San José, Costa Rica, since 1956

Colón Stays Steady against the Dollar

After 23 years of steady devaluation against the dollar, something strange is happening to the colón: It hasn’t moved much in nine months.

And if anything, it’s pushing to gain value against the dollar.

This has been good news for the country’s importers, who can now buy more with their colones and operate with wider margins, said Central Bank economist Eduardo Prado.

And though a slightly more valuable colón tends to squeeze exporters for the opposite reason (a more valuable colón means higher local production costs), many of these businesses have welcomed the lower inflation that the change in exchange rates has brought.

“What we’ve seen in 2007 is satisfaction in the business sector with how the Central Bank has managed” with the change in the exchange rate, said Luis Monge, executive director of the Chamber of Foreign Commerce and Representatives of Foreign Companies (CRECEX).

The change came Oct. 17 of last year, when the Central Bank switched to a different system for calculating the value of the colón against the dollar (TT, Oct. 20, 2006).

Previously – that is, since 1984, after the catastrophic currency devaluation of 1981 (TT, Dec. 4, 1981) – the Central Bank had used a system of mini-devaluations to lower the value of the colón against the dollar a fraction of a percent every month (a system known as a “crawling peg”).

The new “crawling band” system adopted in October allows the exchange rate to float between an upper limit, the ceiling, and a lower limit, the floor, with the Central Bank using its foreign reserves to buy or sell colones as needed to set the price limits.

Since the very first day of the change, the colón has been “stuck to the floor,” Prado said, meaning that it gained value against the dollar, and it is pushing to gain more.

One of the consequences, Prado explained, is lower inflation, which was one of the goals of the change. In the short term, a more valuable colón lowers the cost of imports, giving Ticos more buying power and thus lowering inflation.

Also, one long-term way the new monetary policy could lower inflation is by making it less attractive for foreigners to invest heavily in the colón, which has pushed inflation in the past, said Pablo Villamichel, a Citibank economist and vice-president of the U.S. Chamber of Commerce’s Committee on Economy and Finance.

Though Prado pointed out that there are many external factors influencing inflation as well – especially the international cost of fossil fuels and grains – inflation has indeed been going down.During the past 12-month period, inflation was only 8.75%, down from 12.4% the previous period.

That’s one of the things that made the new exchange rate policy palatable for some exporters despite the rise in the colón’s value, said Mónica Araya, the president of Costa Rica’s Chamber of Exporters (CADEXCO), and a some-time skeptic of the Central Bank’s new exchange policy.

“We can say that it has helped in a certain way because inflation has been going down,” she said, although she reiterated her call for the Costa Rican market to start offering financial tools to help Costa Rica’s exporters insure themselves against the new risk the exchange policy brings.

For his part, Eddie Fernández, the manager of electric-cable exporter Conducen, said the change hasn’t much bothered the company’s business, and in fact they have “taken advantage of the stability.”

“Really, there hasn’t been any effect because it’s behaved itself well,” he said.

As the colón remains on the floor, however, the pressure is toward a more valuable colón.

“Many people say the colón should be worth a little more, but the bank won’t allow it yet,”Villamichel said.

One of those sources is the international business weekly The Economist. In its “lighthearted” Big Mac Index, which ranks the value of world currencies based on the local price of the iconic burger, Costa Rica’s currency came out 36% undervalued (though the periodical pointed out that the Index’s methodology works best when applied to developed countries).


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