Costa Rica: Costa Rica adopts new exchange rate regime, moves to free-floating currency
February 12, 2015
On 31 January, the Central Bank of Costa Rica (BCCR) announced the adoption of a managed float exchange rate regime. Under the new system, which took effect on 2 February, the value of the Costa Rican colon (CRC) is allowed to float against the U.S. dollar (USD) and the Central Bank stated that it will only intervene when the currency shows excessive fluctuations. The new system substitutes the country’s nine-year-old currency band system, which established a range of 500 CRC to 800 CRC per USD between which the Costa Rican colon could float before the Central Bank would step in to adjust its value.
The decision is intended to allow for greater flexibility in the exchange rate and to improve the effectiveness of the Central Bank’s inflation-targeting regime. According to the Central Bank, the currency had already been in a “de facto” float since December 2013, as the Bank has not intervened to adjust its value since then, making the imposed caps irrelevant. In addition, the Central Bank said that it had sufficient international reserves to take measures to limit excessive exchange rate volatility should this prove necessary going forward. Costa Rica’s international reserves incremented from USD 3.1 billion in 2006 to USD 7.2 billion in 2014.
In recent years, the colon exhibited low volatility and remained relatively close to the lower bound of the currency band. From July 2011 to February 2014, it traded at between CRC 489 and CRC 518 per USD. In mid-March of last year, the colon depreciated against the U.S. dollar, recording the weakest value in more than four years and trading at 560 CRC per USD. In July 2014, the colon appreciated slightly and has fluctuated only slightly since then.
The colon remained quite stable following the Central Bank’s announcement to switch to a managed float. On 2 February, it traded at 538 CRC per USD, which was 1.7% stronger than on the same day of the previous month. The colon depreciated slightly in the following days, reaching a value of 544 CRC per USD on 12 February, which was 0.6% weaker than the same day of the previous month and 6.8% weaker in annual terms.
Franco Uccelli, Executive Director of Emerging Markets Sovereign Research at JPMorgan, commented on the exchange rate regime change, stating:
“With the band system having exhausted its relevance in the determination of the exchange rate, we view the transition to a more market-driven FX system as positive for the country. Moreover, with ample foreign reserves, the positive impact of lower oil prices on external accounts, and the planned issuance of a new $1bn Eurobond by the government, we expect the colon (CRC) to remain broadly stable in the near term, before converging with global trends and depreciating modestly in the latter part of the year.”