The involuntary form of dollarization, called partial or de facto dollarization, occurs when one or several foreign currencies circulate alongside a national currency, with usually the banking system also operating in those currencies. These developments largely eschew the direct control of the authorities. Partial dollarization, stretching from low to virtually full dollarization, typically stems from disorderly macroeconomic conditions. In most countries high dollarization is a spontaneous response—often desperate—to persistent high or hyperinflation. In the case of high dollarization, full dollarization is now considered an exchange rate regime choice and can offer, under certain circumstances, an attractive option to countries that find themselves confronted with a protracted economic crisis. In Cambodia, dollarization surged suddenly and significantly during the period 1991–93, primarily as a result of massive dollar inflows. Very high dollarization in Cambodia thus was principally an exogenous shock, and has resulted in low inflation and economic stability. Yet dollarization has been persistent, despite increased economic and political stability.
There is a sizable amount of cash dollars circulating in the Cambodian economy, of which we provide an econometric estimate since early 1995. Residents keep a substantial amount of dollars in cash as a store of value, probably owing to the limited public confidence in the banking system and shallow financial intermediation. These dollars circulate very slowly in the economy, which remains relatively little monetized and operates predominantly on a cash basis, in particular as regards the national budget. The low estimated velocity provided by our empirical analysis is consistent with inflation that has remained subdued in spite of the large dollar money supply in the economy. In this regard, the most important policy measure for the National Bank of Cambodia was to eliminate its financing of the government budget deficit after mid-1998, which used to be the main source of inflation in Cambodia in the early 1990s.
In the face of very high dollarization, the National Bank of Cambodia’s monetary and exchange policies and the Ministry of Economy and Finance’s budget policy have served Cambodia well since 1999. By refraining from budget financing and from refinancing commercial banks on the one hand, and by producing a current budget surplus and an overall budget deficit entirely financed by foreign financing on the other, both institutions have been conducting mutually reinforcing macroeconomic policies. This mix has provided a stable riel supply, which in turn resulted in a relatively stable exchange rate, while the dollar supply has been absorbed by large idle cash balances held by residents and the export of excess dollar banknotes by commercial banks. Very high dollarization, coupled with prudent macroeconomic policies, has thus largely sheltered the Cambodian economy from international economic turmoil, while providing a propitious environment for growth and poverty reduction, provided advantage is taken of this situation to push forcefully ahead with wide-ranging structural reforms.
In our opinion, this policy stance is appropriate in the short to medium term. We do not favor endeavoring to de-dollarize the economy, beyond executing the budget fully in national currency, as the current economic context is not favorable for such an under-taking; nor do we recommend full dollarization. The current policy stance is not a panacea, however, and developments will need to be constantly monitored to ascertain that the domestic and international macroeconomic environments remain auspicious for the continued implementation of the aforesaid policies. Downside risks of the current policy mix are linked to uncertainties of the growing economy. They could involve increased dollar inflows, stemming from renewed investment and higher tourism receipts, coupled with improved financial intermediation and the launching of financial markets. Similarly, large amounts of idle cash dollar balances could flow into the banking system, as confidence improves. Heightened bank capital requirements, coupled with excess liquidity, constitute a strong incentive for increased lending in the future.24 Such developments could result in higher inflation, as the National Bank of Cambodia currently has no means to sterilize dollar inflows or dollars released from cash balances, and enhanced financial intermediation could lead to increased velocity of money circulation.25 These likely developments call for improved policy tools capable of handling a more complex economy that will come from higher development. Fiscal discipline will need to remain a cornerstone of the authorities’ policy mix, and the National Bank of Cambodia will need to strengthen drastically its supervisory capacity and its ability to influence bank liquidity, presumably via the eventual development of some type of financial instruments.
A number of studies have found that once an economy is highly dollarized, it is very hard to reduce dollarization significantly, even if economic and political stability has been restored. Only Liberia, with a long history of dollarization, reintroduced its own currency in the 1980s. In Cambodia, dollarization could be marginally reduced by implementing the budget entirely in riels, and by issuing treasury bills in riels,26 but beyond that move, neither a single-currency board arrangement, nor an administratively enforced de-dollarization, appears desirable, as either would likely result instead in a de facto full dollarization.