Exchange Rate, Costa Rica Colons and Dollars From Some Years Back

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    Check out this article on the state of the Costa Rican economy some years back and keep an eye out on our next one for comparative purposes.

    The short answer to that question is—Overvalue the national currency.  That is exactly what the Central Bank of Costa Rica has been doing for more than two decades.  Throughout the years since 1984, under a system of daily mini-devaluations, the dollar exchange rate for the Costa Rica colon was gradually increased.  But in most years the domestic rate of inflation exceeded by several percentage points the devaluation rate.   In 2006 the Central Bank replaced the mini-devaluations with a system of bands in which the colon was allowed to float between lower and upper limits with the upper limit gradually increasing, in July 2010 reaching 630 colons for one dollar and July 2011 over 700 colons with a continuing floor of 500. However, beginning in October 2009 the colon gained value precipitously, the exchange rate falling from a high of 590 in October 2009 then continuously going downward to then hover near the 500 floor since June 2010.  During 2012 the ceiling continued to increment upward, but the colon consistently hovered around the 500 floor.

    An overvalued currency harms exports, subsidizes imports, exacerbates balance of payment problems, negatively affects tourism and foreign residents with dollar incomes, deters foreign productive investment, inflates real estate prices, and invites speculation in non-productive activity.  So why would the Central Bank continue policies that are harmful to the nation´s economy and exacerbate already difficult social inequality and other indicators of social well-being?

    Costa Rica has an economy highly dependent on export earnings.  If exporters try to increase their prices to compensate for a weak dollar a strong colon means less competitively priced products on international markets.  If prices cannot be increased, as is usually the case, businesses must nevertheless pay their operating costs in colons while receiving fewer in return for the dollars earned–  92% of export earnings are in dollars, but 70% of costs are in colons.  In 2011 Citing the appreciation of the colon, two of the biggest agricultural exporters, Dole and Del Monte, closed down some of their container and melon operations, laying off a considerable number of employees.  Associations of export businesses and the Tourism Chamber vigorously complain, yet the problem continues.

    With an overvalued colon imports become relatively cheaper.  This has the adverse consequence of encouraging importing of goods that compete with locally based production.  The consumer goods industry in Costa Rica is relatively well-developed, with some sectors also geared to exporting to Central America.  Historically, national production has been to some extent protected by import tariffs.  These are now largely being eliminated under the provisions of CAFTA, the Central American Free Trade Agreement with the United States implemented under the Arias Administration.  The combination of an overvalued colon and the elimination of protective tariffs could mean that some sectors of domestic industry will go under.

    While the economy began to recover in late 2009 from the internationally induced recession, Costa Rica maintains a problem with balance of payment deficits.  The combination of reduced or lower valued export earnings and increased import expenditures impels the balance of payments into further deficit.  The deficit in recent years is mitigated somewhat by the flow of short-term, speculative dollars.  But this speculative flow is the problem, not the solution. During the first Quarter of 2010 exports, lead by pineapple and bananas, grew 11% with respect to Q1, 2009. Pineapple exports continued to increase moderately during 2010 to 2011.  However, as might be expected with cheapened dollars, imports increased 24% in the same period, widening the current account deficit, a trend which continued into 2012.

    The principal foreign exchange earner in Costa Rica is tourism, an industry with income in dollars but expenditures in colons.  For visiting foreigners, Costa Rica is no longer a bargain. As word gets around in the United States and elsewhere that their dollars don´t go very far, tourism suffers.

    An overvalued currency is a deterrent to productive foreign investment, a central element in the development strategy of the Arias government and the current Chinchilla administration.  For a foreign company to establish and operate a business in Costa Rica they must exchange undervalue dollars for Overvalued colons.

    There are many thousands of foreigners resident in Costa Rica that depend upon pensions or other income in dollars.  In the years since late 2009 foreign residents have been hit hard in their pockets, a substantial decline in value of the dollars they exchange, plus suffering additionally from a 4% to 6% domestic inflation in the cost of goods and services.  The nation has programs to attract foreign retirees that will fail if their dollars won’t go very far.  So too will programs like medical tourism suffer.

