Central Bank Prez Pleased With Money System

July 18, 2008

With the Central Bank’s reserves shedding $675 million – 16 percent of its current $4.26 billion – in less than three months, many observers are wondering where the institution’s monetary policy is headed.

The federal institution used a good chunk of its reserves, close to $600 million, in May and the first two weeks of June to support a weakening colón, according to Central Bank President Francisco de Paula Gutiérrez.

On May 22, the colón traded against the dollar for ¢524.64 on MONEX, the domestic money market.

The colón rebounded in June, prying itself from the bottom limit of the exchange rate and floating freely without the Central Bank’s intervention.

But it took a downturn this week, hitting a new all-time low against the U.S. dollar Tuesday, selling for as much as ¢555.

That night, the bank’s board of directors cut the exchange’s upper and lower limits, with the floor moving from ¢488.73 to ¢500 and the roof falling from ¢572.49 to ¢555.37.

That upper limit will rise each working day by ¢0.06.

So far, Central Bank figures for July indicate reserves have fallen by about $75 million since June.

Despite the turmoil, Gutiérrez seemed at ease as he discussed the bank’s reserves and approach to monetary policy:

TT: The Central Bank recently sold roughly $600 million to prop up the colón. Is the bank still intervening in the money market?

FG: The episode in May where there was an increased demand for dollars opened a nice opportunity for us to begin to act on liquidity in the economy … because for the first time in the system of exchange rates (upper and lower limits), we had a significant difference between the floor and the exchange rate on MONEX.

The Central Bank had two options: either increase interest rates or decrease our reserves and take colones out of the market.

We started to decrease reserves, lessening part of the abrupt volatility in the exchange market. We withdrew colones … and we were in a better position to act on interest rates with less of an impact on the money market. (Since then, the bank has increased several interest rate benchmarks.)

The bank has said that it reserves the right to intervene when it considers it necessary. … The bank does not try with its exchange policy to modify the tendencies of the exchange rate … nor does it want there to be big episodes of volatility, because that creates a lot of noise in the system.

How does a drop in federal reserves affect foreign trade?

It shouldn’t have much of an effect. What will be important for foreign trade is in which direction the exchange rate moves. A high exchange rate for colones could make exports a little more attractive and imports eventually a little less attractive.

We have achieved flexibility in the exchange rate. The community – the entire country – has to begin to … get used to having flexibility in the exchange rate.

Some critics say the Central Bank should switch from its current system to one that allows the colón to float freely. What do you think?

If what they’re saying is that the bank should not intervene in the market, I think we’re never going to see that. In my vision, that is not where we’re aspiring to go. We plan to move toward a controlled floating system.

Other critics say Costa Rica should peg its currency to the dollar. What’s your response?

I think people say we should switch to the dollar for two reasons. One reason is that people don’t have confidence in the Central Bank. The other is that, with Costa Rica’s economy so linked to that of the United States, the country’s ability to have an independent monetary policy is very low.

I think that to arrive there, we have to have the entire economy in order. If we don’t have the economy in order, I prefer then to have the exchange rate as an additional tool to make adjustments (to the economy).

Is there a bottom line beyond which the federal reserves should not fall?

The question is what would be an adequate level of reserves. Traditionally, the amount is determined by the level of a country’s imports. It is also measured by cash flow in and out of the Central Bank. By those measures, we have more than enough.

Do you see Costa Rica heading down the same path as Mexico, Argentina, and Brazil, whose plummeting currencies sparked economic turmoil?

I’m not seeing that at this time

 

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