The international Monetary Fund supports a decision by Costa Rica to let the colon float in a limited way.

Representatives of the fund, after a two-week visit here also supported the central government’s takeover of a $2.8 billion debt run up by the Central Bank in defending the colon exchange rate.

“Supported by prudent fiscal policy, these steps should help entrench the gradual decline of inflation to the low single digits envisaged by the authorities,” said the fund in a report released last week.

Now the colon is devalued daily, and although the amount varies in practice, the devaluation totaled 8.4 percent in 2005.

The Banco Central de Costa Rica proposes a daily range for the colon. At first the range will be limited, but some observers believe the colon eventualy will be let loose to face market forces.

The Banco Central ran up the $2.8 billion debt keeping the colon rate in check. The central bank was, in effect, subsidizing the exchange rate maintained by the state banks. The is a proposed law in the legislative hopper for the central government to assume the $2.8 million debt of the Banco Central. The central government will issue bonds to cover the debt, which is something the central bank cannot do.

The head of the fund’s mission that visited here was Dominique Desruelle, division chief in the Western Hemisphere Department. The mission also backed new taxes.

“Looking ahead, Costa Rica’s main challenge is to increase economic growth in a sustainable and balanced way,” said Desruelle in a statement. “Higher economic growth, combined with a significant reduction in inflation, would improve the living standards of all citizens and reduce poverty. The mission agreed with the authorities that a multi-pronged approach was necessary to accomplish these goals.

“At the center of this strategy is the initiative to pass a comprehensive fiscal reform, with a focus on the income tax and the value-added tax. The mission recommended a package of sufficient size to ensure medium-term fiscal sustainability, provide resources for the recapitalization of the central bank, and allow for an increase in spending on infrastructure, education, and other social needs.

“The mission agreed with the authorities’ proposal to develop a multiyear budget framework, which would allow the government to present to the public a clear medium-term economic and fiscal strategy and, hence, enhance budget transparency. The mission concurred with the authorities that an increase in the level of infrastructure investments is needed, as long as efficient and transparent mechanisms are used and these investments do not increase fiscal risks.”

While inflation in the country has remained in the double digits, Costa Rica’s “near-term” economic outlook remains favorable, the fund reported.  For 2006, the country’s gross domestic product is expected to increase by 6.5 percent, while inflation is likely to remain at 12 percent, it said.

The fund said, however, that Costa Rica’s economic outlook is not “without risks as a cooling of the U.S. economy or a further increase in oil prices could adversely” affect economic activity.

Costa Rica’s main challenge, said the IMF, is to increase economic growth in a “sustainable and balanced way,” adding that higher economic growth, combined with a significant reduction in inflation, “would improve the living standards of all citizens and reduce poverty.”

The fund statement said it strongly supported the Costa Rican government’s commitment to seek ratification and implementation of a U.S. free-trade pact with Central America and the Dominican Republic.  The United States, Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, and Nicaragua signed the treaty in August 2004.  The legislatures of all those countries except Costa Rica have ratified the agreement