Costa Rica lowers reserve requirements on domestic currency

The Central Bank of Costa Rica is set to lower reserve requirements in an effort to boost credit growth and promote de-dollarisation.

The monetary board agreed to reduce the requirement rate by three percentage points to 12% on the deposits that banks must maintain at the central bank. The adjustment will take effect on June 16.

The central bank has not adjusted the reserve requirement since 2005, and has not reduced it since 2002. The move also follows two interest rate cuts in March and May this year, totalling 50 basis points.

The measure, however, only applies to deposits held in the domestic currency, the colon. As a result, the central bank hopes to promote financial de-dollarisation by reducing the cost of financial intermediation in domestic, but not in foreign, currency.

The recent monetary easing measures represent a change in the central bank’s monetary policy stance, which had been hawkish from January 2016 up until its latest rate increase in November.

By reducing the reserve requirements, the central bank said it hopes to stimulate credit conditions at a time when economic activity has slowed and unemployment remains high. It estimates the decision will release 381 billion colones (nearly $650 million), according to local news outlet Q Costa Rica News.

In March, Costa Rica’s year-on-year GDP growth was 1.8%, down from 3% from the same period last year. 

Core inflation edged up in April to 2.4%, 0.2 percentage points higher than the first-quarter average. The central bank’s target inflation rate is a band of 2–4%.

De-dollarisation

Costa Rica has one of the highest levels of credit dollarisation in Latin America, the International Monetary Fund says in a March report. In December, foreign currency made up roughly 40% of credit and slightly more in deposits, and the portion of banks’ liabilities in foreign currency was roughly 10%.

The fund staff warned that a large external shock could generate liquidity and solvency risks for the Cost Rican financial system.

The IMF staff recommended the introduction of different reserve requirements in domestic and foreign currency, to help reduce the risks.

They also suggested imposing additional capital requirements contingent on the expansion of credit to unhedged borrowers, as about two-thirds of foreign currency credit to businesses goes to these borrowers.