Costa Rica to Accelerate VAT Reform After Downgrade--Update

By Michael J. Casey 

Costa Rica is accelerating the introduction of a new value-added tax and pursuing other overhauls aimed at improving governance and spurring growth following a credit ratings downgrade last week by Moody's Investors Service, the country's president said Monday.

But in an interview, President Luis Guillermo Solís warned that his country's finances could be detrimentally affected if the U.S. Federal Reserve too abruptly raises rates over the coming year. The president was in New York to address the U.N. General Assembly and meet with investors.

Mr. Solís, who assumed office in May, said the one-notch downgrade of Costa Rica's rating from an investment-grade Ba1 to speculative-grade Baa 3 should motivate the country's historically divided legislature to forge a consensus for tax overhaul. Until recently, Congress had resisted his government's efforts to introduce a bill to migrate a selective 13% sales tax to a comprehensive VAT at the same rate, which aims make it harder to evade taxes and bring in an additional $555 million annually in revenue. On Friday, three days after the downgrade, the government started a dialogue with the legislature's 13 different parties in a bid to overcome the logjam.

"One of the reasons why Moody's decided to downgrade us was because the incapacity of governments in the past to agree with the legislature for comprehensive tax reform," Mr. Solís said in the interview.

In a statement accompanying its ratings announcement Tuesday, Moody's took issue with persistently high fiscal deficits, which it forecast would reach 5.8% of gross domestic product this year and 6% in 2015 in a continuing increase from 4.5% of GDP in 2009. The deterioration has "materially worsened" Costa Rica's debt burden, the ratings firm said, noting that government debt-to-GPP is expected to rise to 40% this year, having been as low as 25% in 2008. The Moody's downgrade puts its rating on par with Fitch Ratings' BB+, also one notch below investment grade, and a notch above Standard & Poor's BB rating for Costa Rica.

Mr. Solís said that he is also determined to grow the economy into a fiscally healthier state, highlighting $2.4 billion in planned infrastructure expenditures over the next year. With concerns rising that climate change-led reductions in water supply will reduce Costa Rica's hydroelectricity supply from 90% of all power generation to 70%, the government has plans to develop geothermal power by tapping into the country's volcanic activity.

To add a targeted two percentage-point increase in the country's growth rate, bring unemployment down from 9% and poverty down from 20%, Mr. Solís's government is aggressively pitching to foreign direct investors, talking up the benefits of a relatively well-educated workforce in its traditional strengths such as health sciences and high-tech manufacturing. This comes after some recent exits by foreign companies, including chip maker Intel Corp., which in the spring announced 1,500 job cuts in the country, and textile maker Hanesbrands Inc., which said it would relocate its Costa Rican unit to Vietnam.

Mr. Solis said Intel was building a research lab in the country and that various other multinationals were also expanding operations in his country, including consulting firm Accenture, which on Monday announced it would create 330 new jobs in a new financial services and accounting division in the country.

"We are tied into the current global scenario," he said. "Companies come and go and we have to get used to that and we have to compete in that context."

He is concerned, however, that tighter monetary policy in the U.S. might disrupt his government's expansion plans.

"I hope that whatever happens it is done in such a way that it doesn't impose on us the consequences of abrupt change," Mr. Solís said of the impact of an expected Fed rate increase on Costa Rica and other emerging-market economies. "We are trying to be sensible about our own policies and it would be terrible if those sensitivities are not supported by the United States and other countries that have such tremendous impact on our economies."

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