity of capital flows (especially of FDI) should adequately finance the external deficit.
Table 2: Macroeconomic indicators 2004 4.1 13.1 -4.3 -3.6 2005 5.9 14.1 -4.8 -2.3 2006 6.5 (6.8) 11.0 (11.0) -4.9 (-5.0) -3.1 (-2.8) Forecasts 2007 2008 4.7 (4.7) 4.6 10.0 (10.0) 9.0 -4.7 (-4.8) -4.8 -2.5 (-2.5) -2.2 2009 4.9 8.0 -4.8 -2.0 2010 4.8 7.0 -4.8 -1.9

1.40

Real GDP growth (%) Inflation (%) Current account balance (% of GDP) Consolidated public sector balance (% of GDP)

Source: BCCR, Revisin Programa Monetario 2006-2007 [review of the monetary program for 2006-2007], July 2006, and authors estimates based on a macroeconomic consistency model. Shaded areas show IDB projections; the bracketed figures are BCCR forecasts.

1.41

Costa Ricas external sector will continue to be heavily driven by Intels export performance, that corporation accounting for one fifth of the countrys total export sales. In fact, the robust economic growth rates recorded in 2005 and 2006 (including an upward revision of 2005 GDP growth from 4.1% to 5.9%) were largely due to upswings in that sectors exports. Contingencies associated with this firms operations could impact Costa Ricas GDP growth forecasts and current account balance. If international interest rates continue to trend up, as expected,

20

21

This section is based on BCCR forecasts and IDB macroeconomic consistency modeling. The projections presented match the 2006 IMF Article IV forecasts. On 17 October 2006 the authorities introduced a system of exchange-rate bands, the first step in the adoption of a monetary regime based on medium-term inflation targets.

- 13 -

they could affect the countrys debt rating and hence the debt service.22 In a departure from developments over the past three years, world oil prices are not expected to continue their steady climb, which could have spurred inflation in the country and put pressure on the current account deficit. However, world prices for oil and petroleum products can be influenced by very complex combinations of economic and political variables, and unforeseeables in the global arena could affect this assumption. 1.42 The foregoing macroeconomic scenario assumes that the Government of Costa Ricas reform package will move forward in the areas on which it has placed priority: ratification of the DR-CAFTA, passage of tax reforms, and increased public expenditure on investments and services for the poorest sectors. The possibility exists, however, that the authorities may not be able to forge the necessary political consensus to carry this entire agenda forward (see the section on risks). That could alter the countrys business and investment climate and dampen economic growth prospects.

22

For a detailed analysis of these debt scenarios, see Annex IV.

- 14 -

II. PREVIOUS STRATEGIES AND PORTFOLIO:

LESSONS FOR THE NEW STRATEGY23

2.1 This analysis, based on an assessment of the Banks work in Costa Rica in 20022005, looks at findings for the whole of 2002 (covered by the Banks 1999-2002 country strategy) and the first 30 months of the 2003-2006 country strategy.24

A.
2.2

Aligning programming cycles with country challenges

The Banks country strategy with Costa Rica (BCS-CR) for 2003-2006 dovetailed with the governments National Development Plan, with the two blueprints sharing both the same long-term objective of poverty reduction and medium-term goals relating to sustainable growth driven by gains in competitiveness, with the countrys new trade agreements as a backdrop. In order to move forward within this strategic blueprint of the Costa Rican government, the BCS-CR for 2003-2006 rested on two pillars: (i) locking in macroeconomic stability, and (ii) speeding up production sector development. The programming for 2003-2006 was consistent with the issues the country was managing and aligned with national priorities. However, some difficulties were encountered in executing the support activities programmed in the BCS-CR. The composition of the Banks country program evolved over the strategy span. A significant portion of the loans originally programmed either were not approved or were approved some time after the dates envisaged in the strategy, and the Bank approved other operations that had not been programmed originally. This was a result of shifts in government priorities and a consequence of institutional factors in the country. In Costa Ricas deeply rooted democratic tradition, decision-making requires consensus-building, and decisions thus take time. This is especially true for the passage of legislation and particularly to secure congressional ratification of loans from international organizations. The Bank has continued to make an important contribution to the country through its loan portfolio and nonlending products such as the policy dialogue, numerous technical-cooperation operations, Multilateral Investment Fund (MIF) projects, the presence maintained by the Inter-American Investment Corporation (IIC), and small social entrepreneurship projects. Interviews with individuals who were prominent players during this period reveal a clear recognition of the technical support provided by the IDB in the design and discussion of the tax reform bill,

2.3

2.4

23

24

This section is the fruit of a coordinated effort (though each unit worked independently) of the Banks Office of Evaluation and Oversight (OVE) and Regional Operations Department 2 (RE2). In response to recommendations made by the Board of Executive Directors concerning evaluation exercises, Costa Rica was selected as one of the first two pilot cases in which OVE and Management instituted a technical dialogue before OVE finalized its report. The two teams undertook a joint information-gathering mission to the country in February 2006 and then drew up separate reports, sharing information for discussion on the same analytical base. Though the BCS-CR currently in effect covers 2003-2006, the review stopped at December 2005; it also takes in all of 2002, which OVEs 1990-2001 evaluation did not.

- 15 -

implementation of the treasurys single-till system, modernization of the customs administration and the National Evaluation System (SINE), promotion of regional planning and land-use management, and development of the environmental management strategy and the national water resources policy. In addition, the Bank contributed to the conceptual design of an agenda to complement the DR-CAFTA and played a leading role in the foremost issues on the countrys public agenda. As part of its regional agenda, the Bank has supported Costa Ricas participation in the Puebla-Panama Plan and the Central American Electrical Interconnection System (SIEPAC).

B.
2.5

Challenges in executing the programmed operations, and achievements IDB operations approvals between 2002 and 2006 totaled US$160 million. An examination of their distribution between the two strategy pillars shows that virtually 100% of the initiatives were for production sector development (Annex I, Table 1). Annex I also shows some differences between the planned lending program for 2003-2006 and the program ultimately executed. Two of the six loans proposed in the BCS-CR low-case lending scenario (there were eight in the high scenario) have been approved to date (for a total of US$126 million). Approval of an urban poverty alleviation loan (CR-0145) is expected toward the end of 2006. Three other loans totaling US$34 million that had not figured in the original BCS-CR program were approved. The BCS-CR programmed loans that were approved represent 32% of the total sum of programmed operations in the low-case lending scenario.25 A sizeable portion of the programmed sum for operations that have not been approved is accounted for by the hybrid loans sectoral component.26 That loan was developed in response to the Costa Rican governments request that various projects be grouped together into a single loan in order to cut down on the time it would take to obtain congressional ratification for this external borrowing.
Originally, the government had proposed that an operation be designed on the basis of a plan for reducing the fiscal deficit by about 1% of GDP per year. At that time, the Bank did not have a suitable instrument to address this request (today, a performance driven loanPDLwould be one possibility), and it therefore made a counterproposal of a hybrid loan to be composed of a two-tranche policy-based loan (PBL) and a two-stage investment loan. The condition attached to the PBL was the governments planned tax reform, which had the support of the two majority parties in the Legislative Assembly at the time. The investment component (competitiveness and investment reforms) was to address the challenges facing the country in terms of its competitiveness and global marketplace positioning. The support to be provided in this area was to consist of five separate subcomponents:

2.6

2.7

25 26

This rises to 45% if the urban poverty alleviation loan is included. This operation is equivalent to 75% of the low-scenario lending total and 86% of the high-scenario total.

- 16 -

exports and external trade, rural roads, e-Treasury, education, and science and technology. 2.8

The delay in securing passage of the tax reforms held up the processing of the other projects envisaged in the hybrid operation, even though on the technical side many of them were ready for approval. A string of changes in the Ministry of Finance (four different ministers during the administrations term) and in the rest of the cabinet led to a number of shifts in course, delays in putting the investment component together and, ultimately, a rescaling of this program.27 Three years after the tax reform bill was first proposed, the government agreed with the Bank to separate the PBL and investment components.
In June 2005 the Bank approved a loan for the Pro-Competitiveness Productive Investment Program (CR-0156), while the PBL continued to await congressional approval of the tax package. With the changeover of administrations in May 2006, the incoming authorities decided to rework the PBLs objectives so that it might help supply the countrys borrowing requirements during the transition to full implementation of the tax reform measures. As of the date that this country strategy was prepared, the tax legislation had not yet been passed by Congress.

2.9

2.10

The legislature has yet to ratify three of the five projects approved by the IDB during the period reviewed here. This situation stems from an intrinsic feature of the countrys institutional dynamic, which entails more than 15-month waits for congressional loan approvals. The combination of behind-schedule final project approvals and the fact that the fiscal PBL did not materialize precluded a complete analysis of the performance indicators set out in the 2003-2006 BCS-CR. However, that strategy paper contained a series of indicators relating to country objectives associated with prospective IDB operations. OVE evaluated a selection of those indicators, presented in Table 2 in Annex I. An analysis of the table figures shows that Costa Rica achieved its targets for some of the indicators, especially the economic-activity goals (GDP, exports). As for fiscal challenges, on the spending side the country reached its deficit-reduction objectives but revenues were up only slightly, despite the considerable increase in customs receipts in 2005 and 2006 to date thanks to the TICA (Customs Control Information Technology) system implemented with Bank support. Reductions in poverty fell short of the target. Technical-cooperation projects (TCs) feature more prominently in the IDB product mix in Costa Rica than in other middle-income countries in the region.28 This indicates that the low lending levels to the country have not limited its access to nonreimbursable funding. However, less than half the TCs carried out during the period examined here focused on support for possible loans (11 out of

2.11

27

28

The education and e-Treasury subcomponents (the latter was transferred to CABEI) were eliminated; the local counterpart was raised and the Banks originally-envisaged financing reduced. Costa Rica has one of the highest TC/loan ratios among comparable-income countries in the region. It is not eligible for the Fund for Special Operations (FSO), which is intended for highly indebted, low per capita income countries, but the Bank was able to provide financing from Trust Funds for most of the many TCs mounted in the country.

