* Capital inflows soar amid interest rate arbitrage
* New measures seek to limit private sector credit
* Officials fear destabilizing foreign capital exit
By Isabella Cota
SAN JOSE, Jan 31 Costa Rica will slap limits on
bank lending in a bid to prevent borrowers from exploiting an
interest rate gap that has sparked a local credit boom and drawn
an influx of potentially destabilizing foreign capital.
Over the last two years, locals and foreigners alike have
been taking advantage of differences between the rates on
dollar- and colon-denominated loans and borrowing heavily in
dollars - a repeat of lending practices that have caused havoc
in other emerging markets.
The interest rate gap was so wide that for a brief period
last year, savvy investors could take out a dollar loan at 6
percent and deposit the same funds in local currency to earn
more than 11 percent: a gain of 5 percent or more.
Central bank President Rodrigo Bolanos said on Thursday
state and commercial banks would face limits on lending in both
dollars and colons this year to curb the lending boom and reduce
the attractiveness of colon deposits.
"The measures will temper private sector credit growth and
contribute to a rebalancing of this portfolio toward the
national currency to avoid families and businesses becoming too
exposed to currency risk," the central bank said.
The gap between dollar loans and colon deposits has now
narrowed to about 1 percent. But foreign investors still see
Costa Rica's benchmark rate of 8.3 percent as attractive, given
rates near zero in developed economies, and continue to convert
dollars into colons to invest in local debt.
This puts upward pressure on the currency, which the
central bank aims to keep in a band against the U.S. dollar, and
officials fear it could lead to destabilizing outflows when the
investments mature and the trade is reversed.
Policymakers have announced higher taxes on foreign
investment to deter speculators. The latest measures aim to
limit the domestic implications of the interest rate gap.
Growth in private sector credit leapt from 5.9 percent in
2010 to 11.9 percent in 2011 and 15 percent in 2012, with dollar
loans soaring 18.7 percent last year, central bank figures show.
Eastern European countries have struggled to control
problems stemming from similarly heavy borrowing in foreign
currencies. In Hungary, for example, many households took out
loans denominated in Swiss francs because of lower rates.
But when the global crisis pushed the forint down sharply
against the franc, rising loan payments pushed families to
default on mortgages, cut private spending and strained bank
balance sheets, dragging on the country's economy.
Under the new limits to apply until Oct. 31, banks whose
credit in dollars grew by more than 20 percent in 2012 will not
be able to lend more than 30 percent of the amount loaned last
Those that registered growth in dollar loans of under 20
percent will only be able to increase credit by 6 percent and
credit growth in colons will be capped at 9 percent. But it was
not clear how the limits would be enforced.
"What really doesn't help is when the banks bring in dollars
from overseas to lend them here because it's cheaper to do that
than lend in colons," Costa Rica central bank General Manager
Felix Delgado said.
Growth in Costa Rica's economy, which is about the same size
of the U.S. state of Maine, is forecast to slow to 4 percent
this year from an expected 5.1 percent in 2012, according to new
central bank forecasts.
Bolanos said Costa Rica would keep its inflation target at 5
percent in 2013-14, with a 1 percentage point tolerance zone on
The exchange rate band will also remain. Costa Rica aims to
set a 500-per-dollar floor for the colon with a creeping
ceiling. Defending that band forced the central bank to spend
$1.5 billion buying dollars between March 2012 and Jan. 11, with
84 percent of the purchases made after September as overseas
investors piled into the interest rate carry trade.
The country emerged as an investment hotspot last year when
it returned to international debt markets with a successful
Eurobond issue, its first foray into international markets since
2004. The central bank said Costa Rica would aim to issue
another $1 billion in Eurobonds each year in 2013 and 2014.