For many years, the value of Costa Rica´s currency, the colon, was defined in relation to the US dollar in an unusual arrangement best known as a “crawling peg.” The official exchange rate would change daily, with a steady devaluation at an overall rate of approximately 3.294 colones a month.
However, the weakness of the US dollar led the Costa Rican government to modify this system of “mini devaluations” and, as of October 16, 2006, the exchange rate is allowed to float within a currency band that is still referenced to the dollar, but with a fixed floor and a ceiling that changes at a fixed rate.
With the dollar continuing to falter, the National Coucil for the Supervision of the Financial System (Conassif) recently approved a new regulation that will provide investors and international businesses with a series of additional options to protect against unpredictable exchange rates.
The ruling, which will go into effect once it has been published in La Gaceta, the nation´s official daily, will permit financial intermediaries to offer forward contracts, FX swaps, and currency swaps.
For example, if materials are to be imported from the United States for a construction project, the instability of the exchange rate represents a financial risk as well as an impediment to accurate budget planning. A forward contract with a bank eliminates the guesswork by establishing in advance what rate will be used for the purchase of dollars on a specific future date.
FX and currency swaps, meanwhile, allow investors to swap temporary surplus funds in one currency into another for better use of liquidity. This protects against adverse fluctuations in the exchange rate, although beneficial movements are forfeited.
