Undoing and Avoiding Dollarization

1
Undoing and Avoiding Dollarization

• Comments by Ilan Goldfajn

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How to undo dollarization? At first glance the
answers are depressing..

• Galindo and Leiderman (GL) find that
  dollarization has been growing in spite of a
  major reduction of inflation and a shift toward
  central bank independence.
• GL say dedollarization can be very difficult and
  very costly.
• Herrera and Valdes (HV) say that the Chilean case
  is not easily implemented elsewhere.
• Caballero, Cowan and Kearns (CCK) say that
  removing external vulnerability requires trust
  that is bound to take a significant time (e.g.
  even Chile is not there yet).

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At second glance they remain depressing..

• Dedollarization does not happen by decree
  imposing forced restrictions on dollarization
  leads to off-shore deposits and financial
  intermediation declines in the economy (GL)
• Main pre-requisite Keep sound monetary and
  fiscal policies for decades (GL)
• Dedollarization is a side effect of a persistent
  and long process of disinflation and
  stabilization (GL, CCK for Australia)
• But do we have this patience (discount rates) in
  Latin America?
• Moreover, the pre-requisite (necessary condition)
  may not be sufficient. Dedollarization does not
  happen automatically. Need to develop markets.

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So, is there any lesson for a poor policy maker
that wants to do the right thing?

• The answer is plenty, if you keep reading the
  papers. My summary is the following
• Policy makers should be active in developing
  markets when international conditions permit and
  fundamentals are improving. Surf the wave, dont
  surf if there is a hurricane.
• Reversing public sector dollarization is more
  rapid than private sector dedollarization (CCK
  about Australia, GL about Israel). Check the
  costs though.
• Issue domestic currency debt to locals first (CCK
  about Australia, GL about Israel, HV about
  Chile).
• Foreigners will come later when trust is there.
  Australia 100 years of clean inflation and
  default record (CCK).

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More Lessons

• Float your currency to create incentives for
  dedollarization (HV). Avoid spurious intervention
  (CCK for the case of Chile).
• Dont be too ambitious. While increasing
  nominalization (fixed, long, in domestic
  currency) of public debt is a final goal, in the
  meantime, CPI indexing reduces external
  vulnerability (HV, AL)
• Develop foreign exchange derivatives markets
  (forwards, swaps) to redistribute currency risk
  (Australia, Israel).
• Prudential regulations should be in place to make
  sure FX risks are rightly assessed by banks.
  Systematic guidelines to banks is optimal but
  limits on mismatching and exposure are good
  initial steps.

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The Case of Brazil Public Debt
Dollar linked debt/ Total Debt
Nominal Debt/ Total Debt
42
10
set 03 9,0
9
40
8
38
7
36


6
5
34
4
32
3
30
set 03 26,5
2
28
1
26
jan 02
abr 02
jul 02
out 02
jan 03
abr 03
jul 03
jan 02
abr 02
jul 02
out 02
jan 03
abr 03
jul 03
7
The Case of Brazil External Debt
240
220
200
jun 03 US 189,0 bi
180
US bilhões
160
140
120
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
1S2003