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Value of Colón Likely To Increase Further

February 1, 2008
The pressure is still on for the colón to gain value against the dollar, unnerving exporters and U.S. dollar wage earners.
Even with the release of the Central Bank’s new monetary policy, the country’s moneyed class is still on the edge of its seat, waiting to see if the bank will make any further moves to allow the colón to appreciate.
In play is the lower limit that the bank has set for the colón-dollar exchange rate.
As dollars brought by tourists and foreign investors flood into the Costa Rican economy, the value of the colón against the dollar continues to push up and nudge the exchange rate down, forcing the Central Bank to intervene and buy up the dollars.
By absorbing that foreign currency, the Central Bank keeps the colón’s exchange rate from dropping below the lower limit.
In the last few weeks, the Central Bank has had to intervene at near record levels – acquiring almost $43 million last week alone – and even with that intervention, in some parts of the market, dollars are still trading below the bank’s lower exchange limit.
While tamping down the colón’s value in this way helps exporters and others who earn in dollars and spend in colones, in the long run it can push another worrisome trend: inflation, which last year exceeded 10%.
For every dollar the Central Bank buys, it has to emit colones, and more currency in the market generally can mean higher inflation.
The situation also creates another inflationary pressure in the form of currency speculation from abroad.
The colón’s constant push to gain value against the dollar makes it look like a lowrisk bet for foreign investors. Couple that with recent interest rate cuts by the U.S. Federal Reserve and lots of speculators could be switching short-term dollar investments to colones – once again, pushing inflation up.
Getting the exchange rate to float on its own would help fix both of those situations – the first by eliminating the need to emit colones and the second by introducing a greater element of risk that would make the colón a less attractive investment.
That’s why most analysts think that a drop of the Central Bank’s lower limit is likely. The only questions are when and how much.
The last time the Central Bank dropped the floor of the exchange rate was Nov. 21, a Wednesday, and the colón gained 4% on the U.S. dollar overnight.
At that time, the Central Bank set the lower limit on a gentle 0.06-colón-per-day downslope, which the exchange rate has since followed exactly.
Fernando Estrada, an international analyst for local finance company Aldesa, said that a recent emergency cut in an important  U.S. interest rate by the Federal Reservemeant that perhaps the Central Bank will have to take a few months to “consolidate the situation” before doing anything with the exchange rate limits.
At the same time, Estrada said, a weakening U.S. economy might slow the flow of dollars coming into the Costa Rican economy, thereby alleviating some pressure on the exchange rate.
But a report by Citigroup economist Jorge Pastrana late last year predicted that the Central Bank would move to make the colón completely free-floating by the second half of 2008.
The report said it expects the local currency will strengthen to about 450 colones per dollar.
 

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