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COSTA RICA'S LEADING ENGLISH LANGUAGE NEWSPAPER

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For exchange rate, 5 years of stability

From the print edition

A major achievement of the Costa Rican economy is that the colón-dollar exchange rate – which has hovered around ₡500 to the dollar since 2007 – is no longer a source of anxiety for Ticos or companies. Once the country’s most important economic indicator, the exchange rate has dropped off the radar for short- to medium-term economic planning. 

To appreciate how unprecedented exchange rate stability is, observers should take a long-term view by looking at the Central Bank’s exchange rate on Jan. 1 for each of the past 30 years (see graph). 

Clearly, something happened in 2007. Up to that year, devaluation of the colón averaged 11.18 percent during 23 years. Since 2007, despite a slip to 11.52 percent in 2009, devaluation of Costa Rica’s currency has averaged only 0.71 percent, with the colón actually gaining value against the dollar in 2007, 2011 and 2012. 

It’s not surprising that the Central Bank’s records only go back to 1983. From 1978-1982, Costa Rica suffered its worst currency devaluation ever, from 8.6 to 45.2, an average of 107 percent per year. These disastrous numbers cannot communicate the chaos they entailed, as the Central Bank ran completely out of dollars, and then defaulted on bonds it issued to pay its dollar debts. Those  who went through those hyper-inflationary times and saw prominent Costa Rican companies go bankrupt, will never forget. But big upheavals enable major change: Costa Rica junked its import-substitution model, nationalization of dollars by the Central Bank was abolished, and the country switched to a modern, open, export-oriented economy. 

Once things settled down, the long climb from 45.20 colones per dollar in 1983 to 517.90 in 2007 reflects a natural strategy for a country exporting principally agricultural commodities, including coffee, sugar and bananas. The 10 percent or so of devaluation every year helps keep the dollar price of these types of exports competitive in international markets. 

But the world changes, and Costa Rica has done a pretty fair job of adapting. The original basket of three commodities became much more varied, including ornamental plants, fish, seafood and tourism, among others. As low-cost producers of coffee, such as Vietnam, emerged in commodity markets, Costa Rica was able to brand itself as a premier gourmet coffee producer and command premium prices for its golden beans. Most important of all, Costa Rica managed to diversify away from agricultural commodities as its main dollar earners, towards services and high-tech manufacturing. 

The change in the devaluation pattern that became evident in 2007 was the result of a change in how the exchange rate was set by the Central Bank, adopted in September 2006. Until then, the Central Bank led the dollar foreign-exchange market under a mini-devaluation strategy, with frequent, very small devaluations, in a predictable pattern that businesses could forecast. The Central Bank would set buy and sell exchange rates, which other exchange- market participants (mostly banks and securities brokerages) then fell in line with. 

Starting in September 2006, the Central Bank changed its approach. Instead of directly setting an exchange rate, it would now set upper and lower “bands,” or intervention rates at which it would enter the market to keep the exchange rate within reasonable bounds. As long as the exchange rate stayed within the upper and lower exchange rate bands, the Central Bank would stay on the sidelines and let supply and demand between other market players determine the rate. 

The lower band was set at ₡500 to the dollar, and since 2007, investment flows into the country became big and steady enough so that, together with the much more varied export-revenue mix, the exchange rate under the new, basically free-market foreign-exchange regime, stabilized. This stability proved solid enough for the exchange rate to get through the 2008-2010 world economic downturn with only one slip – the 11.52 percent devaluation in 2009 – followed by immediate recovery, with slight revaluations in 2011 and 2012. 

Though traditional exporters grumble that lack of colón devaluation hurts their competitive position in the world market, the stable exchange rate since 2007 has been the single biggest factor allowing Costa Rica to finally bring its inflation rate into single digits. This is the biggest contribution that the Central Bank and the government can make to the economic well-being of the poor.

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