    The real estate market is negatively affected by over-valuation of the colon.  Sellers almost always list their property in dollars, so there is now a higher price.  This is a problem in that many real estate sales are to foreigners.  This problem is seriously compounded by the appreciation of real estate values over the last decade.  Even during the 2008 and 2009 financial bust and international recession, when real estate most everywhere in the world was falling in price, this was not generally the case in Costa Rica.  There has been a highly inelastic price response to abundant offerings of properties of all types and falling demand. All real estate companies report a substantial decline in business since 2008.

    The drop in the value of the dollar when the same currency is appreciating against the Euro is related to an apparent influx of speculative capital and wealthy Costa Ricans changing currencies.  In the United States and Europe interest rates are very low and the economies stagnant, whereas in Costa Rica interest rates are quite high and the economy, so far at least in spite of high-interest rates and tight credit, is modestly recovering.  Why the Central Bank maintains high-interest rates while the economy needs stimulation is one more indication that something is wrong in the higher circles of power.  So dollars and Euros enter and the local moneyed elite move around their liquidity, but not necessarily into productive investments.  The interest rate on bank-issued Certificates of Deposits has fallen in 2010 to 2012 to an average of 2.5% so this is not where capital is flowing.  Both private and state banks here carry their accounts in dollars and banking assets have fallen as the devaluation is recorded as operating losses.  However, this does not mean that banks and other financial entities are not in receipt of these dollars.  Foreigners can set up an account at a Costa Rican bank and then use those funds to invest in short-term speculative activity.  Wall Street Investment banks and wealthy American plutocrats that have access to money at low interest look to countries with higher interest rates to loan out money to local banks, who in turn loan it out at high interest, or they invest in local stock markets and investment funds that bring quick returns.  Data is just not publically available to determine where the dollars are coming from and where they land– or how much money is entering and being laundered from illicit activities.   There are some Investment Funds that are returning 5% to over 8% (see  however, there is no information available on investment flows at the websites of either the Central Bank or the Superintendency of Financial Entities, or  There is no evidence of an investment boom in productive activity.   There has been a modest recovery of productive foreign investment in 2010 from the decline caused by the financial crisis and international recession.  In 2008 foreign direct investment was $1,896 million, in 2009 this fell to $1.354 million and in 2010 recovered slightly to $1.413 million and has maintained around that level into 2012.   Only manufacturing and services investment evidenced increased in 2010, mainly for medical supply products and call centers.  Tourism, banking, and real estate declined in value since 2008, while levels of foreign investment in agriculture were negative between 2008 and 2011.   So where are all these dollars going?  The Central Bank knows but appears to keep that a well-guarded secret.

    In reading what little is available on the Costa Rican exchange rate there are some innuendos that the wealthy friends of Central Bank officials and the PLN hierarchy are scheming to enrich themselves through currency or other financial speculation.  It is certainly the case that personalities in the dominant political party, the PLN, have a cozy relationship with the moneyed interests; this became very clear in the great debate over CAFTA.  However, I have found no evidence to lend these assertions any credibility.  After all, Costa Rica has indicted three former presidents for graft, so it is difficult to believe that corruption on this scale could be involved.  Rather, it is the ideological blindness of official thinking combined with control of the Central Bank by the local plutocrats, that is the problem.  Since 1984, the Presidency of the Central Bank as been occupied by only 4 notables of the financial elite class of Costa Rica—two of the Presidents, Eduardo Lizano and Rodrigo Bolaños, for lengthy tenures of repeated appointments.

    It is important to keep in mind the experience of Argentina in 2001-2003.  That country suffered a complete economic collapse due in good part to pegging the peso to the dollar so that the peso was overvalued by a wide margin.  Dollarizing meant surrendering   control over monetary and fiscal policy.  Exports collapsed, imports increased, balance of payment deficits ballooned. Then to make matters worse productive state enterprise were privatized at bargain prices to local and foreign capital.  State policies allowed a great inflow of foreign loans and speculative capital.   Argentina under the left of center Kirchner government recovered in subsequent years by devaluing the peso, defaulting on foreign debt, ending speculation, renouncing the neo-liberal policies that created the disaster and reorienting its monetary and fiscal policy toward national development.

