Front Matter

Front Matter

Adrián Armas, Eduardo Levy Yeyati, and Alain Ize
Published Date:
July 2006
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    Financial Dollarization

    The Policy Agenda

    Edited by

    Adrián Armas

    Alain Ize


    Eduardo Levy Yeyati

    © International Monetary Fund 2006

    All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission.

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    Library of Congress Cataloging-in-Publication Data

    • Financial dollarization : the policy agenda / edited by Adrián Armas, Alain Ize, and Eduardo Levy Yeyati.

      • p. cm.

    • Includes bibliographical references and index.

    • ISBN 1-4039-8759-9 (cloth : alk. paper)

    • 1. Monetary policy – Developing countries. 2. Currency question – Developing countries. 3. Developing countries – Economic policy. I. Armas, Adrián, 1965 – II. Ize, Alain. III. Levy Yeyati, Eduardo.

    HG1496.F56 2006

    332.4’ 564—dc22


    10 9 8 7 6 5 4 3 2 1

    15 14 13 12 11 10 09 08 07 06

    Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne

    Nothing contained in this book should be reported as representing the views of the IMF, its Executive Board, member governments, or any other entity mentioned herein. The views expressed in this book belong solely to the authors.


    List of Tables

    List of Figures

    List of Abbreviations


    Aggregate effective currency mismatch


    Asset-liability management


    Asset management company


    Central Bank of Bolivia


    Basel Committee on Banking Supervision


    Central Bank of Chile


    Bank credit to private sector


    Central Reserve Bank of Peru


    Banco Hipotecario del Uruguay


    Bank for International Settlements


    Bank of England


    Banco de la República Oriental del Uruguay


    Collective action clauses


    Capital asset pricing model


    Capital adequacy ratio


    Circuit breakers


    Consumption capital asset pricing model


    Contingent credit line


    Certificate of deposit


    Exchange rate-indexed securities


    Committee on the Global Financial System


    Corporación Nacional para el Desarrollo


    Consumer price index


    Debt Management Office


    Data Quality Assessment Framework


    Emerging Market Bond Index


    Exchange rate


    European Union


    Foreign currency deposits


    Financial dollarization


    US Federal Fund rate


    Fund for Fortifying the Banking System


    Fear of floating competitiveness targeting


    Full-fledged inflation targeting


    Latin American Reserve Fund


    Floating rate notes


    Fund for Stability of the Banking System


    Foreign exchange


    Gross domestic product


    Generalized method of moments


    Harmonized index of consumer prices


    Inter-American Development Bank


    International Accounting Standard


    International financial institutions


    International Financial Reporting Standards


    International Financial Statistics


    Index-linked Gilt edged market makers


    Intermediate inflation targeting


    International Monetary Fund




    Inflation targeting


    Liquid asset requirements


    Letras Financieras do Tesouro


    London Inter Bank Offering Rate


    Lender of last resort


    Monetary and Financial Systems Department


    Minimum variance portfolio


    New Banco Comercial


    Nominal exchange rate


    Net foreign currency assets


    Net international reserves


    Non-performing loans


    Notas do Tesouro Nacional


    Obligations assimilables du Trésor


    Organization for Economic Cooperation and Development


    Ordinary least squares


    Office for Planning and Budgeting


    Pakistani rupee


    Political risk rating


    Quarterly projection model


    Real effective exchange rate


    State Bank of Pakistan


    Special Data Dissemination Standards


    Special drawing right


    Treasury bills


    Treasury inflation-indexed debt


    Unidad de fomento


    Unidad de fomento de la vivienda


    Uncovered interest rate parity


    Unidades reajustables


    Vector autoregressive


    Value added tax


    World Economic Outlook

    Notes on the Contributors

    Adrián Armas is Head of the Economic Studies Department at the Central Reserve Bank of Peru.

    Agustín Carstens is Deputy Managing Director at the International Monetary Fund.

    Jorge Cayazzo is Senior Financial Sector Expert in the Monetary and Financial Systems Department, International Monetary Fund.

    Roberto Chang is Professor of Economics at Rutgers University, New Brunswick, and Research Associate at the National Bureau of Economic Research.

    Kevin Cowan is Senior Economist at the Central Bank of Chile. He was a Research Economist at the Inter-American Development Bank at the time of the April 2005 Lima conference.

    Óscar Dancourt is Acting Governor at the Central Reserve Bank of Peru.