- 17 -

32 operations. totaling US$5 million), and most of them28 of the 32were designed around the second BCS-CR strategy pillar (speed up production sector development). 2.12

The MIF has also played an important role in Costa Rica. MIF approvals came to US$11.6 million, spread among 16 operations. Like the TCs, the MIF portfolio has revolved around the second BCS-CR strategy pillar. Support focuses include measures to strengthen the National Concessions Council (CNC), clean production, promotion of the factoring industry, and the Dynamic Entrepreneurship Program. The Private Sector Department (PRI) has no active operations in Costa Rica at this time. A number of PRI transport sector initiatives have been held up because of concession structuring delays. Furthermore, owing to restrictions in place in the Bank until 2006 PRI could not prospect for business in sectors that were private sector domains.
The IIC approved five operations totaling US$23.9 million which deal mainly with support for financial institutions. The IIC has invested in three Central American/regional investment funds; Costa Rica has benefited from five operations for a total of US$1.5 million in such sectors as manufacturing, software, agroindustry, and financial services. Three Social Entrepreneurship Program small projects totaling US$1.8 million are providing support notably for an organic production system, an increase in microcredit, and expansion of lending services for rural microenterprises.

2.13

2.14

2.15

The Banks portfolio implementation during this period was influenced by the fact that most of the projects took quite some time to fulfill the conditions precedent to disbursement. This had to do with delays in congressional ratification of loans, public finance strictures, some government procurement issues, ex ante controls by the Comptroller General, and operational shortcomings in some executing units.
At the countrys request, the Bank has promoted a policy under which executing units are incorporated into the permanent structure of the State agency in charge of the project. Although this is a positive step in that it helps strengthen the State, it has resulted in significant delays in project implementation during times of political change or when a programs priority on a sectors agenda has been downgraded.

2.16

C.
2.17

Lessons learned and recommendations In 2002-2005, the Banks assistance was aligned with the countrys objectives and was relevant to national priorities, but there were difficulties nonetheless in terms of implementation effectiveness. The Bank was involved in the DR-CAFTA and tax reform agendas, and its actions were relevant and effective in sector-specific issues by way of investment projects in the fields of education, health, the environment, and energy. However, the bulk of the financial assistance (loans) for the country envisaged in the BCS-CR could not be deployed.

- 18 -

2.18

In the future, enough flexibility should be built into lending scenarios for the country to accommodate shifts in government priorities and in its institutional dynamic. This will entail devising a base-case lending scenario addressing the governments most immediate and strategic priorities and a high-case scenario with operations requiring more analysis. Because of the time it takes for loans to be ratified by Costa Ricas Congress, it may prove difficult to align them with the governments political agenda.29 The design of new operations should include a thorough analysis of the political risks associated with the countrys institutional dynamic, especially in the case of programs for which the attached conditions entail the passage of a law or progress in implementing complex institutional reforms.
Other recommended means of improving the Banks interventions in the abovementioned institutional environment include: (i) ensuring that a broad political consensus exists before embarking upon loan operations requiring the passage of legislation; (ii) evaluating the possibility, whenever practicable and/or pertinent, of devising instruments that are not backed by sovereign guarantees and do not require congressional approval; (iii) diversifying the scale of, and target sectors for, Bank actions so as to mitigate the political risk associated with its operations; and (iv) taking the countrys political cycles into consideration, avoiding new loan approvals during the final stage of an administration.

2.19

2.20

2.21

Going forward, the fiscal space for Bank-supported operations will have to be carefully analyzed and the country will need to be given financing options grounded in the New Lending Framework (NLF) programmatic approach. The hybrid program was a Bank counterproposal to a request by the Government of Costa Rica for which the Bank did not have a suitable instrument at that point in time. The Bank should make every effort to align its interventions with the administrations high-priority issues, making full use of the NLF toolkit. There is a broad consensus as to the high priority of infrastructure (electricity, highways, ports, etc.) on the countrys development agenda. Infrastructure sector operations could be structured without sovereign guarantees (and include Private Sector Department participation), congressional ratification not being required in this case. Costa Ricas Legislative Assembly attaches a great deal of importance to how a request to borrow will translate into tangible benefits for society at large or for the sector in question. This influences the chances of winning support for policy-based loans (PBLs), whose desired impact may become apparent only over a medium-term time horizon. Consequently, if the Bank embarks upon the design of PBLs, the following steps are recommended: (i) link PBL resources with policy

2.22

2.23

29

An amendment has now been introduced in the Assembly rules under which certain bills can be fast-tracked through Congress. This provision does not yet apply to all bills under congressional debate, however (e.g., it does not cover approval of trade agreements or external loans).

- 19 -

reforms that will yield tangible benefits in the short term; (ii) make every effort to ensure that PBLs design and the presentation of PBL proposals to the country are well timed vis--vis the governments political time horizon for the reforms in question; and (iii) align the operations to reforms that have already been approved and thereby minimize the image of conditionality that is created when such programs are aligned to future laws. 2.24

In regard to the long time it can take for project execution to begin, steps should be taken at the design phase to see that all disbursement preconditions will be fulfilled before the loan is approved. The remaining conditions, which in some instances are determined by the operations design and the countrys institutional dynamic, should be closely monitored to ensure information accuracy in all relevant bodies. This applies particularly to the National Financing Council (CONAFIN) which performs prior reviews of the viability and advisability of any proposed external borrowing by the country.30 The Bank should take advantage of Costa Ricas fiduciary capacity and gradually have project management functions migrate to the countrys own systems. This also would increase the chances for successful project implementation by creating greater ownership of the operations. As another part of this effort, making executing units part of the permanent public sector apparatus should ensure the necessary political support and technical capacity for their effective operation. The Private Sector Department has not realized its full potential in Costa Rica. The concessions bill, which was headed toward passage at this writing, could improve the concession picture in the near term and could promote the use of this Bank window in new spheres. Other types of public-private partnerships in which the Bank could participate should also be explored (e.g. public utilities). The broadening of the private-sector mandate and clientele has removed various sector restrictions for PRI finance, thereby opening up opportunities for engagement in sectors that promise to be Costa Ricas strongest economic growth drivers in the coming years (tourism, financial sector, and biofuels, to name a few). The evaluation of the Banks intervention should encompass a longer span than the term of a single administration, since experience shows that strategies overlap and implementation periods run longer than any one government term.

2.25

2.26

2.27

30

The Ministry of Finance and MIDEPLAN are working on restructuring CONAFIN on the basis of the establishment of the National Public Investment System, the development of which is supported by the PRODEV facility.

- 20 -

III. THE BANKS STRATEGY WITH COSTA RICA FOR 2006-2010 A.

3.1

Objectives and strategy focus The BCS-CRs general objective is to help deepen Costa Ricas economic growth and social progress. To that end, three strategy pillars have been devised relating to the Government of Costa Ricas policy challenges and priorities discussed in section I: (a) strengthen the macroeconomic and public expenditure management framework; (b) deepen the countrys growth and international positioning model; and (c) create opportunities for inclusive economic growth. Progress toward those aims will depend on a set of actions that together comprise the Banks country strategy focus: Institute a permanent policy dialogue underpinned by the Banks technical expertise in the spheres it targets for support. Successful implementation of the intervention options proposed in the BCS-CR will depend in part on the Banks capacity to add technical value to its financial contribution. That nonfinancial value, in turn, will be key to securing support from institutions that currently have a say in decisions on Bank loans (National Financing Council, Congress). Promote the use of new lending instruments suited to the countrys needs and demands. The Costa Rican government has apprised the Bank of its general preference for investment instruments for the countrys high-priority sectors (infrastructure, competitiveness, social sector). In some cases such support could be delivered via modalities where clearly defined objectives and counterpart implementation capacity are key (CCLIPs, PDLs). Under such modalities the Bank requires congressional approval just once for the entire credit line at the program outset. Moreover, the country cost of credit fees would be lower since the amount of funding at the borrowers disposal could be adjusted to the needs of each phase in the investment project. In addition, conditions are right for exploring the possibility of nonsovereign guaranteed lending to the public and private sector, looking to financially solid institutions with sound policies. Target technical cooperation resources to BCS-CR-supported country priorities. Over the years the Bank has provided Costa Rica with a whole array of nonlending products and technical-cooperation support. Going forward it should employ this type of supports more strategically, focusing resources on areas in which the Banks technical input would be most relevant to attaining country objectives in the sector. Progressively transfer responsibilities to the countrys fiduciary systems. The use of Costa Ricas own procurement and operations monitoring systems could help reduce transaction costs of Bank operations. The BCS-CR proposes a number of initiatives to that end. Strengthen the activity of the Banks private sector windows. The BCS-CR incorporates into each intervention sphere a number of private-sector work focuses

3.2

3.3

3.4

3.5

3.6

- 21 -

set out in the Strategy Guidelines for Private Sector Support (Annex VI) approved by the Bank in August 2006. By virtue of its new private sector mandate the Bank can take a broader view of this activity and now can deliver support to nontraditional sectors. The strategy guidelines specify infrastructure, the financial sector, agribusiness, sustainable tourism, and housing as priority targets for privatesector support. However, tighter PRI/IIC/MIF coordination in work with Costa Ricas producing sectors will be needed to capitalize on these opportunities. The existence of an IIC regional office in Costa Rica provides the physical presence necessary to facilitate that task. 3.7 The following sections discuss strategic intervention focuses from a comprehensive IDB Group perspective, indicating lending and nonlending products that could assist the Costa Rican government and the countrys private sector.

