By Catherine Santos

Helen Farfan Marcelo Moran

By Catherine Santos

Helen Farfan Marcelo Moran

Dollarization in El SalvadorDollarization in El Salvador

What is dollarization?

What is dollarization?

• Official Dollarization

• Semi-official dollarization

• Unofficial dollarization

El SalvadorEl Salvador

Facts about dollarizationFacts about

dollarization

• When do we implement dollarization in a country?

• The inflation rate in 2001 was around 4%.

• Real GDP was around 3%

El Salvador at the beginning of the 21st Century

El Salvador at the beginning of the 21st Century

• Implementation of neoliberal economic policies.

• External debt was manageable.• The economy is strongly tied to the United States.

• The real source of foreign exchange was remittances from the U.S.

• Implementation of neoliberal economic policies.

• External debt was manageable.• The economy is strongly tied to the United States.

• The real source of foreign exchange was remittances from the U.S.

El Salvador at the beginning of the 21st Century

El Salvador at the beginning of the 21st Century

Service Privatized Change Since

Telephone 1998 37%

1999

Electricity

1992 221%

Over the last decade

Water Not priv 33%

Since 2005

Data from 2002 indicate the cost of these basic services amounted to 41% of a minimum wage earner's salary

Gini CoefficientGini Coefficient

•40.5% of income is captured by the top 10% of the population

•It has the 5th highest Gini coefficient in the world wth a coefficient of 52.3 (World Bank 2002).

•40.5% of income is captured by the top 10% of the population

•It has the 5th highest Gini coefficient in the world wth a coefficient of 52.3 (World Bank 2002).

Effects of Dollarization in El SalvadorEffects of Dollarization in El Salvador

• Dollarization ensures that El Salvador’s fortunes will rise & fall with America’s.

• El Salvador faced several shocks initially– Increasing oil prices, US economy slowdown

• The effects are both positive and negative

Would El Salvador be better off having not Dollarized?

• Dollarization ensures that El Salvador’s fortunes will rise & fall with America’s.

• El Salvador faced several shocks initially– Increasing oil prices, US economy slowdown

• The effects are both positive and negative

Would El Salvador be better off having not Dollarized?

Positive and Negative Effects of DollarizationPositive and Negative Effects of Dollarization

Positive Effects Positive Effects Negative EffectsNegative Effects

• Currency Risk Eliminated• A more stable currency• Lower Country Risk

Premiums• Lower transaction costs

between former currency & the US dollar

• Gains in policy credibility

• Encourages competition– Boosts productivity & innovation

• Currency Risk Eliminated• A more stable currency• Lower Country Risk

Premiums• Lower transaction costs

between former currency & the US dollar

• Gains in policy credibility

• Encourages competition– Boosts productivity & innovation

• Predicted benefits that never materialized

• Prices have increased rather than dropping

• Wages only rose minimally

• Distrust of Gov’t by some of its constituents– Monetary Integration Law

• Predicted benefits that never materialized

• Prices have increased rather than dropping

• Wages only rose minimally

• Distrust of Gov’t by some of its constituents– Monetary Integration Law

BankingBanking

Positive EffectsPositive Effects Negative EffectsNegative Effects

• Regulations were restructured & tightened

• Improved transparency• Small Banks can compete

with larger banks• Initially Lower

Interest Rates on Mortgage and Personal Loans

• Corporate borrowing rates are low

• Regulations were restructured & tightened

• Improved transparency• Small Banks can compete

with larger banks• Initially Lower

Interest Rates on Mortgage and Personal Loans

• Corporate borrowing rates are low

• Elimination of True Central Bank

• No Lender of Last Resort

• Lost control of their own money supply

• Lost income through Seigniorage

• Currently Interest Rates are almost as high as before dollarization

• Nearly impossible to reverse

• Elimination of True Central Bank

• No Lender of Last Resort

• Lost control of their own money supply

• Lost income through Seigniorage

• Currently Interest Rates are almost as high as before dollarization

• Nearly impossible to reverse

Global Financial IntegrationGlobal Financial Integration

Positive EffectsPositive Effects Negative EffectsNegative Effects

• Banks have improved their performance– Gaining competitiveness in the Central American Region

• Better integration into the Int’l financial system

• Higher credibility among foreign investors

• Easier access to cheaper Int’l borrowing

• Banks have improved their performance– Gaining competitiveness in the Central American Region

• Better integration into the Int’l financial system

• Higher credibility among foreign investors

• Easier access to cheaper Int’l borrowing

• Never attracted influx of Foreign Investment– Foreign Bank presence remains negligible

• Posting some of the lowest Growth rates in the region

• Never attracted influx of Foreign Investment– Foreign Bank presence remains negligible

• Posting some of the lowest Growth rates in the region

Annual TrendsAnnual Trends

Annual TrendsAnnual Trends

Annual TrendsAnnual Trends

The Issuing Country

The Issuing Country

Choices:•Passive Acceptance•Active Encouragement•Active Resistance

Choices:•Passive Acceptance•Active Encouragement•Active Resistance

The Issuing Country (Cont.)

The Issuing Country (Cont.)

Advantages• May lead to increased trade• Elimination of exchange rate risk

Advantages• May lead to increased trade• Elimination of exchange rate risk

The Issuing Country (Cont.)

The Issuing Country (Cont.)

Disadvantages• Affected by shocks in other countries• Losing control of currency in circulation outside of the U.S.

Disadvantages• Affected by shocks in other countries• Losing control of currency in circulation outside of the U.S.