    Julio de Brun is Director of the Centre for Banking and Financial Studies, ORT University, Uruguay, and Executive Director of the Private Banks Association, Uruguay. He was formerly the Governor of the Central Bank of Uruguay.

    Augusto de la Torre is Senior Regional Financial Sector Advisor of the Latin American and Caribbean Regional Office of the World Bank.

    Francisco de Paula Gutierrez is Governor of the Central Bank of Costa Rica.

    Antonio Garcia Pascual is Economist for the Monetary and Financial Systems Department of the International Monetary Fund.

    Francisco Grippa is Senior Economist of the Monetary Division at the Central Reserve Bank of Peru.

    Eva Gutierrez is Economist for the Policy Review Department of the International Monetary Fund.

    Daniel C. Hardy is Deputy Division Chief of the Monetary and Financial Systems Department of the International Monetary Fund.

    Luis Óscar Herrera is Director of the Financial Policy Department at the Central Bank of Chile.

    Socorro Heysen is Deputy Division Chief of the Monetary and Financial Systems Department of the International Monetary Fund.

    Allison Holland is Debt Management Advisor for the Monetary and Financial Systems Department of the International Monetary Fund.

    Stefan Ingves is Governor of the Central Bank of Sweden. He was the Director of the Monetary and Financial Systems Department at the time of the April 2005 Lima conference.

    Claudio Irigoyen is Chief Economist at the Central Reserve Bank of Argentina.

    Alain Ize is Area Chief for the Monetary and Financial Systems Department of the International Monetary Fund.

    Olivier Jeanne is Deputy Division Chief of the Research Department of the International Monetary Fund (currently on leave, visiting the Department of Economics of Princeton University).

    Miguel A. Kiguel is Academic Advisor at the Financial Stability Centre, and Professor at the Torcuato Di Telia University.

    Leonardo Leiderman is Professor at the Berglas School of Economics at Tel Aviv University, Israel.

    Eduardo Levy Yeyati is Professor and Director of the Center for Financial Research at the Business School of the Torcuato Di Telia University and Research Associate at the Research Department of the Inter-American Development Bank.

    Gerardo Licandro is Director of the Research Department of the Central Bank of Uruguay.

    Rodolfo Maino is Senior Economist at the Monetary and Financial Systems Department of the International Monetary Fund.

    Juan Antonio Morales is Governor of the Central Bank of Bolivia.

    Christian Mulder is Deputy Division Chief of the Monetary and Financial Systems Department at the International Monetary Fund.

    Masahiro Nozaki is Economist at the Western Hemisphere Department of the International Monetary Fund.

    Eric Parrado is Advisor at the Financial Policy Division of the Central Bank of Chile.

    Ceyla Pazarbasioglu is Division Chief of the International Capital Markets Department at the International Monetary Fund.

    Robert Rennhack is Division Chief of the Western Hemisphere Department at the International Monetary Fund.

    Markus Rodlauer is Senior Advisor at the Western Hemisphere Department of the International Monetary Fund.

    Renzo Rossini is General Manager of the Central Reserve Bank of Peru.

    Klaus Schmidt-Hebbel is Chief of Economic Research at the Central Bank of Chile and Professor at the Catholic University of Chile.

    Philip Turner is Head of the Secretariat Group at the Monetary and Economic Department of the Bank for International Settlements.


    The editors wish to thank all those who contributed to this volume and participated in the April 2005 Lima conference, (The Policy Implications of De Facto Dollarization), which was co-sponsored by the International Monetary Fund (IMF) and the Central Reserve Bank of Peru (BCRP). We wish to thank in particular Agustín Carstens, IMF Deputy Managing Director, for fitting the conference into his busy schedule.

    We would also like to recognize the special efforts of all those at the IMF and BCRP who provided logistical and editorial support to the production of this volume and the preparation of the conference. We are most indebted to Magally Bernal for her untiring and excellent assistance in preparing the conference, putting together the volume and, more generally, making sure that all loose ends were taken care of. We also wish to thank Funke Fasalojo and Hortense N’Danou, who provided valuable back-up support to Magally, and to Graham Colin-Jones, the Monetary and Financial Systems Department (MFD) editor, for his excellent editorial work.

    We are also grateful to Julia Vivanco and Jose Rocca at the BCRP for coordinating the on-site work for the conference and ensuring the success of the event. More generally, we wish to thank Óscar Dancourt, Renzo Rossini and the management of the BCRP for their warm hospitality during the conference.

