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CR President Solis Comfortable with Colon, We're Lost in the Cloud

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First, a note of thanks to Paul (eppicat4) for helping me navigate the path through the apparently un-mapped maze enabling me to post a 'new topic' to the ARCR forum. I could find no directions for this task. 'Right click' failed me. Humbled, I.


In the past there has been unvarnished derision against one contributor that fears for the economic future here. He's got a point.


Developing economies worldwide are falling like cards leaving Costa Rica as seemingly the last man standing. Or maybe just leaning for support against the extinguished volcano still claimed 'eruptive' in Fortuna resort advertisements.


I'm reminded of Dali and the bizarre crutches he liked to use to support his hallucinations. The simile says something of my perceptions of the place.




None of us own a crystal ball - mine is cloudier than a mountain top during the rainy season.


We've all read how export and tourist industries here wish for a lower valuation for the CR colon. We residents selling dollars would be advantaged, too. The colon, an inexplicably pricey currency causes CR products to become noncompetitive on the world market. Discourages investment. No new jobs.


Yesterday, President Solis voiced his pledge that he will allow the CR Central Bank to remain 'independent' and he will not attempt to influence their currency peg. Has he found a 'bully pulpit'? So one can therefore assume that the colon will continue trading in its present tight range.


Solis' actual lack of influence regarding this pledge recalls the very nature of CR's unbacked, turn-the-printing-press-on-a-little-faster-please currency. (Yes, we can discuss the US$1 characteristics later, but it is the worlds' 'reserve currency', a different beast).


US Dollars, Euros, Swiss Francs, Swedish Kroner, Thai Baht, are very liquid and convertible currencies that trade on the world market.


The Colon does not effectively trade outside of the border of this country that's 1/3 the size of Florida with a GDP equivalent to a large American city's combined education and police budgets.


Normally, a country's anticipated economic condition going forward determine its currency value. Job growth (and its quality) is the main engine for economic growth.


Certainly, Costa Rica enjoys advantages in climate, relatively good security and a population segment of well-educated people that are striving to create a world-class location. But they are forced to take two steps forward to counter everyone back on their road to success. The govt is not supportive but a drag on production.


Costa Rica has recently lost many high-quality jobs from companies leaving the country. Por ejemplo, Intel chip-maker had the worlds' 2nd largest factory here, and computer chips for years were CR's largest export, more than bananas, coffee and pineapples. What happened? CR's electrical/power costs are about the highest in the world, even while ICE brags that they just enjoyed a period of sourcing (free-to-low-cost) 100% renewable energy. Intel cites these extreme costs as one reason they grossly shrunk their operations here.


I note that it seems businesses are charged a higher 'commercial' rate, perhaps triple (?) then the already grossly high rate for households. Air conditioning in hotel rooms or power to run machinery shouldn't be a crippling cost. Large businesses should be given price breaks to encourage expansion and job growth, not putative charges.


Costa Rica is very slow to allow business creation because of tramites. I seem to recall it takes around 150 days to open the doors of your store here, but only about two days in Singapore. Your business can't hire if it can't even get the doors open.


The unsettling tax situation while the legislators ponder the value-added scheme doesn't support job growth. Last years' attempt to charge hotels five years back taxes doesn't support job growth.


Contract law and property ownership are negative factors here for siting businesses or attracting residents because breaking a contract or squatting on illegally-obtaining title is tolerated. Should one be so unlucky to fall into this hole, be prepared to wait years and years for the courts to even hear the case. And any judgement is liable to endless appeal. How can one consider opening a business here?


The govt needs to borrow 46% of next years budget, not the highest % for a country, but reflective of the lack of will to cut fat pensions and duplicated govt workers. Humans everywhere seem to suffer this debilitating malady, though.


The conditions I've noted of falling employment, monopoly pricing of electricity, unbridled bureaucracy, uncertain contract law, coupled with high national debt do not support a strong currency.


So one could look around and wonder if the housing and commercial construction sectors are pulling the country ahead? I'll not share my opinion on how some/many of these projects are 'funded'. Please note that published govt statistics show a decline in all types of construction during the last 'trimester' across all provinces of the country.


Is there a condo bubble? One developer is offering to finance your down-payment without interest for 18 months for his 'preventa' project.




Right. He has not broken ground, may not even have los permisos in hand, but will happily pocket your monthly funds while you accumulate your 20% down payment. Once complete, you better have your 'hipoteca' in hand from a bank to close the deal.


The developer's sales pitch? "You will enjoy locking in the (lowest) sales price now while your property value increases". As every ad states in our free bienes raices magazine, "Real estate is your best investment" (see 'US HOUSING BUBBLE OF 2008-9').




