Abstract
The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Summary of WP/92/65
“Currency Substitution: The Recent Experience of Bolivia” by Benedict Clements and Gerd Schwartz
One of the more puzzling aspects of Bolivia’s economic performance since 1986 has been the persistent increase of currency substitution in the domestic banking system. Foreign currency deposits have been permitted since 1985, when the de-dollarization decree of 1982 was suspended. Despite low inflation rates and a high degree of external stability achieved as a result of the successful 1985 monetary reform and adjustment program, Bolivia has been experiencing a rapidly increasing share of foreign currency deposits in the domestic banking system. The share of such deposits in broad money increased from less than 15 percent in early 1986 to over 76 percent in September 1991, and quasi money is currently over 90 percent “dollarized.” In view of the country’s sustained macroeconomic stability, the surge in the degree of currency substitution raises the question of whether factors traditionally thought to drive this process, such as expected exchange rate depreciation and interest rate differentials between U.S. dollar and domestic currency deposits in the banking system, play a significant role in explaining the degree of currency substitution in Bolivia. If they do not, then little hope can be pinned on diminishing dollarization through traditional remedies, such as reducing inflation and increasing interest rates on boliviano bank deposits.
This paper analyzes the determinants of currency substitution in Bolivia during the period following the 1984-85 hyperinflation when--notwithstanding the success of the macroeconomic stabilization and adjustment program that began in August 1985--dollar deposits in the domestic banking system increased rapidly from 1986 through 1991. Consistent with previous research, the authors find that expected depreciation and interest rate differentials are statistically significant determinants of the degree of currency substitution. However, they note that the explanatory power of these variables is fairly low compared to that of variables measuring the degree of inertia in the currency substitution process. The results of the analysis suggest that reversing the process of currency substitution may be very difficult. Given the relatively low responsiveness of currency substitution to expected depreciation and interest rate differentials, and considering the fact that significant stabilization has already occurred, the authors conclude that there may be relatively little scope for reducing the current level of currency substitution in Bolivia in the near future.