1. Strengthening the macroeconomic and public expenditure management framework

3.8 Costa Ricas fiscal vulnerability (deficit, Central Bank losses, public debt) and inflationary pressures need to be dealt with in order to speed the pace of its growth and social progress. If those imbalances can be moderated, funds now earmarked for debt service can be freed up and the country will be able to direct more resources to social expenditure and investment. The authorities have said that they intend to supplement revenue-boosting tax reforms with measures to make public spending more efficient and effective. The Bank could contribute primarily in the following areas:

3.9

Development of public-expenditure management capacity. The PRODEV program is currently assisting the Ministry of Finance by way of a technical cooperation (TC) operation to strengthen the national public investment system and design a management-for-results model. This TC will generate a plan of action that could receive additional assistance through the PRODEV facility. The Costa Rican government has also asked the IDB and the World Bank to conduct an in-depth study on the countrys capacities for the formulation, execution, monitoring, and evaluation of its public expenditure (Public Expenditure Review), with special emphasis on an analysis of sectors that are top government priorities (infrastructure, education, etc.). This analysis could serve as a basis for a future support operation aimed at improving the effectiveness and efficiency of expenditure. Technical assistance is also proposed to support the development of a fiscal risk management strategy for natural disasters, encompassing both the physical management of public assets and financial management (reserve funds, contingent credit arrangements, and insurance) aimed at covering costs of contingent obligations. Support for tax reform implementation and macroeconomic scenarizing. The time horizon for implementing tax reforms and for the government to start receiving the ensuing revenues will depend on the sequencing of the reform bills passage and, more specifically, on the final architecture of the reform that emerges

3.10

- 22 -

from the debate in the legislature. This means that, as the government moves forward on full implementation of the tax reform package (2008, 2009), it may have to borrow as some of its external bonds mature. The chances of this happening will be all the greater if the government proceeds with investment increases in priority sectors and/or the Central Banks capitalization31 before it starts to receive the full revenue streams ensuing from the reforms. In that event, the Bank might be able to assist the country by way of unrestricted resources through a PBL with a policy matrix comprised of the tax reform laws that have been passed at that time and are being implemented.32 In the meantime the Bank is designing a macroeconomic consistency and debt sustainability analysis model. These tools will yield a better picture of the aggregate effects of certain Costa Rican government policies and fiscal outcomes and relate them to selected international variables (interest rates, oil prices, the U.S. economy, etc.).

2. Deepening the countrys growth and international positioning model

3.11 Costa Rica opted to open its economy to external markets and to attract foreign direct investment as a growth strategy long before DR-CAFTA came into being. Now, however, this treaty and others currently on the negotiating table (European Union, CACM) open up the possibility of leveraging the strengths of the Costa Rican growth model; at the same time, they draw attention to the need to act on some remaining weak areas. The diagnostic assessment points to the need for a cross-cutting and sector-specific policy agenda to strengthen linkages between Costa Ricas most dynamic economic sectors and the rest of the production system, especially SMEs. The Bank can contribute to the achievement of these objectives through the following types of interventions:

3.12

Support for the Infrastructure Development Plan. The Costa Rican government has set itself the objective of renovating and enlarging the nations infrastructure base. This decision tallies with various analyses that have identified the infrastructure deficit as one of the prime obstacles to the deepening of Costa Ricas growth and further opening of its economy.33 The Bank has a proven track record in the design and execution of energy projects in Costa Rica and at the regional level, and its expertise in this area has led to a productive working relationship and exchange of experiences with the Costa Rican Electricity Authority (ICE).34 In the coming years the Bank will continue this avenue of support to the country through a

31

32

33

34

The government has said that it intends to use some of the resources generated by these reform measures for this purpose, by transferring Central Bank losses to the central government. The Costa Rican government has stated that it intends to ask Congress to renew its authorization to issue external debt bonds. The present authorization expires in 2008, but its approval authority was used up in 2002. During the transition to the renewed authorization, the Bank could supply the countrys most immediate borrowing requirements. Policy Dialogue Paper (IDB, 2006); Investment Climate Assessment (World Bank/IDB, 2006); Strategy Guidelines for Private Sector Support (IDB, 2006); Programa Estado de la Nacin [State of the Nation Plan] (2005), and Programa de Gobierno [Government Platform], 2006-2010. Execution of the third stage of the Electric Power Development Project (CR-0036) was recently completed. Costa Rica also is the regional headquarters for SIEPAC (CA-0007).

- 23 -

Conditional Credit Line for Investment Projects (CCLIP), to provide a way to link investments in the electricity sector to specific electric power generation outcomes. Under this facility an analysis could be undertaken at some future point of local-currency products and/or partial credit guarantees to assist the country. The Banks private-sector windows could finance other power generation projects, eventually through nonsovereign guaranteed loans to ICE. The latter ventures include the Veraguas hydroelectric project (now in the exploration phase), for which the Bank is implementing a US$1.5 million TC operation. A bill to increase the ICEs borrowing authority is currently being debated and, if passed into law, could facilitate many of the above-mentioned proposals. The Private Sector Department is in contact with companies interested in bidding for build-operatetransfer (BOT) contracts for wind power plants of up to 60 megawatts total peak capacity.
3.13 To help develop road infrastructure, the Bank is currently supporting the countrys work to strengthen the National Concessions Council (CNC) under a MIF project, this being a crucial step for the road concession programs success. The Bank can contribute in this respect by providing concession financing through its private-sector window. It also could assist with road maintenance and rehabilitation by delivering support for the National Roads Council (CONAVI) investment plan through a multiphase project involving three stages stretching over 10 years. The Bank could, in addition, join a cluster of institutions (including CABEI and CAF) in providing financing for the Atlantic corridor. The Banks Private Sector Department (PRI) is exploring possible participation in concessions for the San Jos-Cartago and Radial Heredia highways and the San Jos beltway. The IDB also is working with CABEI on the development of a feasibility study for a rail freight project. Port development is one of the core determinants of Costa Ricas competitiveness, given the shortage of physical capacity and high costs. The Bank could participate in the port of Limn development investment program as part of the public-private investment consortium. Balancing the countrys development objectives with environmental sustainability concerns will require sound management of its water resources. The Bank has assisted with the development of a national water resources strategy in which sewer system expansion and wastewater treatment is one of the main objectives.35 The strategy proposes the pursuit of initiatives that keep the fiscal impact to a minimum, attract local and international private investors and, whenever possible, tap the local capital market (issues of bonds or other types of debt paper). The Bank is developing an operation along these lines (in principle, nonsovereign guaranteed) to support public utilities investment in the province of Heredia (CR-0149).36 The

3.14

35 36

This support is continuing through the design of a national water resources management plan. Operation developed by a team from the Private Sector Department and Regional Operations Department 2.

- 24 -

possibility of developing municipal works finance vehicles with Banco Nacional de Costa Rica (BNCR) is being explored as well. 3.15

Enhancement of competitiveness and promotion of industry linkages. In June 2005 the Bank approved a US$116 million loan37 for a pro-competitiveness reform program (CR-0156). This operation, once ratified by the Congress, will be executed in its entirety by the present administration. The Bank will continue to deploy its lending and nonlending toolkit to support the countrys effort to bolster its trade agreement negotiation and implementation capacity.
In the production finance sphere the Bank could assist Costa Rican industry sectors through a variety of products to make this kind of financing more readily available to small and medium-sized exporters by way of the IDB Group windows (MIF, PRI, IIC), aligning its efforts to the Building Opportunity for the Majority initiative.38 Potential instruments include the creation of venture capital funds for production finance and business incubators (MIF), particularly in the area of SME technological innovation. The Private Sector Department can contribute by way of lines of credit under a Trade Facility program and support for development of an SME equity market. In addition, the MIF and the IIC will continue to develop new financial products such as leasing and factoring. The BNCR has expressed interest in outsourcing its microcredit operations to a new company that it would control, in which the IIC and/or the MIF could participate with financing and an equity stake. The Pro-Competitiveness Productive Investment Reform Program (CR-0156) includes a component on financing technology innovation in businesses. The Bank could supplement this line of support by assisting with the development of a national innovation strategy.39

3.16

3.17

Narrowing of regional development gaps and support for sustainable tourism. Mainstreaming Costa Ricas less developed regions (especially border areas) entails strategic planning, attracting regional investments, and building local entrepreneurship. Loans for two projects in this area approved in 2004 and 2005 are awaiting congressional ratification: Sustainable Development of the Sixaola River Binational Watershed (CR-0150) and Sustainable Development of the Atlantic Hutar Region (CR-0157). Support for the regions could be supplemented by an operation of the same kind to further development of the Chorotega, North Hutar, Central Pacific, and Brunca regions. This intervention would complement a project to promote tourism in protected areas (CR-L1001), in December 2006. The Strategy Guidelines for Private Sector Support identify sustainable tourism as a priority sector by virtue of its growth potential and the dearth of financial-system lending to the sector (currently less than 1.9% of total system lending). PRI is exploring hotel-sector investment prospects. The MIF will continue supporting

37

38 39

This loan consists of three components: (i) support for foreign trade; (ii) rehabilitation of rural roads; and (iii) science and technology. Building Opportunity for the Majority (IDB, 2006), www.iadb.org/bop. The Bank-administered Korea Fund for Technology and Innovation could provide support for this initiative.

- 25 -

initiatives to diversify tourism offerings and upgrade tourist services, institute uniform standards for ecotourism service certification, and design new nontraditional tourism products. Work will continue with tourist industry associations to help diversify their product menus, improve service quality, and help link actors in the industry chain. 3.18

Enhancement of environmental management capacity. For Costa Rica to deepen its growth model, its environmental agenda will have to be strengthened. The countrys ambitious agenda in that sector is being supported by the Bank through various TCs, including one operation to analyze the main institutional and technical challenges the Ministry of the Environment and Energy is managing.40 This TC has identified a set of challenges in terms of reorganization and investment for which support could be provided by means of a specific Bank operation. 3. Creating opportunities for inclusive economic growth
The Costa Rican governments strategy priority is to narrow the opportunity gap and lower the poverty rate by at least four percentage points over the next four years (Government Program for 2006-2010). The policy priorities set by the government with a view to attaining this objective include: ameliorating the physical milieu in high-poverty areas across the country (housing, basic infrastructure), creating a social safety net, and expanding secondary education as a vehicle for including societys poorest and bolstering the growth strategy. The Bank is helping to further many of these policies in the region through the Building Opportunity for the Majority initiative, and proposes to contribute to the governments objectives in the following areas:

3.19

3.20

Enhance housing market access for the poorest. Toward the end of 2006 approval is expected of a Bank operation to improve the physical milieu in highpoverty urban centers (CR-0145). That operation, in combination with a cadastre and registry project already under way (CR-0134), could serve as a platform to enable the countrys poorest to access the housing market (upgrading of essential services, land titling, credit-line access, etc.). The Strategy Guidelines for Private Sector Support identify potential nonsovereign guaranteed operations with BNCR and the national mortgage bank (Banco Hipotecario de la ViviendaBANHVI) to channel funds to productive projects in growth sectors (tourism infrastructure, technological innovation, housing) and develop a mortgage securitization market by way of Sociedad Titularizadora Centroamericana, a company formed by BNCR and BANHVI. Support the launch of a social safety net. One of the pillars of the governments social policy will be a new plan to assist chronically poor households. The authorities have devised a conditional transfers program and other measures to

3.21

40

The other TCs are: (a) Support for Development of a National Environmental Strategy; (b) Water Resources Management; and (c) Strategic Planning for Sustainable Regional Development.

