Costa Rica to Reduce Interest Rates to Stem Currency Surge

Costa Rica will lower interest rates as part of a series of measures to reduce capital inflows that have made the country’s currency the best performing in Latin America this month.

The coupon on 10-year local bonds sold by the central bank will fall to 8.5 percent from 9 percent, Finance Minister Edgar Ayala told reporters in San Jose today. The interest rate on deposits fell to 8.9 percent today from 9.2 percent at the start of the year and will continue to decline, Ayala said. Further measures will be announced by the central bank, he said.

“Capital inflows enter Costa Rica because we have an exchange rate system where the currency is basically guaranteed to be stable,” Ayala said. “If Costa Rica pays interest rates of 10 percent, as we did in December, and rates abroad are around 2 percent, there is an enormous return that investors can take advantage of.”

President Laura Chinchilla said Jan. 15 that “speculative capital inflows are real and massive weapons of mass destruction” against the Central American economy. The central bank has bought more than $150 million this year to defend the currency and Chinchilla vowed to seek legislation as early as next week that lets the government raise deposit requirements on inflows and taxes on outflows.

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Costa Rica’s colon has gained 2.2 percent so far this year through yesterday, the most among Latin America economies tracked by Bloomberg. The currency was little changed at 497.29 per dollar today.

A stronger currency hurts exporters by making their goods more expensive abroad. The central bank lets the colon’s value fluctuate daily within a “crawling band” system that allows for movement between a fixed ceiling and floor. The band on Jan. 15 ranged from 491 colones to 502 colones, according to the central bank.

“Speculative capital inflows can go out of the country as quickly as they came in, which can lead to a lot of undesirable consequences in local capital and money markets,” said Carl Ross, managing director of investments at brokerage Oppenheimer & Co. in Atlanta, in a Jan. 16 phone interview. The proposals “may lead some investors to try to rush in before the rules change and it might lead some to leave before the rules change,” he said.

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