As an example of how job growth influences a nations economy and therefore its currency, today the US released job data for September which revealed a slowing rate of job growth.


One of the US Fed's two mandates is to control inflation, and the target is to stay under 2%. Rising wages from job growth that leads to competition among employers to pay more to higher qualified workers is one of the most powerful forces to cause inflation. Less jobs, like today's data revealed, mean lower wages and low inflation going forward.


The announcement of slowing job growth in the US set off a worldwide chain reaction.


One nano-second after the release of today's job data the worlds ever-alert financial computer algorithms spit out buy/sell orders and caused the US Dollar to trade lower because low inflation will force the Fed to wait to raise the Fed funds rate, a persistent 'fear' for some time. Had there been more jobs created, the dollar would have strengthened with an assumed higher Fed funds rate to come. Stronger currencies are indicative of a disciplined Central Bank trying to keep growth and inflation under control.


Bottom line, while any country's Central Bank can briefly 'support its currency' (making it stronger by buying it up with dollars on the open market creating a 'shortage') or deflate its' own currency by selling it for (usually) dollars, outside forces also move it, and rarely if ever can any country long afford to overwhelm 'international opinion' when going against the financial resources of the entire world.


Uniquely, the colon is lightly-to-not traded on the open world market, so the CR Central Bank marches to its own drummer. Interestingly, nothing happening outside these borders matters to affect its value. Russians meeting with Iraqi officials to share intelligence and expand the war? Hohum. Coffee prices collapsing? Pura Vida.


One could use the words 'artificially' or 'by fiat' when describing how the colon's value is derived. Interestingly, while Scotiabank pays more or less for dollars than the BNCR, there is no 'black market' to change dollars here like exists in many other countries.


I once sat down in a puro-campo cantina with the VP of the CR Central Bank and over a Rubia asked him why CR didn't just follow Ecuador, Panama and other countries and dump the colon for the US$1.




I understand how job growth supports an economy and influences currencies. Strong currencies allow for low inflation environments, weak currencies help exporters, make imports expensive. But I'm sitting on top of that cloudy mountain with the rest of you trying to part the vapors to see what direction this train we're riding is taking us.


It would seem likely to become an increasingly bumpy ride.




I've attached a supporting opinion piece of comparative economics that will further inform the discussion. "Seeking Alpha" is a worthy addition to your daily reading regimen.





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To me, the point of any country's financial situation is to learn to live with it. Unless you are a citizen of Costa Rica, you are not in a position to change anything, really.


So I would say -- whatever your beliefs are about the current financial conditions in the country, adjust your budget accordingly, be very careful when buying property or opening a business (as we have said thousands of time here), have a "what if..." plan so you are not gobsmacked by a financial downturn.


As foreigners, we can all sit around bemoaning the government policies of Costa Rica -- or just get on with life. Maybe for some people, it is interesting to research and know all the ins and outs of economic conditions, but I, for one, would rather watch the birds eating the bananas at my bird feeder.

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OK, I couldn't read all of that. It was just too all over the place for me. However, I would just like to make one factual observation with respect to the value of the Colón. Virtually all of the central bank's interventions have been to prop up the value of the dollar, not the Colón. Without intervention the tipo de cambio would be lower than it is now, not higher. There are many structural reasons for the Colón being too strong, but the central bank's policies are not one of them. Here is a link to an article from last week's La Nación about this issue: http://www.nacion.com/economia/banco-central/Central-programa-reservas-atajar-dolar_0_1514048604.html. (I know that La Nación is now a pay portal, but everyone is suppossed to get 12 free articles a month.)

Edited by induna
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"I would just like to make one factual observation with respect to the value of the Colón. Virtually all of the central bank's interventions have been to prop up the value of the dollar, not the Colón. Without intervention the tipo de cambio would be lower than it is now, not higher."


Induna was kind enough to provide a link (see his contribution) to an article in La Nacion that included a chart of the recent currency interventions by the CR Central bank. I had not seen this and it was the opposite of what I would have expected. All actions were to to apparently to buy dollars by selling the colon thus weakening the colon. Astounding.


I set out the case yesterday that the govt seems anti-business and borrows 46% of the budget. I mentioned other factors that collectively are the kind that hinder growth, which we are seeing, and thus it could be expected that the colon would weaken.


Why does this matter to you, or even Eleanor the Second?


Do you spend any money here?


If one believes the colon will remain stable and inflation low, one might drop a large chunk of their investment money into a 8% interest paying colon-denominated CD.


If one believes the colon is due for a correction, one would temporarily limit the amount of US$1 they change or postpone a major purchase in anticipation of a better rate later.