- 26 -

ensure preferential access to social services and employment training.41 The program will include contingent transfers designed to encourage secondary-school attendance and completion, comprehensive child care, and early childhood stimulation. The Bank has amassed a wealth of experience in this area as it delivered technical and financial support for similar initiatives in a number of countries across the region, and it is making this experience available to Costa Rica. One option would be to mount an operation to help increase the supply of social services to better equip the country to address the heightened demand associated with the conditional transfers program. 3.22

Improve access to secondary education and employment training and make them more relevant. The attainment of universal secondary education is an effective vehicle for fostering the countrys economic growth and social inclusion. The Costa Rican government will work toward that goal by combining increased investment in education with the conditional transfers program to encourage students to remain in school. The Bank can help to increase the secondary education systems internal efficiency and its external impact (ability to link into employment opportunities). Such an intervention would ensure better supply conditions for implementation of the conditional transfers program and would lay the groundwork for universal secondary education in the country. This could be complemented by a realignment and modernization of the National Training Institute (INA) to tailor its offerings more closely to business community needs. Implementation of the strategy 1. Lending scenarios
The strategy outlined here seeks the closest possible alignment to Costa Rican government priorities, the fiscal space available for public investment projects in the country, and the authorities future borrowing strategy. Consequently, the BCS-CR presents a base-case lending scenario matching the 2006-2008 work program, comprising operations that are high government priorities and could be approved in the current fiscal environment. In December 2006 two operations totaling US$70 million (Urban Poverty Alleviation and Tourism in Protected Areas), programmed during the preceding strategy cycle and endorsed by the current administration, were approved. The 2007 lending program calls for two operations totaling US$262 million, one being a first US$250 million loan for phase one of a US$500 million conditional credit line for investment projects (CCLIP) operation to support the Costa Rican Electricity Authority (ICE).42 That operation

B.
3.23

41

42

A pilot program launched in July 2006 ties cash transfers to secondary school attendance. This initiative attests to the new authorities commitment to this type of intervention. The Bank has a history of supporting the ICEs investment plans (stages I, II, and III of the Electric Power Development Program), hence the appearance of an operation of this type in every other country strategy or so.

- 27 -

figures in ICEs externally funded investment plan.43 The second loan would supply US$12 million for a project to strengthen the Ministry of Environment and Energy (MINAE), requested by the new administration at the start of its term. In 2008 the Bank could process approval of a global operation to develop the Chorotega, North Hutar, Pacific, and Brunca regions, which would complete the regional support line that currently takes in the Atlantic Hutar and Sixaola regions (awaiting congressional ratification). Prospects for that loans approval in 2008 would depend on progress made on securing parliamentary ratification and disbursement eligibility for those projects. 3.24 The Banks Costa Rica portfolio (including operations awaiting ratification), the two loans slated for consideration by its Board of Executive Directors in December 2006, and projects envisaged in the base-case lending scenario would generate roughly US$304 million in disbursements in 2006-201044 (Table 3), up slightly from the US$275 million disbursed during the previous strategy span. Estimates of total Bank lending to the country in the base-case scenario are in keeping with the overall fiscal capacity of the Costa Rican public sector as projected from the macroeconomic outlook described in section I. Net lending flows (Table 3) in the base-case scenario would be negative in 2006 and 2007, slightly positive in 2008, and increase moderately in 2009.

Cuadro3: FLUJOS NETOS ESCENARIO BASE PRESTAMOS CON GARANTIA SOBERANA Categorias 2003 2004 2005 2006 2007p 2008p 2009p Desembolsos Cartera 88,4 100,2 41,6 30,894 57,328 53,140 48,439 Pipeline 39,800 75,150 Total 88,4 100,2 41,6 30,894 57,328 92,940 123,589 Pago de Principal 93,0 110,2 208,9* 41,200 82,500 84,400 84,500 Flujo Neto de Prstamos (4,6) (10,0) (167,3) (10,306) (25,172) 8,540 39,089 Fuentes: 1) Proyecciones de Desembolso de COR/CCR y Sede; y 2) Debt Service Projections Report on Approved Balances, Finance Department. *cancelacin anticipada por parte del ICE de un prstamo de apoyo al desarrollo del sector elctrico.

2010p 51,597 101,950 153,547 83,900 69,647

3.25

A shift from the base case to a high-case lending scenario would depend first upon a bolstering of fiscal capacity to carry out the countrys priority investments in a manner consistent with the governments stated debt sustainability objectives.45 The Banks macroeconomic projections indicate that greater fiscal headroom for public investment could be created by the passage of the tax reform

43

44 45

The ICE investment plan calls for an average of US$110 million in external financing annually between 2007 and 2010 and for US$220 million per year between 2011 and 2014. In both cases, external finance estimates for the investments amply exceed the portion to be covered by the Banks CCLIP. Operations to 31 December 2009. In his August 2006 report to Congress, the Minister of Finance said that the scope for new externally-financed investments must be consistent with the policy of keeping the countrys public debt stock at the current level (56% of GDP) or reducing it.

- 28 -

laws.46 However, the revenue-boosting measures would not have a significant impact on fiscal accounts until 2008, and possible work focuses to shape a high lending scenario have been conceived as starting only in that year. At that point the Bank and the Costa Rican authorities, as part of a midterm review of the BCS-CR, will analyze the state of the public accounts and the feasibility of increasing the investment account through new Bank support operations. Some of the indicators to be considered separately in determining whether to shift to a high lending scenario are: (i) progress made in implementing the tax reform measures and their translation into increased government revenues; (ii) progress toward the achievement of a large enough primary surplus, in combination with current GDP growth rates and interest rates, to enhance debt sustainability; and (iii) advances in lowering public debt levels to approach the BCS-CR matrix target (50% of GDP in 2010). Secondly, as noted earlier, new loan approvals to constitute a high-case scenario would be dependent upon progress made in securing congressional ratification and declaration of eligibility of the Bank-approved projects that are awaiting ratification (three) and of the four operations that could be approved in 2006 and 2007. 3.26 Decisions on the possibility of adding new loans to the pipeline will be made in the course of programming exercises as from 2008. The Costa Rican government is devising a set of action lines that could help put together a high lending scenario, including modernization of the government procurement and contracting system, road infrastructure finance, support for expanding the national social safety net, and secondary education improvements. Approval of the US$250 million balance of the credit line referred to above would fall into the period covered by the next strategy. One potential work focus is the structuring of a quick-disbursing loan to help supply the governments 2008 or 2009 borrowing requirements. An average of approximately US$250 million in debt will fall due in each of those years, and the government hopes to cover these maturities with revenues generated by its tax reforms and by a bond rollover, which would need congressional authorization.47

2. The Banks exposure and its share of financing to Costa Rica

3.27 At 31 July 2006, Costa Ricas external public debt stock stood at US$3.633 billion, of which US$1.323 billion was owed to multilateral and bilateral agencies. The debt to the IDB48 at the end of 2005 totaled US$686 million (52% of the countrys total multilateral debt); 36% of the total in that category was owed to CABEI,

46

47

48

These estimates are consistent with the maintenance of a large enough primary surplus to permit a gradual reduction in the public debt to more sustainable levels (Annex IV). The Minister of Finance referred to this in a statement to Congress in August 2006 regarding the administrations borrowing and debt policy. If there is a delay in securing this authorization, the Bank could assist the country by way of the above-mentioned policy-based loan (PBL). Figures shown for Costa Ricas IDB debt and other IDB debt figures include the portfolio of the FSO, the MIF, and the Ordinary Capital only. The projections of IDB and external debt service are based on a nominal interest rate that starts at 5% in 2005 and then rises 500 basis points annually, reaching 7% in 2009. In computing the service on bonds, it has been assumed that the balance will be rolled over at a nominal fixed rate of 8%.

- 29 -

4.5% to the World Bank, and 7.5% to other institutions. Over the past six years, CABEI has accounted for 45% of total external funding disbursements, private bonds for 42%, and the IDB for 11%. CABEI disbursements soared from US$173 million on average in 2000-2001 to US$306 million in 2002-2005. 3.28 Costa Ricas IDB debt represents 1.2% of the Banks portfolio. The total resources made available to the country in any lending scenario would still mean a low IDB Costa Rica exposurewell below the prescribed 18% ceiling for individual borrowing country exposure. Debt indicators also would remain below the established Bank exposure limits.

3. Country financing parameters and fiduciary risk49

3.29

The country financing parameters (CFPs) constitute the general framework for IDB financing of investment projects in Costa Rica. In view of the countrys commitment to its development program, its ownership of Bank operations, and its fiduciary capacity, no ceilings have been set on the share of total project cost that the Bank may finance or on eligibility of expenditures for coverage by investment loans (see Table 3). However, the Bank may not finance current expenditure of the type defined in Costa Ricas Financial Administration Act. This affects the percentage of total project cost and of local expenditures that the Bank can finance, even though it has done away with restrictions in both those cases. The Bank is able to finance payments of taxes, fees, and duties so long as they represent a reasonable proportion of total project cost.50 With regard to fiduciary risk status, Costa Rica is moving toward greater use of its own systems for IDB operations execution. The IDB, with the World Bank, has analyzed the fiduciary capacity of Costa Ricas public agencies by means of a Country Financial Accountability Assessment (CFAA) and has examined the government procurement system in a Country Procurement Assessment Report (CPAR). The Bank has therefore identified the fiduciary risks for its operations in Costa Rica, which are being mitigated through steps to monitor and strengthen public finance management by way of the PRODEV facility. The gradual transfer of fiduciary responsibility for procurement to the country is feasible because it has adequate procurement legislation in place. The Government Procurement Modernization Project (CR-0152) included in the 2007 lending program would provide financing to implement the CPAR recommendations. The procurement-system support would be complemented by actions to strengthen government financial management pursuant to the CFAA recommendations. That report acknowledges Costa Ricas great strides in this regard but says there still is room for improvement in such areas as transparency, accountability, internal controls, institutional coverage, and ex post financial

3.30

3.31

49 50

The IDB coordinated development of the Costa Rica CFPs with the World Bank. Government and decentralized agencies are exempt from taxes. The loans in the current portfolio are being executed by government ministries, so no taxes have had to be paid.

