Central Bank Changes and the Effect on Currency Exchanges and Interest

A couple of weeks ago, the Central Bank of Costa Rica decided to stop the ages-old policy of setting a daily buy/sell rate (exchange rate) for converting dollars to colones and vice versa. This daily exchange rate was known as the tipo de cambio, and was generally a very small spread, maybe 2.5-4 colones. It changed every day, increasing a fraction of a colone and thus devaluing the currency against the dollar… daily.

The central bank had been concerned for some time, and with good reason, about dollarization, a trend toward the use of dollars instead of colones. For instance, I have often advised people to hold dollars and not colones. Not real smart to hold a constantly devaluing currency right? I also have advised people in The REAL Costa Rica to NEVER buy anything** priced in dollars as that is the equivalent af saying “please screw me”. You see this of course in all the tourist areas. The advantage (to the BUYER) is always to buy items priced in colones. Then negotiate from there.

So the Central Bank decided to eliminate this policy and instead publish a spread, MUCH wider (20-30 colones or more) than before and allow the financial institutions to set their own tipo de cambio. The Central Bank then polls those institutions to see what is the REAL exchange rate being offered and publishes that average on the web site. This was and is a pretty excellent idea but forces wise users of dollars and colones to think what may be best for them.

Here is a chart showing the ever increasing devaluation of the colone UNTIL the 17th of October. Note that on that date, the colone reversed direction and began to increase in value against the dollar. Recall that until the 17th, the central bank set the devaluation daily, but after the 17th, Costa Rica financial institutions were free to set their own exchange rate so long as it fell within central bank guidelines.

Well this is interesting stuff as it may have a profound effect on those of us who live here as well as the tourists who visit CR and bring those dollars.

Here are some of the things that people might want to consider and some oddities I have already seen and a couple of thoughts to ponder.

• If you do use US dollars to buy things here, the burden falls even harder on you to find out what exchange rate is being offered to you. This is true either when you are buying (exchanging dollars for) colones or paying a bill in a restaurant in dollars and will be receiving change. In the past week, I have been offered from 510 to 526 colones per dollar. THAT is a pretty big spread. In fact, I was given a 525 colon rate at a large restaurant just this morning. Looking at the chart above, I was offered more in change than the highest rate being offered at the banks! I chose not to use my credit card as I could make more on the exchange!
• Costa Rica has been for years one of the few locations in the world who did not screw the tourists by offering them a ridiculously low exchange rate. The San Jose airport was (and still is) the exception usually beating the poor tourists out of 15% or so. However the stores, restaurants, and many hotels gave excellent exchange rates, often as good or better than the banks. Sadly, this is changing and many hotels, expecially the higher end and boutique location now screw the tourists mercilessly apparently considering currency conversion as a handy profit center. The central bank changes will not affect this, so you tourist types, check the link above and learn how to convert currency.
• The exchange rate, while still devaluing, is doing so at a seemingly slower rate. I recently answered a question from a reader about interest rates in Costa Rica pointing out that the high 11-13% rates were not “real” as the colone was devaluing at about 12% annually. I expect these “high” colon rates will be dropping a bit to adjust for the (perhaps) lower deflation of the colon.
• Merchants who priced items in colones saw their profits (and inventory valuation) decrease daily along with the daily devaluation of the colon, so any slowing of this decline is really good news for them.

It is way too early to say what effect all this will have on those of us living here, but from the chart above, it is clear things are changing and possibly the colon is not loosing value quite so rapidly. Some math genius might make an argument that buying an 11% CD in colones might be a value depending on how goes the colone.

If the currency stabilizes, there certainly be less reason to “hold dollars”. The CD interest rate for colones may begin to fall though if devaluation is slowed. For now though, I still think it is wiser to spend colones but hold dollars.

** Exceptions are large value purchases i.e. cars, houses, rent, etc.