Recent exchange rate stability offers relief to businesses
After the colón got off to a rocky start in 2014, the Costa Rican currency has entered a period of relative stability. The Central Bank’s (BCCR) efforts to quell volatility in the currency seem to be working, but analysts note there are bigger problems facing businesses in Costa Rica on the horizon.
Soon after the first round of presidential elections in February, Costa Rica’s currency’s started a mild but steady devaluation. The roughly 10 percent devaluation stressed many citizens and businesses with debts or expenses in dollars, who suddenly had to pay more to meet financial obligations after enjoying a robust colón for years.
The Central Bank’s board of directors made a major decision to try to stabilize the currency on June 26. The bank announced it would use the country’s international reserves to meet foreign currency demands of the non-banking public sector. This meant that large government agencies, such as the National Oil Refinery, or RECOPE, and the Finance Ministry would go to the BCCR when they needed dollars instead of the foreign currency exchange, Monex. The Central Bank said in a statement that the currency purchases by the non-banking public sector were made without considering the behavior of the currency market, meaning that daily needs for hard currency could inadvertently exacerbate an already wobbly colón.
The BCCR’s plan was to sync large foreign currency purchases with opportune timing in the market by supplying the day-to-day dollar demands of government agencies like RECOPE. The amendment allowed state banks to continue using Monex for their dollar needs.
The BCCR set a range of how much of its reserves it was willing to part with to front the non-banking sector. During his 100-day assessment of the government, President Luis Guillermo Solís reiterated the Central Bank’s commitment to maintain “adequate” reserves to protect the currency from external shocks, including a gradual pullback of monetary stimulus by the U.S. Federal Reserve and other developed economies.
So far, the strategy seems to be working.
“With the change in the methodology for public-sector purchases it seems to us that the Central Bank has sent the message that it wants to minimize volatility,” ALDESA securities analyst Adriana Rodríguez told The Tico Times.
Rodríguez said it is possible the colón will level off between 535 or 530 to the dollar in coming months. The average exchange rate for the colón to the dollar was 545.34 in the week of Aug. 25.
“We think that many important sectors of the economy are happy with where the rate is today,” she added.
While there is always a chance the currency could fluctuate again, analysts The Tico Times consulted opined that the exchange rate, while important, was not the biggest concern for the private sector today.
“I don’t think that the exchange rate is the principal concern of most businesses right now. There are other fears that are weighing more on them and the exchange rate is not one of them,” said Luis Mesalles, associate consultant for Ecoanálisis, a San José-based economic consultancy.
The government’s fiscal deficit, currently at 5.4 percent of gross domestic product, is projected to increase to 6 percent by the end of the year, according to the Finance Ministry. The cost of business remains stubbornly high, including electricity, which is the highest rate in Central America. Poor infrastructure, including some of the worst ports in the world, according to the World Bank, also limits economic growth.
Munish Manchanda, statutory examiner for the Costa Rican-American Chamber of Commerce, said maintaining a relatively stable exchange rate would be “imperative” for the Solís administration and Central Bank President Olivier Castro, but he agreed there was more at play.
“What we need to see is how to move the economy. It’s not just about the exchange rate, it’s how do we improve the overall situation of the country. Unemployment rates are still high, how do we get more employment? How do we get more investment? How do we remain competitive against other nations pitted against us in the region?” he asked.
“There is a long-term risk not only to the exchange rate but also a risk to the country’s economic rating,” Manchanda said. “Time is running out.”
President Solís has taken some steps to address the fiscal deficit and unemployment, but his efforts have been met with mixed responses. Vice President and Finance Minister Helio Fallas announced several tax evasion measures aimed at improving tax collection, and a 2 percent tax on credit card charges.
In 2012, the Finance Ministry collected just over 13 percent of GDP in taxes, far less than it claimed was needed to finance the government. Solís said during his speech on Thursday that tax evasion cost the government 13.37 percent of GDP in uncollected revenue. The government has turned to selling billions of dollars worth of bonds to keep the government’s doors open.
On Thursday, Solís also mentioned his decision to cap some large public pensions and leave 85 percent of current public-sector vacancies unfilled, a move he claimed would save the government ₡22 billion, more than $40 million. The deficit, however, remains at nearly $2.7 billion.
“I think that the Finance Ministry knows what it wants to do. What bothers me is that what they want to do probably won’t solve the fiscal crisis,” Mesalles said.
Earlier this month, the president unveiled an employment strategy that aims to create 217,000 jobs in the next four years. The private sector, however, bristled at not being consulted by the executive branch before the plan was announced. Manchanda said the administration needs to continue reaching out to the private sector when developing similar plans in the future. Unemployment in Costa Rica was 8.5 percent, or some 188,000 people, in 2013, according to the National Household Survey.
“Stability in the currency made a lot of people relax, but there is still cause for concern,” Mesalles added.
Álvaro Conejo, plant manager for Baxter Productos Médicos Ltda., a Costa Rican manufacturer and exporter of medical supplies in Cartago, said devaluation had offered some relief to his bottom line after years of an unfavorable exchange for his exports. Conejo, who has worked for Baxter for 27 years, said he is still uncertain about where the currency would go next.
“Stability is what helps us the most,” Conjeo said. “The exchange rate could go one way and hurt us or another and help us, but stability is the best we can hope for.”
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