- 30 -

controls in government financial administration to ensure good governance and efficient resource use. Among the top priorities are strengthening of the public investment system to improve allocation of public monies and modernization of the Office of the Comptroller Generals control system, focusing on ex post controls and tightening internal control systems in public institutions.

4. Monitoring the strategy

3.32 The Banks strategy with Costa Rica outlined in this paper will be monitored on an annual basis so that timely adjustments can be made to the Banks work in pursuit of the strategy, to remain aligned to the countrys objectives. To this end, a set of benchmarks has been devised for the countrys objectives in each IDB action area. The Bank will monitor these indicators in close coordination with the Costa Rican government, particularly the Ministry of Finance and the Central Bank, as well as the respective executing agencies. Approximately midway through the BCS-CR span the Bank and the authorities will review the state of the public finances and, on that basis, decisions will be made about developing new operations. Most of the monitoring indicators in the BCS-CR are related to the countrys objectives under the National Development Plan, which contains baselines and targets to be met in 2010. Towards the end of the current administrations term of office, MIDEPLAN will conduct an assessment of the targets, on the basis of which fulfillment of the country objectives linked to the Banks support operations will be evaluated.

5. Engagement of other cooperation agencies

3.33 The World Bank accounts for a minority share of development finance to Costa Rica. Its 2004-2007 strategy focuses on education, infrastructure, health, and strengthening of public administration, targeting particularly the telecommunications sector and education (see strategy matrix). In recent years CABEIs share in development financing to the country has soared after that agency made its project appraisal, approval, and implementation procedures more flexible. Such is the case of the financing provided for a prepayment of the ICEs debt to the Bank, loans to the private sector, and a nonsovereign guaranteed loan. CABEIs strategy in Costa Rica emphasizes public administration programs, road infrastructure (roads and highways), regional integration, competitiveness, and business climate. One bilateral cooperation provider is the Japanese government, which is supporting a sizable physical infrastructure (bridges, water and sanitation), sustainable agriculture, environmental and ecology portfolio. The Andean Development Corporation (CAF) might participate in infrastructure ventures.

6. Strategy implementation risks

3.34 Implementation of the new BCS-CR is subject to macroeconomic, environmental, and political-institutional risks. Some of them inherently fall within the country domain: the Bank will monitor these continually. In other cases, the Bank will activate various mitigation measures described at the end of this section.

- 31 -

3.35

Macroeconomic risks: If Costa Rica implements the tax reforms that have been set in motion and carries out the necessary investments in infrastructure and human capital, it may well achieve over 4.5% economic growth. But one important consideration when forecasting growth is the heavy weight of the high-tech export industry and Intels lions share of those sales. Business decisions in that corporation could have a more than one percentage point impact on national GDP. A delay in congressional ratification of the DR-CAFTA also could adversely impact growth conditions. A further macroeconomic risk for the BCS-CRs operation is a domestic one, stemming from the countrys fiscal strictures. A delay in winning legislative approval for the tax reform package and/or a lag in the receipt of the ensuing tax revenues could ultimately shrink the fiscal space for approval and subsequent execution of projects.
On the external front, rising international interest rates present a moderate degree of risk for the country. If the tax reforms pass, the countrys international market borrowing requirements would likely decline, thereby mitigating the negative impact of higher international interest rates. Another external factor has to do with world oil price behavior and the oil bill. This effect has been tempered to some extent as the country has built up its international reserves and strengthened its external position. World oil price movements are unpredictable, however, as they reflect political, geostrategic, military, and economic factors, so the oil-price risk cannot be entirely ruled out.

3.36

3.37

Political risks: The chief political-institutional risk stems from the highly fragmented nature of the Legislative Assembly at present and the difficulty that the various blocs have had thus far in building consensus. The incumbent Partido Liberacin Nacional (PLN) is the largest minority bloc in Congress, with 25 votes; 29 votes are needed for a simple majority and 38 for a two-thirds majority (required for ratification of international loans and for projects of significant strategic importance). In these circumstances it may be difficult for the Executive to elicit the necessary consensus to secure congressional passage of the tax reform bills and other important legislation. In such an event, the expected upswing in government revenues would either not happen at all or would be longer in coming. This, in turn, would diminish the governments investment capacity and, by extension, its ability to execute Bank projects. Recent tax-reform developments in Costa Rica suggest that it would be well to bear these types of risks in mind. In view of this situation, the administration opted to segment the tax reforms sent to the Assembly in order to diversify this risk. A further risk associated with the legislatures fragmentation is the possibility of a protracted delay in its ratification of Bank operations. A related concern is the high probability that toward the end of the current administrations term it will become more difficult to secure congressional ratification of new borrowings. Natural hazards/environmental risks: If Costa Rica were to sustain a direct hit in a natural disaster the Bank would have to adjust its actions to meet emerging needs.

3.38

- 32 -

This could affect the makeup of the BCS-CR program and its implementation schedule. 3.39

Sectoral risk: In regard to electricity sector loans, the Costa Rican administration has sent a bill to the legislature that would authorize the ICE to borrow up to US$700 million through 2010, based on a percent-of-GDP formula. Borrowings below that ceiling could be undertaken by the agencys decision alone, probably though this still needs to be clarifiedwithout the need for congressional ratification. Implementation of the ICE CCLIP project could be speeded up if it were approved at the same time as the aforementioned legislation. If not, the Assembly would follow its traditional debate route for the ICE borrowing bill, in which case its ratification likely would take some time. Institutional risk: Under an agreement between the Bank and the country, operations have been designed, wherever possible, to have executing units be part of the permanent structure of the government agency in charge of the project. A potential risk exists, however, if the units staffing table, organization, and budget resources are not clearly defined, since this could take a project off track. Such situations have arisen in the past, especially when a government agency has been going through a political transition. During the previous strategy span this occurred fairly frequently. Another potential institutional risk could derive from the operating mechanics of the National Financing Council (CONAFIN) and other bodies that would have to issue no-objections to the design of IDB investment operations in the country. Any delays in these bodies decisions regarding projects submitted for their review will add to the scheduled design timeframes. IDB actions to mitigate identified risks: The New Lending Framework (NLF) offers an array of innovative products that make for a programmatic approach, greater flexibility in IDB operations approval and implementation, and greater country fiduciary and budgetary responsibility. These tools will make it possible to mitigate some of the internal risks relating to the strategys implementation and, in particular, risks for successful project execution.
Projects will be designed to be as closely aligned with the countrys development plan as possible. An effort will also be made to align the bulk of the operations with the countrys political cycle, concentrating programming in the early years of a governments tenure in a bid to mitigate the elements of political risk that increase as an administration nears the end of its term. In addition, the Bank will propose in each case that the conditions precedent to disbursement be fulfilled before the loan is approved, so as to expedite project implementation. In order to mitigate external environmental risks, the Bank has proposed to the country a fiscal impact analysis of possible natural hazards. This preventive work will help the authorities to better plan what steps to take in the event of a disaster of this sort. In the meantime, the Bank is producing a regional analysis of the impact of natural disasters in Central America. As part of the project design process, the

3.40

3.41

3.42

3.43

- 33 -

Bank will seek to establish incentives to ensure that executing units are duly set up and operate well throughout the implementation period. 3.44 With respect to the role of the National Concessions Council (CONAFIN), the Bank is exploring with the country the idea of an early consultation process to address CONAFINs and other agencies requirements so as to minimize project preparation delays. It has also been agreed that these bodies could be approached at the start of the design process for each operation by means of a project concept note. This would make it possible to ascertain, early on in the design phase, if CONAFIN concurs with a projects approach and objectives. In the context of PRODEV, the Ministry of Finance and MIDEPLAN intend to reformulate the investment project approval process, including the role of CONAFIN in that process, on the basis of the restructuring of a National Public Investment System.

ANNEXES

Annex I Page 1 of 2

PREVIOUS STRATEGIES AND PORTFOLIO: LESSONS FOR THE NEW STRATEGY TABLE 1: PROGRAMMING AND APPROVALS, 2002-2005 (millions of US$)
Loans programmed in the BCS-CR Programmed amount in BCS-CR Lending scenarios Low I II II II II I II II 15.0 395.0 100.0 200.0 20.0 50.0 10.0 High 100.0 200.0 20.0 50.0 10.0 100.0 200.0 15.0 695.0 126.1 9.2 116.8 Change in priority of new administration Approved on 29 June 2005, awaiting ratification Change in government priority Approved on 20 December 2006, awaiting ratification Approved on 21 July 2004, awaiting ratification Rescaling of the program Rescaling of the program Reorienting the program toward other regions

Loan

Strategy pillar51

Approved amount52

Current status (December 2006)

Number CR-0140 CR-0156 CR-0154 CR-0145 CR-0150

Title in BCS-CR Pro-Competitiveness Sector Reform Program (Pro-Competitiveness Support Program, phase I) Pro-Competitiveness Productive Investment Program53 (Pro-Competitiveness Support Program, phase I) Modernization of the National Congress Urban Poverty Alleviation Sustainable Development Binational Sixaola River Basin Support for Consolidation of Public Finances (ProCompetitiveness Support Program, phase II) Growth and Competitiveness Investment Facility II (ProCompetitiveness Support Program, phase II)

Sustainable Development Binational San Juan River 54 Basin Total programmed amount, 2003-2006 BCS-CR

51

Strategy pillar I: Lock in macroeconomic stability; Strategy pillar II: Speed the pace of production development within the framework of increasing global economic integration. Amount originally approved. Three of five programs were approved and are included in this project as components: (i) foreign trade, (ii) science and technology for competitiveness, and (iii) participatory rehabilitation of rural roads. Not included in the 2003 update.