    Greece, Portugal, and Spain are now approaching an Argentine like collapse.  The choice is to adopt extreme austerity measures or, following Iceland´s example, default on their debt.  Returning to their old currencies and leaving the euro behind will reassert national control over their economic and social policies, now being dictated by the German and French financiers, the European Central Bank, and the IMF.

    In Costa Rica, the overvaluation of the colon is a direct consequence of the policy of the Central Bank.  According to the President of the Central Bank, Rodrigo Bolaños, where the colon falls within the band is a strict function of the number of dollars as versus the number of colons in circulation.  More dollars exchanged on the Monex, the money market for the large players, and at the state and private banks, means a fall in the value of the dollar.

    I suppose such narrow criteria for establishing the exchange rate is to be expected from a Central Bank staff of Costa Rican economists with a U.S. education and business administration graduates of Harvard, Wharton or other bastion of monetary orthodoxy.  They are fully indoctrinated in the conventional wisdom of neo-liberalism.  Two of key elements of this narrow thinking are that the purpose of monetary policy is to control inflation largely with interest rate adjustments and that state guidance of the economy is contrary to the economic principles of free enterprise.

    Central Bank officials have stated that the elimination of the mini-devaluations and adopting the system of bands was to have better control of inflation, moderate the trend toward dollarization, and to avoid Central Bank injection of dollars to protect the exchange rate, causing Central Bank deficits.  Actually, the mini-devaluations worked reasonably well.  For businesses the rate was predictable and it facilitated the export development strategy adopted since the 1980s.  The rate was adjusted on the value of dollars and other traded currencies in relation to domestic inflation, although the spread between inflation and devaluation in most years meant an appreciation of the colon.  Contrary to Central Bank spurious rationales, Costa Rica´s high rates of inflation, as well as the partial dollarization of the economy, have been consequences of its export-led integration into the global economy and really not to exchange rate policies.  The current 5-6% rate of inflation, down from double-digit levels previously, is a consequence of the slow economy, certainly not an overvalued colon.

    One of the more absurd pronouncements by international business publications espousing the doctrines of monetarism and globalization is that every country should peg its exchange rate for dollars to the price of a McDonalds hamburger in the United States.  Well, today a Big Mac in Costa Rica is more expensive in dollar terms than in the  U.S.  In this wisdom, it does not matter that the cost of labor that serves up the burger in a local franchise is 1/5 the cost in the U.S., or that the cost of constructing a fast food joint is 1/5 that in the U.S., or that the cost of producing buns and meat are lower, or that commercial land to locate a franchise is cheaper.

    The McDonalds idea has more relevance if it is reversed.  An intelligent exchange rate policy would at least in part evaluate the cost of the factors of production– labor, materials, and capital–in the national economy in relation to the values in the economies of trading partners.  If these were the criteria than a $3.75 Big Mac in the United States would cost the equivalent of $.80 in colons.  This $.80 price would have the added virtue of making the Big Mac affordable for the low-waged Costa Rican servers who dish out the burger.  It would also help the deteriorating standard of living of ordinary Costa Ricans if the government development strategy would provide incentives for domestic production of food staples like rice and beans, also helping to keep farmers on the land and out of the urban slums, instead of removing tariffs on the import of foreign foodstuffs and a range of consumer goods as required by CAFTA, the Free Trade Agreement with the United States.

    Certainly controlling inflation and adjusting disequilibrium’s in the supply of currencies need be factors in monetary policy.  But the essential goals of the policies of the Central Bank should be those of development of the national economy.  This is accomplished by fiscal policies that allocate resources into chosen sectors vital to economic and social development and monetary policies that support the development goals established.  The current and past political administrations in Costa Rica, blinded by their neo-liberal ideology, have no idea how to go about this.

    Apparently, the Central Bank intends to take two measures that might be expected to at least partially contain the flow of speculative capital.  In June 2011 the Central Bank lowered interest rates by 1% to a reference rate of 5%, expecting to stimulate credit extension to businesses and stimulate consumer spending, with a possible consequence of raising the inflation rate from a projected 4% to 6%.  This might make the country less attractive to foreign speculators searching for high-interest returns.  The other policy, to take effect in August 2011, is a form of capital control, ¨encaje¨, used elsewhere in Latin America and has the grudging acquiescence of the IMF–a 15% interest free deposit in the coffers of the Central Bank will be required of all foreign investments in instruments of less than one year maturity.

