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Financial Dedollarization: Policy Options

Financial Dedollarization: Policy Options. Comments Mauricio Cárdenas Washington, D.C. December 2, 2003. Three different topics. What are the effects of financial dollarization on growth and financial intermediation? Apparently not very good.

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Financial Dedollarization: Policy Options

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  1. Financial Dedollarization:Policy Options Comments Mauricio Cárdenas Washington, D.C. December 2, 2003

  2. 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.

  6. Latin America: Deposit and Loan dollarization Sources: Central bank statistical publications; and Fund staff estimates.

  7. Dollarization trends in Latin America a Notes: USD deposits/total deposits and USD loans/total loans in the domestic financial system. Data for 1999, 2001, 2002 and 2003; Source: Arteta(2003), Honohan(2003) and Bank b Superintendencies. USD debt/total public sector debt. Data for 2001 and 2002; Sou rce: c Calvo, Izquierdo and Mejia(2003) and Central Banks and Finance Ministries. Includes: Bulgaria, Czech Republic, Hungary, Israel, Korea, Malaysia, Morocco, Nigeria, Philippines, Poland, Russia, Slovak Republic, Thailand and Turkey. 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)

  8. 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) 84.6% Indexed Brazil 0.0% 0.3% 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)

  9. 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

  11. 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.

  12. What do CPI indexed bonds do? • Chang and Velasco’s 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.

  13. Yearly Growth Rates: UPAC and CPI 38% 33% CPI 28% 23% 18% UPAC 13% 8% Oct-93 Oct-94 Oct-95 Oct-96 Oct-97 Oct-98 Oct-99 Oct-73 Oct-74 Oct-75 Oct-76 Oct-77 Oct-78 Oct-79 Oct-80 Oct-81 Oct-82 Oct-83 Oct-84 Oct-85 Oct-86 Oct-87 Oct-88 Oct-89 Oct-90 Oct-91 Oct-92

  14. UPAC, UVR and CPI: Monthly percent changes 7% 6% % CPI % UPAC - UVR 5% 4% 3% 2% 1% 0% -1% Oct-98 Oct-99 Oct-00 Oct-01 Oct-82 Oct-83 Oct-84 Oct-85 Oct-86 Oct-87 Oct-88 Oct-89 Oct-90 Oct-91 Oct-92 Oct-93 Oct-94 Oct-97 Oct-72 Oct-73 Oct-74 Oct-75 Oct-76 Oct-77 Oct-78 Oct-79 Oct-80 Oct-81 Oct-95 Oct-96

  15. Mortgage BanksComposition of Liabilities 100% 80% 60% 40% 20% 0% 2000 2001 1990 1991 1992 1993 1994 1995 1996 1997 1999 1985 1986 1987 1988 1989 1998 Ag-02 Indexed Liabilities Peso liabilities Other 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

  19. 14.00% 12.00% Pension Funds (mandatory) Voluntary Pension Funds 10.00% Severance Funds 8.00% 6.00% 4.00% 2.00% 0.00% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Pension Funds Value as Percentage of GDP

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