Chinchilla Says Costa Rica Deficit Plan Faces Failure

Costa Rican President Laura Chinchilla said her administration may not succeed in overhauling the country’s tax system to pare a deficit that has grown to more than 5 percent of gross domestic product.

If the latest push on tax increases fails, “there would not be enough time in my administration to do it and we would leave it to the next government,” Chinchilla, 52, said in an interview yesterday in her office in San Jose. “What we want to avoid is that what’s now only a fiscal crisis contaminates the rest of our economy.”

Costa Rica’s $40.3 billion economy, the second-biggest in Central America, is weighed down by a deficit equivalent to about $2 billion, approximately the amount the country earns from tourism. Central bank President Rodrigo Bolanos predicted in January that as a result, growth will slow to 3.8 percent this year from 4.2 percent in 2011.

Legislation proposed by the government would replace the current national 13 percent sales tax with a 14 percent value-added tax. At stake also is the continued presence of companies such as Intel Corp., based in Santa Clara, California, and Oracle Corp., based in Redwood City, California, that were attracted to Costa Rica by the free-zone system under which some foreign-owned companies pay no income taxes for the first 12 years of operation.

Free Zones

The tax bill would introduce a 15 percent income tax for companies entering free zones after 2015.

Two previous attempts to raise taxes died in the legislature last year. If the current overhaul is approved, the government estimates it would raise at least $600 million in annual revenue. Chinchilla said there is no “Plan B” if the current tax bill fails to pass.

“Because the decision has been so delayed, there are some effects that our economy is already starting to feel,” she said. “Interest rates, for example, have already increased two to three points since the end of last year.”

There is a strong possibility that 18 months from now, Costa Rica’s legislature may still not have approved the tax increases, said Boris Segura, a strategist at Nomura Securities International, in a telephone interview from New York. He said “a kind of dictatorship of the minorities,” referring to procedural maneuvers by small groups of legislators who can block bills, is holding up the tax overhaul.

Prospering Economy

Foreign direct investment in Costa Rica rose 52 percent to a record $1.56 billion in the first nine months of 2011, and a record-high 2.2 million tourists visited the country last year. GDP per capita is $7,691, the highest among in Central America.

High-tech companies such as Intel, the country’s highest revenue earner, Palo Alto, California-based Hewlett-Packard Co., and Armonk, New York-based International Business Machines Corp. have Costa Rican operations. High-tech companies brought in $9 out of every $10 in revenue from free zones during the last decade, according to Gabriela Llobet, director general of the Costa Rican Investment Board.

Chinchilla said in the interview that she met with Intel management and reassured them that they would not lose their tax benefits because the new levies only apply to newcomers.

Increased government spending and stalled tax legislation prompted Standard & Poor to cut Costa Rica’s local-currency credit rating on Feb. 13 by one notch to BB, two levels below investment grade and one level below Guatemala.

The yield on Costa Rica 6.548 percent bonds due in 2014 fell 25 basis points, or 0.25 percentage point, to 2.908 percent this year, according to data compiled by Bloomberg. The yield on Guatemala 2013 bonds dropped 38 basis points to 3.117 percent in the same period.

The colon weakened 0.3 percent to 513 per U.S. dollar today and has depreciated 0.2 percent this year as of 3:45 p.m. New York time. That compares with a 9.2 percent appreciation of Mexico’s peso in the same period. In Panama, the balboa is pegged to the dollar.

(Corrects Guatemala local-currency rating in 12th paragraph.)
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