52 53

54

Annex I Page 2 of 2

Projects approved prior to the BCS-CR or programmed in the updates Project Number CR-0142 CR-0144 CR-0157 CRL1001 CRL1003 CR-0152 Title in BCS-CR Sustainable Agricultural Development Health Sector Development55 Sustainable Development Atlantic Hutar Region56 Tourism in Protected Areas57 Puntarenas Development Program 202058 Modernization of Procurement and Contractual Services59 Strategy pillar II II II II II II Programmed amount in updates 14.4 6.4 16.0 20.0 5.0 5.0 461.8 160.060 Amount of approved operations 14.4 4.4 15.0 Current status (December 2006) In progress In progress Approved on 9 February 2006, awaiting ratification Approved on 20 December 2006, awaiting ratification In pipeline with global operation for regions Change in the new governments priorities

Total programmed amount, 2003-2006 BCS-CR (low-case lending scenario and updates) and total approvals, 2003-2006

TABLE 2: 2003-2006 BCS-CR PERFORMANCE INDICATORS

Objective Baseline -YearTarget -YearResult -Year21.2% - 2005 5.9% - 2005 Objective met?

Poverty reduction GDP growth rate

Medium-term government targets 20.5% - 2002 16% - 2006 2.8% - 2002 4% - 2005

No Yes Yes No Yes

Strategy pillar I Lock in macroeconomic stability Overall objective: Reduction of fiscal deficit 5.9% - 2002 2.9% - 2005 2.2% - 2005 Increase in tax revenue (% GDP) 13.3% - 2002 16% - 2006 13.6% - 2005 Reduction in public spending (% GDP) 23% - 2002 21.5% - 2006 Strategy pillar II Speed pace of production development within the framework of increasing global economic integration Overall objective: Increase non-Intel nontraditional US$3,490 US$4,040 - 2005 US$4,800 2005 exports (US$ million) 2001-2002 Export/import processing time 1 day - 2005 Use of automated system in judicial districts 5 2005 5 Rank 55 (of 80), Rank 88 (of 117), Rank and number of days to start a business Better than 2002 120 days 77 days Private R&D spending as share of total 18% 24% - 2006 23.3% - 2005 Dropout rate, cycle III day program 12.9% - 2001 10% - 2006 10% - 2004

Yes No Yes Improvement in number of days; drop in rank Close Yes

55 56 57 58 59 60

Included in the 2003 update. Included in the 2004 update. Included in the 2004 update. Included in the 2005 update. Not registered in the IDB system. Included in the 2005 update. Includes one project that was not part of the programming because it was approved in 2002.

Annex II Page 1 of 2

2006-2008 WORK PROGRAM SOVEREIGN-GUARANTEED LENDING (millions of US$)

No. CR-1001 CR-0145 2006 approvals Tourism in Protected Wilderness Areas Urban Poverty Alleviation Program Total investment lending 2006 20 50 70

No. CR-1008 CR-1009

2007-2008 lending program 2007 2008 Enhancing Environmental Management Capacity 12 Line of Credit for Electricity DevelopmentICE (US$500 million CCLIP)* 250 Regional Development Program: Chorotega, North Hutar, Pacific, Brunca 45 Total investment lending 362 45 *The IDB country strategy with Costa Rica set out in the body of this paper includes a first CCLIP loan for US$250 million.

WORK FOCUSES FOR HIGH-CASE LENDING SCENARIO SOVEREIGN-GUARANTEED LENDING

Strategy pillar Strengthen the macroeconomic and public expenditure management framework Support for borrowing requirements Modernization of Procurement and Contractual Services Deepen the countrys growth and international positioning model Secondary Education and Employment Preparation Road Infrastructure Program Create opportunities for inclusive economic growth Support for the Social Safety Net

Annex II Page 2 of 2

POSSIBLE NONSOVEREIGN GUARANTEED OPERATIONS AND PRIVATE-SECTOR SUPPORT

Deepening the countrys growth and international positioning model Pipeline CR-L1004 CR-L1006 CR-0149 San Jos-San Ramn toll road (PRI) Banco Interfin MT-103 backed A/B loan (PRI)* Investment in Public Utilities Heredia (PRI/EN2) Banco Cuscatln (IIC) Veragua-Rainforest (IIC) Estrella de Precisin Tecnolgica (IIC) Helechos Internacionales (IIC) Productores de Monteverde (IIC) Business focuses Boruca-Veraguas hydroelectric project San Jos-Cartago highway Wind power plants up to 60 MW Port of Limn expansion and concession Radial Heredia highway and beltway Mortgage securitization San Jos rail freight Hotel sector Solid waste treatment Liberia airport
* Although Banco Interfin was bought by Scotiabank, the institution (Scotia/Interbank) is interested in securitizing MT-103 flows in the second quarter of 2007.

Annex III Page 1 of 1

2007-2008 TECHNICAL-COOPERATION PROGRAM (thousands of US$)

Program of technical-cooperation operations Strengthening the macroeconomic and public expenditure management framework Public Administration Improvement Program (PRODEV) Deepening the countrys growth and international positioning model Base-case scenario Prefeasibility Studies Boruca-Veraguas Hydroelectric Project Preparation and Design of ASP Investments (associated with project CR-L1001) Environmental Management Capacity (associated with project CR-L1008) Support for Negotiation and Implementation of Trade Agreements Sustainable Regional Development Strategies (associated with project of support to regions) Total 2006-2008 Marine and Coastal Resources Management in Puntarenas

CR-T1013

450.0

CR-T1017 CR-T1021 CR-T1025 n/n

1,500.0 500.0 150.0

2,600 6,000.0

Grant (GEF) CR-X1004

2006-2010 MIF PROGRAM (thousands of US$)

Deepening the countrys growth and international positioning model 2006-2007 Assistance to Central American SMEs in meeting technical requirements for CAFTA access Appellation of origin for Central American coffee Support for National Concessions System Development of national franchising Total Work focuses Cooperative business incubators in secondary cities Development of SMEs based on fee-for-environmental-services schemes Internet-based SME competitiveness Development of private equity market for growth SMEs Digital signatures to boost MSME competitiveness Development of cultural and educational tourism Public-private partnerships in subnational governments

546.8 2,500.0 500.0 500.0 4,046.8

2006-2007 NONLENDING PRODUCTS PROGRAM

Strengthening the macroeconomic and public expenditure management framework Comprehensive Public Expenditure Review (PER) (with the World Bank) Debt sustainability analysis Macroeconomic consistency model Evaluation of the decentralization process in Costa Rica and policy proposal Governance profile Deepening the countrys growth and international positioning model The Costa Rican rural economy and CAFTA Workshops on integration and trade challenges for Costa Rica Strategy Guidelines for Support to Costa Ricas Private Sector Creating opportunities for inclusive economic growth Analysis of the Costa Rican labor market

61

Clarification: The 2006-2010 BCS-CR corresponds to the present administrations term (May 2006-May 2010).

Annex IV Page 1 of 3

DEBT SUSTAINABILITY IN COSTA RICA A nations public debt is sustainable if the public sector can generate sufficient revenues to honor 100% of its debt service commitments. A debt sustainability analysis can be used to look at two factors. The first is the fiscal-balance path that will render a given public debt stock (measured as a percentage of GDP) sustainable. The secondthe public debt pathis the level of public debt that the government could incur and service on a sustainable basis, by reference to medium-term projections for fiscal policy variables and parameters relating to economic fundamentals (real growth rate, interest rates, etc.). The IDB has worked with various fiscal sustainability analysis models that incorporate standard models, under certainty, and models reflecting the effect of real exchange-rate corrections associated with necessary current account adjustments. To describe fiscal balance and public debt paths that will be sustainable over the medium term, the analysis has been based on the model developed by Edwards and Vergara (2002)62 which allows for the explicit incorporation of the domestic debt stock, which in Costa Ricas case represents 36.5% of the aggregate debt. This annex summarizes those studies main findings. The International Monetary Fund and the World Bank have also developed debt sustainability models for Costa Rica, which largely corroborate the IDB studys findings. In every case, it is clear that the countrys primary surplus has to be increased in order to make its current debt levels sustainable and cushion it from any strong external shocks. Standard analysis A countrys fiscal position is sustainable so long as (i) the government can manage the current-period budget constraint without defaulting or resorting to excessive monetization of the debt and (ii) the country does not continue to amass debt to a point where at some future juncture it would have to make a major (and perhaps unviable) fiscal adjustment to be able to service the debt. For the latter purpose the present value of the contracted debt cannot exceed the discounted primary surplus. In the short run, this means that a government must act in accord with the budget constraint, which means that there must be funding allotments for all economic policy measures. In the long run, the notion of intertemporal budget constraint enters the equation and sets a limit on indefinite government borrowing capacity. In these circumstances, the robustness of the public finances can be undermined by any combination of the following: (i) an increase in the debt-to-GDP ratio; (ii) expectations of a lasting deterioration in fiscal outturns; (iii) a slowdown in economic growth; and (iv) an increase in the real interest rates paid on public-sector debt.

62

This model was designed to analyze debt sustainability for HIPC countries with a high degree of debt concessionality. It also factors in the domestic debt stock, which is not always the case in IMF and World Bank studies. Costa Ricas domestic debt is an important factor not only because of its size but also because much of it is foreign currency denominated.

Annex IV Page 2 of 3

In running this analytical model for Costa Rica, consideration has been given to historical data, estimates based on the macroeconomic consistency model developed by the IDB,63 and other analysts forecasts (IMF). Specifically, a GDP growth scenario based on a trend value of 4.5% has been used. Other assumptions include full rollover of the external debt (i.e., its nominal value will remain constant) and no change in the domestic debt stock in real terms. The results of these calculations indicate that for Costa Ricas current public debt levels to be sustainable, its consolidated public sector (including the nonfinancial public sector and Central Bank) will have to run a primary surplus of between 2.5% and 2.9% of GDP over a 10-year time horizon. A comparison of these figures with the average primary surplus posted by the consolidated public sector for 2001-2005 (0.9% of GDP) gives some idea of the corrections that Costa Ricas public sector would have to make. A synthesis of the main findings is depicted in Figure 1.

