Financial Dedollarization: Policy Options

1
Financial DedollarizationPolicy Options
Comments Mauricio Cárdenas Washington, D.C.
December 2, 2003
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Three different topics

• What are the effects of financial dollarization
  on growth and financial intermediation?
  Apparently not very good.
• Should financially dollarized economies try
  de-dollarize? And if so, how?
• This is the common topic in Chang and Velasco
  (CV), Ize and Powell (IP), and de la Torre and
  Schmukler (DS). All framed in GE settings.
• Why financial dollarization is low in some
  countries? e.g., Colombia. Lessons for
  de-dollarizers.

3
de la Torre and Schmukler

• Explore the joint determinants of duration,
  currency, and jurisdiction.
• Dollarization as a symptom. Rational responses
  (coping mechanisms) to systemic risks (i.e.,
  macro price risk, probability and loss of
  default, dilution risk, confiscation risk).
• Equilibrium settles in favor of contracts that
  hedge price risk, even at the cost of exposure to
  default risk. Dominance of dollar over
  short-duration peso contracts.
• Dissuasive prudential regulation may have
  unpleasant effects.
• Focus on fundamental institutions rather than
  exchange rate regime.
• Attacking the symptoms and not the causes can
  backfire.

4
de la Torre and Schmukler

• Dedollarization exacerbates other risks.
• Need for a 3-pronged approach ER flexibility and
  IT, prudential policies, and CPI indexed
  contracts.
• But not that simple
• Dollarization leads to fear of floating
• Higher capital requirements for dollar loans can
  increase short term loans
• Real interest rate volatility may hinder
  CPI-indexed contracts.

5
Ize and Powell

• Policy endogeneity Fear of floating causes (and
  is exacerbated by) dollarization.
• Four types (causes?) of dollarization
• Hedge inflation and ER volatility.
• Inefficient peso intermediation.
• Lower default for dollar earning debtors.
• Dollar deposit insurance (moral hazard).
• Optimal prudential responses
• Hedge inflation and ER volatility. Not useful.
• Inefficient peso intermediation. Lower
  regulations on peso intermediation and develop
  public securities in pesos.
• Lower default for dollar earning debtors. Not
  clear that the intervention to solve coordination
  failures should take this form.
• Dollar deposit insurance (moral hazard). Raise
  capital requirements for dollar loans or
  risk-adjusted deposit insurance premia.

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Latin America Deposit and Loan dollarization
Sources Central bank statistical publications
and Fund staff estimates.
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Dollarization trends in Latin America

Deposits
Loans
Public debt
a
a
b
Country

dollarization

dollarization

dollarization

ARGENTINA

14

20

96

BOLIVIA

92

96

95

BRAZIL

0

0

49

CHILE

15

14

45

COLOMBIA

1

5

59

COSTA
RICA

46

55

53

GUATEMALA

10

25

88

HONDURAS

34

26

95

MEXICO

10

32

42

NICARAGUA

71

84

98

PARAGUAY

64

57

NA

PERU

74

79

92

URUGUAY

85

61

96

VENEZUELA

0

1

67

Average LAC

37

40

75

c
Average other emerging

22

19

39

Source Galindo and Leiderman (2003)

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CPI-Indexation as a Substitute of Dollarization?
Share of Inf-Indexed Deposits
Share of Inf-Indexed Loans
Share of Inf-Indexed Public Internal Debt
Bolivia
0.5
0.1
9.0
8.7 (to Prices)
Brazil
0.0
0.3
84.6 Indexed
Chile
27.3
58.0
73.1
Colombia
0.3
21.2
46.0
Costa Rica
0.0
0.0
20.0
Mexico
0.3
9.3
8.2
Paraguay
0.0
0.0
0.0
Peru
0.0
0.0
0.6
Uruguay
NA
NA
33.9
Venezuela
0.0
0.0
0.0
Source Galindo and Leiderman (2003)
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Colombia Foreign currency deposits ( of total
deposits).
Source Banco de la República
10
Colombia Foreign currency loans ( of total
loans).
Source Banco de la República
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Drivers of low dollarization in Colombia

• Real deposit rates (peso) have been positive.
• Foreign currency loans are prohibited.
• Ban on foreign currency deposits.
• No deposit insurance on foreign currency
  deposits.
• 20 (of capital) limit on banks (long) FX
  position.
• Large domestic public debt.
• Pension funds limits to foreign currency
  denominated securities.
• Role of CPI-indexed instruments.

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What do CPI indexed bonds do?

• Chang and Velascos model captures mutual
  relationships between portfolios, shocks and
  policies
• Under IT, the CPI indexed bonds play no role.
• Fixed ER regime becomes more attractive.
• Ize and Powell CPI indexed bonds are the
  appropriate response when dollarization stems
  from market imperfections.
• de la Torre and Schmukler indexed bonds soften
  the trade-off between price risk and default risk.

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Yearly Growth Rates UPAC and CPI
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UPAC, UVR and CPI Monthly percent changes
15
Mortgage BanksComposition of Liabilities
16
Inflation-indexed loans ( of total loans)
Source Banco de la República
17
Nearly half of the public debt is domestic
Source Ministry of Finance
18
Domestic debt composition
Source Ministry of Finance
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Pension Funds Value as Percentage of GDP