Like keeping up with FATCA and FUBAR and changing regulations for your house-helps bi-annual salary adjustment and Caja payments, none of this has to do with 'bemoaning' anything and everything to do with keeping wary of what might jump out of the bushes and bite you. Happily, most info of this nature could be gained from a laptop propped up next to the bird feeder. :>)


Back to the colon (named after Christopher Columbus) and of most interest to me was induna's comment, "There are many structural reasons for the Colón being too strong, but the central bank's policies are not one of them."


Again that's contrary to my understanding but one reason is that according to this April article in Bloomberg, the drop in oil prices are saving Costa Ricans about $1 billion/yr.





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OK, I guess I'm in a pedantic mood today so I'm going to try to provide a little context to help understand why the Colón is valued as it is against the Dollar, and why the central bank of Costa Rica (BCCR) has the policies it does. It is not my purpose or intent to make any value judgements nor to further an ideological agenda. I merely want to try to communicate the facts, as I understand them, as concisely as I can.


Recent History


Not long before the most recent financial crisis in the US, Costa Rica switched from a system of mini-devaluations in which the Colón was devalued with respect to the Dollar everyday, to a system of Bandas Cambiarias (Exchange Bands) in which the Colón was allowed to float between a pre-set lower and upper limit. The lower limit was 500 and the upper limit increased slightly everyday. (Note that the BCCR uses the rate on MONEX to determine the value of the Colón.) I believe the exchange rate nearly reached 600 before the crisis hit.


From 2008 until January-Februrary 2014, the exhange rate was pegged at the lower band of 500, and the BCCR was forced to make frequent interventions by buying large amounts of Dollars, thus reducing the supply of the Dollars in the CR economy and increasing their price. If the bank had not intervened, it is quite possible that the Dollar would have sunk to 400, or even lower, which would have been disastrous for the export sector of CR. The primary reason for the weakness of the Dollar in CR was because the US Federal Reserve maintained a policy of aggressively devaluing the Dollar and basically giving money free to US banks. This kept interest rates in the US very low making Dollars cheap for everybody and making foreign currencies offering higher interest rate, like the Colón more and more attractive. The combination of low interest rates in dollars and high interest rates colones encouraged a significant influx of dollars into the CR economy from two major sources: 1. foreign investors attracted to higher interest rates, and 2. Ticos borrowing money in dollars to buy homes and cars since the interest was much lower and the Colón so stable at 500. The BCCR took several steps to reduce the potentially destabilizing influx of dollars through these channels, by both placing an absolute limit on the amount of money banks were allowed to loan in dollars to people whose income was in colones, and by implementing a tax on short-term, non-resident capital investments.


During the same period the CR government was facing ever increasing deficits. If these deficits were financed by CR banks, it would inevitably lead to a drastic increase in interest rates as the central government began to compete with private business and individuals for colones to borrow. Tis would force the BCCR to print more money, leading to high inflation, etc., ad nauseum. So, under the Chincilla administration the general assembly passed a law allowing the government to issue $1 billion in bonds each year for four years to finance the debt. Although these bonds were called 'eurobonos', they were in fact issued and paid dollars.


The Eurobonos worked very well (2015 is the last year for them). Inflation has been kept relatively low - less than 5% for three years and this year probably less than 2% - and interest rates in colones have been stable and reasonable. However, the downside of the bonds is that they significantly increased the supply of dollars in the CR, putting further negative pressure on the exchange rate and strengthening the Colón.


2014 to Today


In early 2014 there was a sudden, unexpected change in the exchange rate of about 15% with the Dollar reaching over 570 colones for a brief period. This effectively ended system of Exchange Bands, as the BCCR decided that it need to intervene to contain wild fluctuations in the exchange rate. So CR entered a de facto, and now de jure, system of Administered Floatation in which the Colón has no fixed upper or lower limit, but the BCCR will intervene to damp short-term fluctuations in the exchange rate while allowing the Colón to find its 'natural' level against the Dollar in the medium and long term. Since about April of 2014, the BCCR has been very successful in achieving its goals. The exchange rate has been steady at around 540. It is important to note, however, that the same forces that made the the Colón so strong in 2008 are still in play. The BCCR has had to intervene several times since 2014 to keep the exchange rate from dropping. There is an excess of dollars in the CR economy because the FED is still giving away free money, the local deficit is still being financed in dollars, and the Dollar is still a very attractive currency to borrow for individuals and businesses.


Virtually every economist, banker, and politician in CR understands that the Colón is both too strong to be healthy for the export sector, and that, barring another economic catastrophe in the US, the value of the Dollar must and should increase. However, a rapid and substantial increase in the value of the Dollar would have some very bad effects. The major reason for this is that are a large number of individuals and businesses which have outstanding loans in dollars but whose incomes are exclusively in colones. If the Dollar becomes 10% more valuable, their loans become 10% more expensive. The potential consequences are obvious. So the BCCR is playing a waiting game. They are trying to control the amount of debt held in dollars while waiting for the FED to finally raise interest rates, putting what they hope will be a gradual upward pressure on the exchange rate that will allow the Colón to be slowly devalued while not driving those who have loans in dollars into bankruptcy.


