SAN JOSE, March 1 (Reuters) - Costa Rica should let its currency move more freely, set an inflation target and take more steps to rein in its public finances, the International Monetary Fund said on Friday.
After a regular health-check of Costa Rica's economy, the IMF said further fiscal reforms were needed to reduce the country's debt and deficit, which is almost 5 percent of gross domestic product, although it was moving in the right direction.
Benchmark interest rates of 7.35 percent are attracting record foreign investment into the small Central American nation, leading authorities to slap on taxes and impose other measures in a bid to slow inflows.
The central bank spent $1.5 billion in six months to keep the country's currency, the colon, from strengthening beyond 500 per dollar, but the IMF said such measures were not a long-term solution.
"Directors noted the authorities' concern about exchange-rate flexibility, but generally recommended increasing exchange-rate flexibility as it would allow greater use of exchange rate as a shock absorber," the IMF report said.
"Directors also saw merit in establishing an inflation target as the anchor of monetary policy to protect macroeconomic stability."
Exporters have warned that letting the colon trade outside its current strict band would lead to excessive appreciation and hurt exports.
Unlike most other central banks, the Banco Central de Costa Rica does not set the benchmark interest rate, which instead is an average of rates offered by major financial institutions.
The government plans fiscal reform that seeks to scrap the country's sales tax and replace it with a higher-rate value-added tax, in an attempt to trim the country's fiscal deficit to a 2 percent target by 2018.