    Finally, the editors would like to acknowledge the advice and general editorial support received from Sean Culhane in the IMF’s External Relations Department, who coordinated the arrangements for publication. The patience and advice of Katie Button at Palgrave Macmillan are also very much appreciated.


    Óscar Dancourt and Stefan Ingves

    The materials in this book gather the proceedings of a conference held in Lima, Peru, during 21–22 April 2005 on The Policy Implications of De Facto Dollarization’. The conference was jointly organized by the Central Reserve Bank of Peru (BCRP) and the Monetary and Financial Systems Department (MFD) of the International Monetary Fund (IMF). It originated from a desire by the Peruvian authorities to share with other countries in the region their rather unique experience as inflation targeters in a highly dollarized environment and, more generally, compare notes on how to deal with dollarization and its risks. The conference brought together practitioners, policy-makers and academics who, through research or work in the field, have had a first-hand opportunity to think about the root causes of dollarization and its policy implications. It was attended by representatives from most (if not all) regional central banks, ministries of finance and supervisory institutions, as well as representatives from several multilateral institutions, including the World Bank, the Bank for International Settlements (BIS), the Inter-American Development Bank (IADB) and the Latin American Reserve Fund (FLAR), in addition to a sizable contingent from the IMF.

    The time appears to be ripe for an in-depth review of the policy implications of financial dollarization. Notwithstanding declining, and often quite low, rates of inflation, de facto dollarization has continued to rise (or failed to decline) in most regions of the world, most particularly in Latin America. At the same time, following a number of recent crises episodes where dollarization played an important role, most notably in Asia and Latin America, the view of de facto dollarization as a mostly benign and, on the whole, beneficial phenomenon, has given way to more sobering thoughts. Indeed, the recent Argentinian crisis and its tidal waves throughout the region brought home the realization that dollarization can be a major source of financial fragilities. It can induce liquidity crises and undermine the solvency of banks and their borrowers in the event of large depreciations when most loans, even to those sectors that do not earn dollars, are in dollars. Concerns about the financial impact of exchange rate fluctuations can, in turn, hold monetary policy hostage and greatly complicate crisis management when crises occur.

    The range of policy responses to dollarization and its underlying causes has been quite varied, increasingly proactive and, in many cases, seemingly successful. Comparing notes on such experiences and sharing lessons is indeed a key objective of this book. The experience of the few countries like Israel that have largely de-dollarized based on good and persistent monetary management provides, of course, a key point of reference. But good monetary management and a shift towards more exchange rate flexibility appear to have also paid off in countries that remain highly dollarized, such as Peru, Bolivia, Uruguay and Paraguay. Attempts to reign in dollarization through more aggressive methods, both in the region and outside the region, are also worth looking into. At the same time, many countries have innovated in terms of how to conduct monetary policy under a highly dollarized environment and limit the prudential risks of high dollarization. While the Peruvian experience of formal inflation targeting with an interest rate as an operative target is rather unique, several other countries, including Bolivia and Uruguay, also have interesting experiences to share in this respect. Several countries in the region have also recently reviewed (or are in the process of reviewing) their prudential framework to better assess and internalize the risks of intermediating in foreign currency.

    Last but not least, there has been substantial progress in the academic literature on dollarization in recent years, both of a theoretical and empirical nature, that helps understand the root causes of dollarization and its linkages with monetary and prudential policies. Together with a greater awareness of the need for policy reform, fully grasping the intricacies of the phenomenon at hand is, of course, a key prerequisite for policy action.

    While there are some good reasons for optimism, one needs to remain cautious about the perspectives for de-dollarization and mindful, when formulating a policy agenda, that one size may not fit all. In particular, de-dollarizing only becomes an option when the weak macroeconomic and institutional background that has led to dollarization has made a sufficient turnaround that it can now support a ‘good-quality’ local money that is well equipped to compete with imported ones. In some cases, the policy agenda may need to limit its focus to living with dollarization and containing its risks. In other cases, the preferable policy may be to promote dollar substitutes, such as price-indexed instruments, until the local currency is better able to compete head to head with the dollar. In all cases, good coordination between all policy-makers involved, including central banks, supervisory agencies and ministries of finance, is likely to be crucial in ensuring the successful design and implementation of the policy agenda.

    The chapters in this volume do not pretend to have all the policy answers to an inherently complex and multifaceted phenomenon. The aim of the book is mainly to provide a solid reference piece to help guide the policy response to an issue which is likely to remain high on the agenda for years to come.

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