    An evaluation of the Costa Rica´s economic policy by the IMF in June 2011 recommended that the Central Bank eliminate the system of exchange rate bands and adopt a policy of currency flotation.  Were the CB to eliminate the floor supporting the colon, this could have the effect of further appreciating the colon.  The IMF also stipulated that the fiscal deficit be further reduced, that inflation control must remain the main purpose of CB policy, and that the legislature act on tax reform.  These recommendations from the long-standing IMF pressures to globalize the neo-liberal policies that have been so disastrous for so many countries for decades.

    These prescriptions by the IMF to float the colon is interesting in view of the IMF analysis in April 2011 which was somewhat self-critical of inflation targeting as the core of Central Bank policy and endorsing ¨Capital Control Management Measures¨ (X) on destabilizing and volatile capital inflows causing currency appreciation and asset bubbles.  Such measures to curtail the flow of capital forcing the appreciation of national currencies have been adopted by Brazil, Iceland, Taiwan, Chile, Colombia and several other countries to good effect.

    X ¨The IMF´s Welcome Rethink of Capital Controls,¨  6 April 2011

    An undervalued national currency is better than an overvalued currency, at least in relation to export booms.  Perhaps Costa Rica should look closer at the example of China.  The United States charges that China undervalues their currency to the detriment of the U.S. economy by the flood of cheap Chinese imports.  While this is no doubt overstated—or a diversion to obfuscate the practice of closing manufacturers in the U.S. to invest in china where labor is cheap– it is true that China carefully controls its currency exchange to promote its own economic development.  Of course, this is not the main factor in China´s unparalleled success story.  China rather turned Marx on his head; socialism laid the groundwork for a transition to a raw but vital capitalism.  Not the neo-liberal global capitalism of the West, but a capitalism that utilizes the socialist tradition of strong state institutions that centrally plan the social and economic development of the nation.

    Reform of the Central Bank is a necessity for Costa Rica.  A law to effect reform is currently in the Legislature but not yet on the agenda for action.  The law would make the CB Board of Directors more open to representation by economists of diverse viewpoints and contains strictures against conflicts of interest.

    Published December 10, 2010 AT

    In June 2011 the Legislature rejected a candidate, Kathya Araya Zuñiga, that the Chinchilla administration had proposed to fill a vacancy on the Central Bank´s Board of Directors.  Reasons cited by some delegates was her lack of qualifications and experience.  The current administration and the Aris government before it are experiencing critiques of their clientele appointment practices, the sinecures in the Foreign Ministry especially have been consistently activists or friends of the ruling PLN.

    Establishing an exchange rate that makes economic sense is just a first step for national development. Costa Rica would do well to strengthen its state institutions and define development goals, not by emulating China, but by leaving aside the dogmas of monetarism and neoliberalism and replacing the Central Bank personnel with figures that look to the Nation´s strong tradition of social democracy and social justice. Costa Rica´s  South American neighbors have learned their sad lessons from 20 plus years of globalization orthodoxy and taken new, progressive directions, but Costa Rica, together with Colombia, Honduras, and Panama, just the opposite.  China´s export-led development has very substantially increased the economic situation and welfare of millions of people.  Yet it has also meant that millions of peasants are displaced to barracks in the industrial centers, work for a pittance and live in the most unjust of social conditions, while the bureaucrats and businessmen accumulate incredible wealth.  On a lesser dramatic scale than China, growing inequality and social injustice are prime features of Costa Rican society.  And this is mainly a result of the export-led development strategy, the abandonment of programs of genuine national development, such as food sovereignty, the permissive attitude toward business regulation and business activity while strong-arming labor unions, the lack of effective ameliorative programs for the increasing problems of social inequality, and now the privatization of the very state enterprises that once formed the economic basis of Costa Rica´s social democracy.   It is time for real change.

    Dale Johnson is a retired sociologist resident in Costa Rica since 2000.  He currently does consulting work in agricultural and other development projects.  Email [email protected]    and is currently publishing books on the disastrous situation in the United States.

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