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Slump Worse Than Expected

The Central Bank this week announced a sharp deceleration in economy activity, raising worries that the global financial downturn will hit Costa Rica harder than expected.

Growth during the first 10 months was just 1.1 percent greater than the same period last year. By comparison, economic activity in the first 10 months of 2007 increased 7.7 percent over January-October 2006.

Construction, manufacturing and the hotel sectors have suffered most this year, according to the Central Bank’s economic activity index.

“This confirms our prediction for a sharp slowdown in the economy, which we think will soon enter recession,” the financial advising firm Aldesa said in a statement.

Recognizing that frozen credit markets have dragged down production, lawmakers this week voted to transfer government funds to three state-owned banks to stimulate more than $1 billion in lending.

The Central Bank’s index measures the quantity of goods and services produced across all sectors of the economy, such as the number of melons grown, square meters of housing constructed, and hotel rooms occupied.

Production in the manufacturing and hotel sectors shrunk by 5.3 percent and 2 percent respectively in the first 10 months of 2008, compared to the same period last year.

Construction grew by just 5 percent, down from 18 percent in 2007.

In a sign the downturn is getting worse, half of the sectors measured shrunk in September and October.

Elvia Campos, the Central Bank economist who drafted the report, attributes the slowdown to a tight credit market, lower levels of foreign direct investment, and slower growth in exports and tourism, among other factors.

Production will likely continue to drop as a recession worsens in the United States, Costa Rica’s principal trading partner and its biggest source of tourists and investment.

The U.S. Federal Reserve this week cut its benchmark interest rate to near-zero and announced it would print vast amounts of money to revive credit markets.

“Until these measures bear fruit, we are going to see a substantial slowdown here,” said Eric Vargas, strategy director at Aldesa.

“In the next six months, the economy could easily fall into recession. …Costa Rica is very open and dependent on external sectors.”

Costa Rica’s economy could recuperate in the second half of 2009, leading to gross domestic product (GDP) growth of between 0 and 2 percent for the year, Vargas said. GDP is the value of all goods and services sold.

As economic activity slumps, unemployment could reach 8 percent by July, up from 5 percent last July, when annual figures were last released, Vargas said.

President Oscar Arias, who campaigned on a promise to increase employment and reduce poverty, has publicly asked business leaders to reduce salaries or hours rather than fire workers.

“This crisis will thwart one of the sweetest dreams of my campaign,” Arias said, according to the daily La Nación.

A credit crunch is among Costa Rica’s biggest problems. Spooked by the crisis, banks have hiked interest rates and become choosier about borrowers. The average interest rate on loans in colones is 21 percent, up from 14 percent in April.

Compounding the problem is that after years of too-easy credit, some banks have reached or approached maximum lending limits set by the Superintendence of Financial Entities (SUGEF). A bank’s total assets, weighted by risk, cannot exceed 10 times its “capital base” – a measure that includes equity plus some liabilities.

Lawmakers this week passed Arias’ proposal to give state bonds worth $117.5 million to three state-owned banks. Banks could keep or sell the bonds, which the government would repay over 12 years at an interest rate of up to 15.5 percent. The money would increase the banks’ capital base, allowing them to grant up to $1.18 billion more credit.

“It’s urgent that banks receive these new resources from the state,” Presidency Minister Rodrigo Arias said this week. “It will allow banks to reopen frozen credit markets and lend, above all, to small and medium-sized businesses.”

Another proposal by the Arias administration would allow state banks to grant subordinated debt, whose holders would be repaid last if the bank collapses. The investments could be counted as part of the bank’s capital base, thus allowing them to lend more.

But banks still may be reluctant to lend as a floundering economy makes default more likely, economists said.

Isaac Castro, chief economist at the financial firm Interbolsa, is skeptical about the plan.

“If banks think that proposed projects are too risky, this money won’t be converted into credit.”



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