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Exchange Rate Jumpy; Colón’s Future Unclear

May 14, 2010

Fluctuations in the Costa Rican colón’s exchange rate vis-à-vis the U.S. dollar appear to have neither rhyme nor reason. After hitting its highest value in two years Tuesday, May 4 when ¢503 would buy a dollar, the colón experienced three consecutive days of dramatic drops, finishing the week with a value of ¢532 on the dollar.

Last week’s fluctuations sharply contradicted the prevailing exchange rate trends over the first four months of the year. Since Jan.1, the colón has steadily appreciated, driving the exchange rate from a buy value of ¢558 at the beginning of the year to ¢503 last Tuesday.

In recent months, financial analysts and economists have attempted to make sense of the colón’s sustained appreciation, floating theories about reduced imports, a slow recovery from the global economic recession and an increased demand in Costa Rica for the colón.

But the unforeseen jumps last week defy these explanations. While theories about the colón’s appreciation abound, few reasons were given for the abrupt decline in the currency’s value. Murmurs circulated about possible political manipulation during the final days of the Arias administration, while others contended that insiders were playing the national currency market and turning large profits by swapping currencies before the exchange rate spikes or falls. Few analysts, however, have given credence to these rumors.

“We haven’t seen any evidence of manipulation of the market,” said Jorge Baltodano, manager of investment strategy at Aldesa, a Costa Rican economic analysis firm. “The market is quite transparent. It’s a small market and it’s not a perfect one. (But) even in the U.S. there is no such thing as a perfect market, as was seen by the trading error last Thursday that brought the Dow Jones down. However, as far as manipulation, we haven’t seen any.” On Thursday, May 6, a sharp drop in U.S. markets was attributed in part to a glitch in an electronic trading program.

On Monday, the exchange again finished the day at a ¢532 buy value rate, which was taken as a sign that fluctuations had stabilized over the weekend. However, when the National Currency Exchange (MONEX) closed on Wednesday, the colón had once appreciated to a ¢514 buy value again.

Where the colón will go next is anyone’s guess. History seems to indicate that the colón will lose value versus the dollar as the year goes on. In the last decade, the only year in which the colón appreciated was 2007, when it gained ¢20 on the dollar. The average annual depreciation rate since 2000 has been ¢27, with the exception of 2009, when it depreciated only ¢8. This year’s exchange rate trends have defied that history; to date, the colón has appreciated ¢33.

Some attribute last week’s exchange rate jumps to international market factors. The debt crisis in Greece has sent the Euro’s value spiraling downward over the past weeks. As of Tuesday, 1 was worth $1.27, and has shown an almost daily depreciation against the U.S. dollar. On Dec. 3, 2009, the Euro was worth $1.51.

“There has been continual movement in the international market, especially in Europe with the financial troubles of Greece and the depreciation of the Euro,” said Oscar Ugalde, economics professor at the National University (UNA) and the Latin American University of Science and Technology (ULACIT). “As the Euro depreciates, there is more interest in investing in the U.S. dollar. As demand for U.S. dollars grows, the Costa Rican exchange rate will continue to be affected.”

Not all analysts agree that the Euro’s depreciation is connected to the colón’s decline. However, as the Euro falls against the U.S. dollar and causes the dollar to strengthen against other currencies, in theory, the dollar should gain value against the colón as well.

“There are fluctuations within all exchange rate markets, and many, such as the Euro, are experiencing more significant movement in the exchange rate than Costa Rica,” Francisco de Paula Gutiérrez, former president of Costa Rica’s Central Bank told The Tico Times last week. “We cannot forecast what the exchange rate will be or when it will change. People are complaining about the volatile exchange rate and that the Central Bank is manipulating it. But the reality is other countries have currencies that are much more volatile than ours.”

While the exchange rate has been a hot topic for the Costa Rican business community in 2010, last week’s wild movements will only result in greater efforts to solve the riddle of the country’s exchange rate. However, this may prove impossible.

“Welcome to the era of volatility,” Baltodano said. “People have to get used to it. It’s a matter of market forces. We are in a country where the dollar and colon are both legal tender and people have the right to invest in any money they decide to at any time.”

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