In an interview with Isabella Cota of Reuters on Thursday, Presidenta Laura Chinchilla said that she was ready to take more steps to prevent flows of foreign capital from driving the Costa Rica’s currency higher.
In the interview, Chinchilla said she was worried a capital controls bill sent to the Legislature could stall, reviving interest from speculative investors that have tipped the Central American nation into a battle over its currency.
Costa Rica’s Banco Central (Central Bank) has spent US$1.5 billion in six months to keep the colon from strengthening beyond ¢500 per dollar, but inflows at the end of last year prompted the government to take more drastic steps.
Business leaders are concerned that an appreciation in the currency could hurt the tourism industry and coffee exporters, who sometimes receive payments in dollars.
So the government sent the Legislature a bill proposing to raise the current 8% tax on foreign investments by up to 30 percentage points. It also would require foreign investors to make a deposit at the central bank of up to 25% of the value of any investment, without receiving any interest.
Since then, the central bank has not had to buy excess dollars, but the commission in Congress in charge of reviewing the proposal has not yet approved it.
“(The plan) has given us great peace of mind, but it’s a temporary one because we know quite well that unless the project passes it’ll be very difficult to maintain these conditions,” said Chinchilla, sitting in the living room that leads to her office at Casa Presidencial in Zapote (San José).
“If we were to see a similar flow before the project is approved by the Legislature, we would, of course, turn to other mechanisms. Investors should have no doubt about this, we are totally willing to protect our economy”, she added.
Last month the first female president of this tiny Central American country referred to the potentially destabilizing flows as “weapons of mass destruction.”
On Tuesday, Group of Seven nations issued a statement reaffirming a “longstanding commitment to market-determined exchange rates” and Chinchilla admitted feeling pressure to let the colon float freely. But she said she would stay the course.
“There are (pressures), yes,” she said. “A government should not function based on the pressures of some or others. It should try to adapt a mix of measures that fits every context and generates the appropriate steps forward.”
The Central Bank’s high benchmark interest rate, currently at 7.8%, has lured investors to bring in dollars and buy government bonds in the local currency.
Interest on deposits in dollars is around 2% due to loose monetary policy by the U.S. Federal Reserve. Late last year, interest rates in Costa Rica were as high as 12%.
Even as rates drop gradually, Ministro de Hacienda (Finance Minister) Edgar Ayales has said that it will be impossible to lower them to 45 or even 5% without a significant overhaul of fiscal policy.
Just over year before her term ends, Chinchilla is struggling to introduce a plan to tackle Costa Rica’s budget deficit of 4.4% of gross domestic product (GDP).
The previous plan was killed by the Sala Constitucional (Constitutional Court), which declared it to be unconstitutional last April.
Chinchilla, whose centrist Partio Liberación Nacional (PLN) party lacks a majority in the Legislature, has not given up, she says. She aims to send a new plan to the Legislature before her term ends in May 2014.
“We will not relent in our final efforts to see if we persuade a few congressmen to re-establish the conversation about the fiscal plan,” she said.
“The finance minister is currently undertaking a new consultation process and we will see if a new situation arises that will allow us to leave a well-ordered country in fiscal terms.”