1

Financial Dedollarization:Policy Options

Comments

Mauricio Cárdenas

Washington, D.C. December 2, 2003

2

Three different topics

1. What are the effects of financial dollarization on growth and financial intermediation? Apparently not very good.

2. 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.

3. Why financial dollarization is low in some countries? e.g., Colombia. Lessons for de-dollarizers.

3

de la Torre and Schmukler

1. Explore the joint determinants of duration, currency, and jurisdiction.

2. 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).

3. 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.

4. Dissuasive prudential regulation may have unpleasant effects.

5. Focus on fundamental institutions rather than exchange rate regime.

6. Attacking the symptoms and not the causes can backfire.

4

de la Torre and Schmukler

1. Dedollarization exacerbates other risks.

2. Need for a 3-pronged approach: ER flexibility and IT, prudential policies, and CPI indexed contracts.

3. 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.

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Ize and Powell

1. Policy endogeneity: Fear of floating causes (and is exacerbated by) dollarization.

2. Four types (causes?) of dollarization: • Hedge inflation and ER volatility.• Inefficient peso intermediation.• Lower default for dollar earning debtors. • Dollar deposit insurance (moral hazard).

3. 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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Share of foreign exchange

deposits in total deposits denominated loans in total loans

1990 2001 2001

Argentina 47.2 73.6 71.6

Bolivia 80.7 91.4 97.1

Brazil 0.0 0.0 0.0

Chile 16.3 12.1 14.0

Colombia 0.3 0.3 11.0

Costa Rica 26.8 43.8 67.2

Dominican Republic 1/ 2.2 20.0 27.6

Ecuador 13.3 100.0 100.0

El Salvador 4.1 100.0 100.0

Guatemala 0.0 5.1 13.3

Honduras 1.8 33.1 22.3

Mexico 10.1 8.1 20.5

Nicaragua 40.3 71.0 ...

Paraguay 1/ 33.9 64.3 52.4

Peru 62.5 74.3 80.3

Uruguay 88.6 92.5 87.3Venezuela ... 0.3 0.5

Share of foreign exchange

Latin America: Deposit and Loan dollarization

Sources: Central bank statistical publications; and Fund staff estimates.

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Dollarization trends in Latin America

Country Deposits

dollarization a Loans

dollarization a Public debt

dollarization b 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%

Average other emerging c 22% 19% 39% Notes: a 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 Superintendencies. b USD debt/total public sector debt. Data for 2001 and 2002; Sou rce: Calvo, Izquierdo and Mejia(2003) and Central Banks and Finance Ministries. c Includes: Bulgaria, Czech Republic, Hungary, Israel, Korea, Malaysia, Morocco, Nigeria, Philippines, Poland, Russia, Slovak Republic, Thailand and Turkey.

Source: Galindo and Leiderman (2003)

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CPI-Indexation as a Substitute of Dollarization?

Bolivia 0.5% 0.1% 9.0%

Brazil 0.0% 0.3%8.7% (to Prices) 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%

Share of Inf-Indexed Deposits

Share of Inf-Indexed Loans

Share of Inf-Indexed Public Internal Debt

Source: Galindo and Leiderman (2003)

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Colombia: Foreign currency deposits (% of total deposits).

0.60%

0,20%

0,30%

0,40%

0,50%

0,60%

0,70%

0,80%

0,90%

Dic

-94

Jun-

95

Dic

-95

Jun-

96

Dic

-96

Jun-

97

Dic

-97

Jun-

98

Dic

-98

Jun-

99

Dic

-99

Jun-

00

Dic

-00

Jun-

01

Dic

-01

Jun-

02

Dic

-02

Source: Banco de la República

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Colombia: Foreign currency loans (% of total loans).

5,10%4%

6%

8%

10%

12%

14%

Dic

-94

Jun-

95

Dic

-95

Jun-

96

Dic

-96

Jun-

97

Dic

-97

Jun-

98

Dic

-98

Jun-

99

Dic

-99

Jun-

00

Dic

-00

Jun-

01

Dic

-01

Jun-

02

Dic

-02

Source: Banco de la República

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Drivers of low dollarization in Colombia

1. Real deposit rates (peso) have been positive.2. Foreign currency loans are prohibited.3. Ban on foreign currency deposits.4. No deposit insurance on foreign currency

deposits.5. 20% (of capital) limit on banks’ (long) FX

position.6. Large domestic public debt.7. Pension funds: limits to foreign currency

denominated securities. 8. Role of CPI-indexed instruments.

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What do CPI indexed bonds do?

1. 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.

2. Ize and Powell: CPI indexed bonds are the appropriate response when dollarization stems from market imperfections.

3. 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

8%

13%

18%

23%

28%

33%

38%

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

Oct

-93

Oct

-94

Oct

-95

Oct

-96

Oct

-97

Oct

-98

Oct

-99

UPAC

CPI

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UPAC, UVR and CPI: Monthly percent changes

-1%

0%

1%

2%

3%

4%

5%

6%

7%

Oct

-72

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

Oct

-93

Oct

-94

Oct

-95

Oct

-96

Oct

-97

Oct

-98

Oct

-99

Oct

-00

Oct

-01

% UPAC - UVR% CPI

15

0%

20%

40%

60%

80%

100%

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Ag

-02

Indexed Liabilities Peso liabilities Other liabilities

Mortgage BanksComposition of Liabilities

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Inflation-indexed loans (% of total loans)

20,0%20,2%

20,4%20,6%20,8%21,0%

21,2%21,4%21,6%21,8%

22,0%

Dic-02 Ene-03 Feb-03 Mar-03 Abr-03 May-03

Source: Banco de la República

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Nearly half of the public debt is domestic

51,4%

48,6%

50,8%

49,2%

50,7%

49,3%

0%

20%

40%

60%

80%

100%

2001 2002 Sep-03

Source: Ministry of Finance

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Domestic debt composition

24 27 29

8 5 33 10 820

19 16

43 38 43

0%

20%

40%

60%

80%

100%

2001 2002 Sep-03

uvr fix usd fix Dtf Cop IPC Cop fix OtherSource: Ministry of Finance

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Pension Funds Value as Percentage of GDP

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Pension Funds (mandatory)

Voluntary Pension Funds

Severance Funds