The Future


It is probably inevitable that the exchange will rise in the medium to long term. It should. The question is how much, how fast, and with what consequences. The major problem is the increasing amount of public debt and how to finance it. This is the last time the government has authorized itself to issue bonds. If they have to turn to local financial system to finance the debt in 2016 it will almost certainly raise interest rates in colones significantly and probably make the Colón weaker. It will also almost certainly be inflationary as the BCCR has to increase the money supply. The government has already approached China about assuming some of its debt at favorable rates. What the FED will do, and what and how drastic an effect it will have, are unknown. It is the sleeping tiger.


That's how I understand the current situation. The Colón is where it is due to many structural factors both internal and external to the CR economy. It is not being propped up, quite the opposite. The government and financial sectors do not want a strong Colón since it puts CR at a competitive disadvantage. President Solis' current statements on the exchange rate were made in the context of a debate brought up recently by the general assembly over whether or not the BCCR should actively intervene to significantly devalue the Colón. The have decided not to do that.


Factual corrections and additions are always welcome.

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induna has presented an clear, solid and factual academic description of the past, present and future state of the colon currency exchange v the US$1. I hope that readers will make the effort to gain from his insights and honor his contribution by reviewing this fine work.


This type of exchange is why I read the ARCR Forum. Together, our joint experiences and knowledge can help us make our lives here better.


In the interim since I posted yesterday, I wondered if there were formulas/calculations that could be made to attempt to forecast currency velocity changes and their direction by inputting directional movements of a country's economic variables. Nope, not on my abacus, there are too many unknown variables. But I did find this excellent site which really opened my eyes about this country, and I site I will now reference monthly.




induna has done well trying to predict the future, apparently his crystal ball isn't suffering the cataracts mine seems to have.


The initial take away from the data revealed at the above link, and I went down the list one economic stat after another while comparing the data with countries of comparable developing nation populations, suggests that whatever forces are presently levitating the colon are having their heads twisted back by the headwinds. Nearly every economic data point points to a weak and getting weaker colon.


- Unemployment is expected to rise from around 9% to 10.5% by the end of the year.

- CR has its lowest growth rate since 2009.

- CR's competitive business ranking v the worlds country's has fallen since 2008.

- CR'S 'corruption index' v other country's has risen for years and is now at its all-time high.

- External debt (as noted by induna) is at its highest % of GDP.


The most crucial support of a strong currency is to have a positive 'balance of payments' and YOY (year over year) exports are down -22.2%, imports are down -10.8%, making for an August, 2015 balance of payment deficit of -$538 million/yr compared to a historic average of -$243 million/yr, even with the drop in the price of oil.


Should the US Fed raise interest rates, even +0.25% would represent a serious challenge to CR's weakening economy. One can wonder now if some tipping point would be reached.


Most alarming was that Costa Rica in August- though having a +2.90% YOY 'food inflation' rate- has a negative growth rate of -0.74%!!!


Costa Rica has a deflationary environment at the moment.


This is alarming should it continue. Deflation feeds on itself and is the most difficult economic cycle to break.


Public consumption behavior in an deflationary environment means "I'll wait to buy it tomorrow when it is less expensive." The economy shrinks. This is evident already from the slowing purchase of imported goods reflected in the index (see link).


For the purpose of this thread, consider that if people slow purchases, sales tax revenues to the govt shrink. The govt already can't pay their bills.


Will this lead to forced govt budget frugality? Will the govt cut pensions? Shrink the bureaucratic workforce? Cut services like the police?


On this bucolic Sunday afternoon I'll leave everyone to ponder the result of these possibilities.



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Marsrox and induna,


Thank you both for this thoughtful, very interesting discussion. I, too, see very hard times ahead for CR, and I wish it weren't so. President Solís, if I recall correctly, has tried and tried to reduce public sector pensions, especially those that, by almost any measure, are excessive, and I recall that he was unable to do so due to push-back from the Asamblea and some of the unions. I don't think that there is any option open to him at this point.


If CR has to look to world markets for help, the imposition of austerity, which will constrict the national economy and cause terrible hardship, possibly for a generation, will be the result. I don't think it will work out well in Greece, and the same goes for CR. Perhaps China will step in, but how much of CR's natural resources will be handed over as a result, will only be known when China comes to collect its debt. I don't think the Chinese do much of anything out of altruism. Not good times, and I'm now thoroughly depressed.

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