Figure 1. Growth Scenarios and Fiscal Adjustment Required for Debt Sustainability
3.10% 2.90% Required fiscal adjustment 2.70% 2.50% 2.30% 2.10% 1.90% 1.70% 1.50% t=3
4.50%

Growth scenarios

t=2

t=5

These findings fall within the same range as the research conclusions of other institutions (IMF, World Bank) and thus bolster a consensus view regarding the fiscal results that the Costa Rican public sector would need to achieve. The IMF maintains that the combined public sector primary surplus would need to be at least 2.5% of GDP for the debt to be sustainable. The World Bank proposes different analytical models: (i) a deterministic scenario in which the findings indicate the need for a primary surplus of between 1.6% and 2.7% of GDP; and (ii) an estimated probability analysis for key variables that gauges the primary surplus requirement to ensure debt sustainability at 2.5% of GDP.

63

This is a Keynesian multiplier model to forecast the GDP growth rate, the inflation rate, the fiscal deficit (as a percentage of GDP), the current account deficit (as a percentage of GDP), and changes in the real exchange rate.

5.00%

t=4

2.20%

t=1

Annex IV Page 3 of 3

Two consolidated public-sector debt path scenarios are posited: (i) tax reforms are passed, and (ii) tax reforms are not passed (all other variables being equal). As shown in Figure 2, if the tax reforms go through, then the debt will approach the threshold of 50% of GDP in 2010; if they do not, then the debt will hold at around 53% of GDP. In both cases, the consolidated public sectors overall result puts the country on a declining debt path. Over the long term, however, the two paths tend to diverge.
Debt/GDP Path
58%

57%

56%

55%

% 54%

53%

52%

51%
Without active policies With active policies

50% 2005 2006 2007 2008 2009 2010

The central governments position also warrants examination. In the current circumstances (no Central Bank capitalization), the central government should run a primary surplus of between 2% and 2.35% of GDP over the next 10 years. This is in line with its 2005 performance (primary surplus of 2.5%), but it presupposes much tighter fiscal discipline given the average primary surplus over the past decade (1.2% of GDP). The picture would change sharply in the Central Bank capitalization scenario (with the central government taking its debt): in that event the central government would have to attain primary surpluses of between 3.1% and 3.5% over this period, at an additional cost to that government of approximately 1.1% of GDP. This estimate is also close to the IMF calculation, which puts the financial cost to the central government at 1.5% of GDP (equivalent to the Central Bank losses). This provides an idea of how much of an adjustment the central government would have to make.

Annex V Page 1 of 2

DOCUMENTS REFERENCED IN DEVELOPING THE BANKS STRATEGY WITH COSTA RICA IDB, Policy Dialogue Paper. May 2006,
http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=725502

1.

2. 3. 4. 5.

IDB, Evaluation of IDB actions in Costa Rica, 2002-2005 (RE2/OD3), May 2006 Inaugural address by President Oscar Arias Snchez, May 2006 Government platform for 2006-2010, Hacia la Costa Rica Desarrollada del Bicentenario [Toward a developed Costa Rica for the bicentennial], November 2005 World Bank, Costa Rica - Country Economic Memorandum: The Challenges for Sustained Growth. June 2006 (currently being discussed with the Costa Rican government) IDB, Strategy Guidelines for Support to Costa Ricas Private Sector, September 2006 IDB, Trade and Integration Policy Note on Costa Rica, April 2006 IDB, Desafos del Sistema de Concesiones en Costa Rica [Challenges for the concessions system in Costa Rica], November 2005 IDB, Nota Sectorial sobre Infraestructura en Costa Rica [Sector note on infrastructure in Costa Rica], November 2005 IDB, Nota sobre Sector Vivienda en Costa Rica [Note on the Costa Rican housing sector], November 2005 IDB, Nota sobre el Sector Financiero en Costa Rica [Note on the Costa Rican financial sector], November 2005 IDB, Nota sobre Administracin Financiera Pblica en Costa Rica [Note on public sector financial administration in Costa Rica], November 2005 IDB, Nota sobre C & T en Costa Rica [Note on science and technology in Costa Rica], November 2005 IDB, Nota Conceptual sobre Mercados Laborales en Costa Rica [Concept note on Costa Rican labor markets], November 2005 IDB, Nota Conceptual sobre Educacin Secundaria en Costa Rica [Concept note on secondary education in Costa Rica], November 2005

6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

Annex V Page 2 of 2

16. 17. 18. 19. 20. 21.

IDB, Nota Conceptual sobre Pobreza en Costa Rica [Concept note on poverty in Costa Rica], November 2005 IDB, Perfil de la Pobreza Urbana en Costa Rica [Costa Rica: Urban poverty profile], November 2005 IDB, Nota sobre Clima de Negocios en Costa Rica [Note on the Costa Rican business climate], November 2005 IDB, Note on Challenges for Democratic Governance in Costa Rica, November 2005 IDB, Nota sobre E-Gobierno en Costa Rica [Note on e-government in Costa Rica], November 2005 IDB, Nota sobre Desafos del Estado de Derecho en Costa Rica [Note on challenges for the rule of law in Costa Rica], November 2005

Annex VI Page 1 of 4

STRATEGY GUIDELINES FOR SUPPORT TO COSTA RICA'S PRIVATE SECTOR The strategy guidelines devised for IDB Group engagement in Costa Rica would prioritize support for development of the countrys private sector in four areas: (i) infrastructure upgrades, (ii) financial sector strengthening, (iii) production finance, especially for MSMEs; and (iv) technology adoption and innovation by businesses. The Multilateral Investment Fund (MIF), the Inter-American Investment Corporation (IIC), and the Banks Private Sector Department (PRI) have identified a series of business opportunities around which to orient future IDB Group efforts. Infrastructure To help spur core infrastructure development and thereby make the country more competitive the IDB Group will concentrate on the energy, transportation, and water and sanitation sectors, the aim being to remove supply chain bottlenecks. The infrastructure agenda will be aligned to the competitiveness agenda to equip the nations infrastructure base for the anticipated new demands. Private-sector engagement in that sector will be promoted, strengthening the concessions system and agencies working in that domain. These activities are intended to help Costa Rica manage two key challenges. The first is to restore decaying essential infrastructure and equip it for the demands created by brisk growth, tourism development, and increased trade thanks to the CAFTA-DR. The second is to institute reforms and modernize core infrastructure sectors, an essential step to attract private investors and facilitate the requisite public investment. PRI will continue developing a lending pipeline focused largely on transportation infrastructure. The draft concessions legislation introduced by the Costa Rican government in June 2006 will spur private investment in this sector, facilitating the expropriations needed for right-of-way accessan issue that has held up projects in the past. In this sector PRI will continue identifying private road concession ventures (e.g. the San Jos-Caldera, San Jos-Cartago, and Radial Heredia highways and the San Jos beltway) and other projects that form part of the countrys concession program. With the Regional Department and the MIF the Bank will continue supporting actions to modernize the port of Mon and other Atlantic and Pacific cargo ports. The IDB also is working with the Central American Bank for Economic Integration (CABEI) on the preparation of a feasibility study for a rail freight project. In the electric energy sector the Regional Department will continue support for preparation of the Veraguas-Boruca hydroelectric project, to see it implemented through a public-private partnership; PRI could explore the possibility of participating in the project finance. Given the statutory prohibition against privatizing over-50 megawatt electricity generating projects, PRI will concentrate on nonsovereign guaranteed lending to the public electric utility, Instituto Costarricense de Electricidad (ICE). In regard to the water and sanitation sector, PRI and the Regional Department are in talks with the Heredia municipal government, Banco Nacional de Costa Rica (BNCR), and other municipalities about a municipal integrated solid waste management project. To that end PRI is looking at

Annex VI Page 2 of 4

nonsovereign guaranteed finance for the Heredia public utilities corporation (Empresa de Servicios Pblicos de Heredia S.A.). Development with BNCR of a municipal works finance vehicle is also being explored. Financial sector Improvements in financial-system regulation and in some institution-specific facets will be promoted to make credit more readily available to MSMEs and help create new financial products to channel financial-system resources to producing sectors, tourism infrastructure, technology innovation, and housing construction. Specific opportunities have been identified for nonsovereign guaranteed structurings with BNCR and the national mortgage bank (Banco Hipotecario de la ViviendaBANHVI). In the housing sector the Bank will continue to help encourage commercial banks to strengthen housing finance via the ABC (savings-grant-credit) scheme or other vehicles. Potential operations have been identified with Sociedad Titularizadora Centroamericana, a company formed by BNCR and BANHVI, to originate and package mortgages for subsequent securitization. To help Costa Rica strengthen its financial system it is hoped that the IDB Group will move into local currency lending to help lessen the sectors vulnerability. About 50% of financial-system credit in the country is foreign currency denominated, which exposes the sector to potential devaluation risks that could have a strong impact on consumer and housing finance portfolios. The IDB will continue to develop its Trade Finance Facilitation Program (TFFP), engaging issuing banks based in Costa Rica or banks elsewhere in the region that can do business in Costa Rica. Given the rapid growth of the countrys export sector (up about 20% in volume terms during 20052006) the demand for export finance is expected to be heavy, especially in nontraditional agriculture sectors and small and mid-sized manufacturing concerns. To assist in this sphere the Bank will work to have other Costa Rican banks join the TFFP. The MIF and the IIC will continue developing new financial products like leasing and factoring, and creating investment funds for equity backing and new productive ventures in the country. The IIC recently approved a long-term loan to Financiera Cafsa S.A. and Arrendadora Cafsa S.A. to finance the growth of those companies loan and lease portfolios, and will continue pursuing this strategy as it identifies financial intermediaries interested in this kind of products. BNCR has indicated that it might wish to outsource its microcredit operations to a new company in which it would hold an equity stake, opening the possibility that commercial financial institutions could buy into the company. For this particular venture the IIC or the MIF might provide financing or take an equity participation in that company. Production sectors With the IDBs broadened mandate, PRI will be able to play a more active role in the regions producing sectors, supplying finance for larger-scale ventures and complementing what the IIC has done in recent years. Costa Rica began diversifying production some time ago when it consolidated its free zones, which helped attract many export-focused companies. Most are in the manufacturing

Annex VI Page 3 of 4

sector, which has grown quickly in recent years and today employs 14% of the workforce and contributes 22% of GDP. This shift has boosted the need for finance for simple and high-technology manufactures alike, notably in the medical product and electronics industries. Under DR-CAFTA Costa Rica expects to continue to attract heavy foreign direct investment to diversify its manufacturing base and heighten the role of domestic providers that are part of the supply chain. Work will be done to prospect for opportunities like the recent IIC loan to Estrella de Precisin Tecnolgica S.A., a company that designs, manufactures, and exports parts and components for medical laboratories and aeronautical industries. Industry linkages will be pursued by connecting MSMEs to suppliers of major local businesses and to the government procurement system. The ongoing MIF regional project intended to encourage strategic partnerships, clustering and other linkages to help SMEs become more competitive will continue operating. The Regional Department and BNCR are exploring a possible guaranteescheme structuring for lending to SME industry clusters, including producers associations. It is hoped that this structure can be used also with commercial banks that are familiar with this kind of vehicle, for which PRI and the IIC could also lend support. The agriculture sector has experienced robust growth since 2003; its 2006 growth rate to date tops 8%. The pineapple, banana, and coffee industries are invigorating the sector and boosting the demand for agricultural chemicals and fertilizers. Following the recent agreement of the Dos Pinos dairy producers cooperativethe countrys leading milk exporterfarm-gate prices have risen, as has national milk production. To further strengthen this sector the Bank plans to continue helping MSMEs to build financial literacy, particularly in supply chain clusters, and strengthen financial management of rural small-farmer organizations. This will enhance these producers access to the financial system and the financial products available in the country. Support also will continue for foreign trade activities to help solidify commerce with the United States and within the region, strengthen institutions, and execute and administer trade agreements, by way of the external trade component of the Pro-Competitiveness Productive Investment Program (1636/OC-CR). In other sectors, particularly the tourism industry, Costa Rica is ahead of its neighbors. Its international incoming tourist revenues are up sharply in recent years and, according to World Tourism Organization forecasts, international tourist arrivals could continue to climb 10% to 12% annually. This strong growth performance, the existence of a national sustainable tourism plan, and the miniscule share of tourism sector finance currently being supplied by Costa Rican banks (less than 1.9% of total financial system lending) suggests that there is room for active IIC and PRI engagement in this sector. PRI is working to identify well designed, financially sound investments that would be candidates for finance support. A number of international chains have expressed interest and are exploring the possibility of building resorts in Costa Rica, especially since the inauguration of the Four Seasons Hotel on Papagayo Peninsula. The MIF will continue backing efforts to diversify tourism offerings and improve tourist services in areas such as adoption of uniform standards for ecotourism service certification and design of new nontraditional tourism products. Work will continue as well with tourism industry associations to

Annex VI Page 4 of 4

help diversify their product menus, improve the quality of their services, and foster links among actors along the industry chain. Technology innovation One piece of the private-sector support strategy is strengthening the national innovation system, through strategic targeting of investment and funding for new business innovation ventures, especially for SMEs. There is a need to rationalize institutional capacity to coordinate and guide technology change, encourage Costa Rican businessesespecially SMEsto bring in modern technologies, and boost human capital investment in strategic areas, with an added push for education, training, and research in enabling technologies. The work focus in regard to support for business innovation will be growth SMEs that have export potential, strengthening the supply of and demand for business development services, promoting business-to-business linkages for certain clusters that already have good competition potential, such as high-tech products, tourism services, and agribusiness. That effort will be coupled with support for economic integration and global market positioning, especially to help Costa Rica execute and administer free trade agreements, including institutional capacity strengthening. The proposed IDB Group interventions are contained in the strategy guidelines reflected in Table 4. It is recommended also that the IDB Group leverage its engagement through the Pro-Competitiveness Productive Investment Program (CR-0156), which includes financing for investments that will enhance the business climate and national competitiveness as the Costa Rican economy becomes more globally integrated. This program is benefiting the countrys production sector, facilitating SME access to innovation, helping businesses join dynamic supply chains that will give them foreign trade access, helping to instill a better understanding of markets, and upgrading infrastructure for transportation of their products. It is recommended also that the Bank assist the Costa Rican authorities efforts to ensure a dialogue with the private sector and institutional coordination, fostering a public-private framework on the basis of which a national competitiveness agenda can be crafted and implemented.

Annex VII Page 1 of 1

COSTA RICA: COUNTRY FINANCING PARAMETERS64

Category Financing matrix or cost sharing: Ceiling on the share of individual project costs that the Bank may finance. Recurrent cost financing: Ceiling on total recurrent expenditures that the Bank may finance. Parameter Up to 100% of the project cost Explanation The Bank may finance up to 100% of the cost of an individual operation. In each case, the Bank will weigh the governments ownership in terms of its contribution to funding its overall development program and to the particular sector or subsector to which Bank resources are to go. Article 6 of the Public Financial Administration and Budgets Act 8131 states that, in order to ensure sound financial management, capital income may not be used to finance current expenditures. The Government of Costa Rica defines current expenditures as nonrecoverable outlays to remunerate factors of production, purchase goods and services, and make transfers to attend to the customary activities involved in the production of goods and provision of services that are the purview of the public sector. Goods and services classified under this heading have a projected useful life of less than one year and as such are not durable goods. At the request of the country, if the costs are eligible, the Bank may provide foreign-exchange financing for local costs. When the financing for a projects local costs is provided in local currency, the only policy restriction is that the expenditure must be eligible. Currently, all taxes and fees in Costa Rica are considered to be reasonable and nondiscriminatory. At a borrowers request, Bank loan proceeds may be used to pay taxes and related fees that represent an added expense in goods and services procurement provided that the Bank deems the amounts of those taxes and fees to be reasonable. Additional charges, over and above the cost of a service, in the form of income taxes will not be covered. Government ministries and decentralized agencies are exempt from taxes, so Bankfunded projects executed by those bodies do not incur tax obligations.

Current expenditures specified in the Financial Administration Act are not eligible for financing.

Local cost financing: The Bank provides foreign-exchange financing for local costs.

Yes

Taxes, fees, and duties: Are there any taxes or fees that the Bank will not finance?

None

64

These CFPs for Costa Rica were developed in coordination with the World Bank, as provided in document GN-2331-5. At this writing the World Bank has not approved its CFPs, but they are expected to be essentially the same.

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MILLENNIUM DEVELOPMENT GOAL INDICATORS65

1990 1. Eradicate extreme poverty Households below the poverty line (INEC) Households below the extreme poverty line (INEC) 2. Achieve universal primary education Net primary school completion ratio (ME, CR) Net primary school enrollment ratio (ME, CR) Net senior kindergarten enrollment ratio (ME, CR) Net junior kindergarten enrollment ratio (ME, CR) 3. Promote gender equality Gross female labor force participation rate (INEC) Share of women in wage employment in the nonagricultural sector (INEC) Ratio of male/female average income levels (INEC) Proportion of seats held by women in the national parliament (UNDP) 4. Reduce child mortality Under-five mortality rate (per 1,000 live births) (MS, CR) Infant mortality rate (per 1,000 live births) (MS, CR) Proportion of children under 1 year of age immunized against measles (MS, CR) Proportion of children under 1 year of age receiving flu vaccinations (MS, CR) 5. Improve maternal health Maternal mortality ratio (per 10,000 live births) (MS, CR) Hospital births (CCSS) Prenatal care for women in the first trimester of their pregnancy (CCSS) 6. Combat HIV/AIDS, tuberculosis, and other diseases HIV/AIDS mortality rate (per 100,000 people) (MS, CR) Prevalence of tuberculosis per 100,000 people (MS, CR) Incidence of dengue fever per 10,000 people (MS, CR) 7. Ensure environmental sustainability Coverage of water supply for human consumption (AyA) Population with access to safe drinking water (AyA) Total population with access to improved sanitation services (INEC) Slum-type, mobile, or makeshift dwellings (MIVAH, CR) Homes with insecure tenure (MIVAH, CR) Overcrowded dwellings (MIVAH, CR) 8. Develop a global partnership for development Unemployment rate for young people aged 15-24 (WDI) Telephone lines and cellular subscribers per 1,000 people (WDI) Personal computers per 1,000 people (WDI) 27.4 9.1 2003/4 21.7 5.6 2015 target 16.0 4.6

98.5 76.7 61.7 5.1

99.5 85.0 90.0 30.0

100.0 100.0 99.0 72.3

21.6 35.3 12.3

31.0 39.0 23.5 35.1

3.7 15.3

2.2 10.1 90.0 93.0

2.0 9.0 95.0 95.0

3.3 92.4 34 (1997)

3.3 99.0 52.0

2.0 97.0 75.0

0.7 9.3 14.3 92.0 50.0 76.0 2.1 12.7 12.1

3.4 14.0 50.3 97.6 80.0 93.5

6.1 14.2 98.7 88.0 1.8 10.7 4.7

8.0 92.0 68 (1997)

15.0 316.0 238.0

65

Numbers are percentages unless otherwise indicated.

Annex VIII Page 2 of 2

Goal 1. 2. 3. 4. 5. 6. 7. 8. Eradicate extreme poverty and hunger Achieve universal primary education Promote gender equality Reduce child mortality Improve maternal health Combat HIV/AIDS, malaria, and other diseases Ensure environmental sustainability Develop a global partnership for development 2015 = 2015 = 2005 = 2015 = 2015 = 2015 = 2015 = 2015 =

Target Halve (relative to 1990) the poverty and malnutrition rates 100% net enrollment ratio Complete gender parity in education Reduce (relative to 1990) the under-five mortality rate by two thirds Reduce (relative to 1990) the maternal mortality ratio by three quarters Have halted and begun to reverse the spread of HIV/AIDS, etc. Various Various