This Selected Issues paper describes the revenue instability and its consequences for Suriname. It explores some options for policy rules that could be considered in the case of Suriname. The paper analyzes inflation in Suriname from its historical and international perspectives, reviews the monetary policy instruments and the institutional framework, and describes the exchange rate regime and its main developments. The paper also analyzes the type of macroeconomic shocks and the domestic transmission mechanism for Suriname.

Abstract

This Selected Issues paper describes the revenue instability and its consequences for Suriname. It explores some options for policy rules that could be considered in the case of Suriname. The paper analyzes inflation in Suriname from its historical and international perspectives, reviews the monetary policy instruments and the institutional framework, and describes the exchange rate regime and its main developments. The paper also analyzes the type of macroeconomic shocks and the domestic transmission mechanism for Suriname.

III. Dollarization in Suriname1

A. Introduction

1. In recent years, Suriname has experienced rapid financial dollarization. Foreign currency deposits as a percentage of total deposits rose from 20 percent in 1996 to 57 percent in 2003, while foreign currency loans as a percentage of total commercial bank loans followed a similar path. This chapter reviews the factors that have contributed to these trends and discusses their potential consequences. Section B provides an overview of dollarization in Suriname. 2 Section C discusses the consequences of dollarization, focusing on the loss of seigniorage or an independent monetary policy. Section D discusses the effects of dollarization on the development and vulnerabilities of the financial sector, and Section E concludes.

uA03fig01

Financial Dollarization, 1996-2003

(In percent)

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A003

Source: Central Bank of Suriname.1/ Foreign currency deposits in percent of total commercial bank deposits.2/ Foreign currency loans in percent of total credit to the private sector by commercial banks.

B. Overview of Dollarization in Suriname

2. Suriname has followed the regional trend toward dollarization. Suriname’s deposit dollarization ratio in 2001 only slightly exceeded the average for countries in Latin America, but with the further acceleration in dollarization since 2001, Suriname may now have become one of the more highly dollarized economies. The fact that only few countries have succeeded in de-dollarizing their economies suggests that the high dollarization in Suriname could prove irreversible and persistent over the medium term. 3

Dollarization by Region

article image
Sources: Reinhart, Rogoff, and Savastano (2003); Central Bank of Suriname.

For Suriname, average for 1993-95.

Number of countries over which an average for 1996-2001 is calculated.

Foreign Currency Deposits for Selected Latin American Countries, 2001

(In percent of total deposits)

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Sources: Central banks; and IMF staff estimates.

Unweighted average for the listed countries.

3. Dollarization began with the deregulation process in the early 1990s and accelerated after the near-hyperinflation during 1993–94. In June 1992, residents were allowed to open and maintain foreign currency deposits at commercial banks, and, in July 1995, to receive foreign currency loans from commercial banks. Dollarization accelerated after the near-hyperinflation episode in 1993–94. During the dollarization process, foreign currency loans increased in tandem with foreign currency deposits. 4

uA03fig02

Financial Dollarization and Inflation 1990-2003

(In percent)

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A003

Source: Central Bank of Suriname.1/ Foreign currency deposits in percent of total commercial bank deposits.2/ Foreign currency credit in percent of total credit to the private sector by commercial banks.

4. Dollarization has not simply been the by-product of valuation effects from currency depreciation. Although the rapid depreciation of the local currency explains part of the rise in foreign currency deposits as a share of local currency GDP, foreign currency deposits have grown much faster than real GDP. Similarly, foreign currency deposits in real terms (deflated by U.S. inflation) increased by more than 10 times during 1995–2003, compared with only a 20 percent increase of domestic currency deposits in real terms.

uA03fig03

Financial Dollarization and Exchange Rate, 1996-2003

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A003

Source: Central Bank of Suriname.1/ Foreign currency deposits in percent of total commercial bank deposits.2/ Foreign currency credit in percent of total credit to the private sector by commercial banks.
uA03fig04

Foreign and Domestic Currency Deposits in Real Terms, 1995-2003

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A003

Sources: Central Bank of Suriname; and IMF staff estimates.

5. The reserve requirements have favored foreign currency intermediation. In December 2002, the Central Bank of Suriname (CBvS) abolished a regulation that prohibited banks from lending to borrowers that had no foreign currency income sources and established a minimum reserve requirement for foreign currency deposits at 17.5 percent. This reserve requirement has been kept significantly below the reserve requirement for domestic currency deposits, which exceeded 30 percent since mid–2002. This compares with the majority of dollarized countries, which typically maintain higher reserve requirement ratios for foreign currency deposits. 5 Moreover, reserves for foreign currency deposits can be kept at interest-bearing accounts at foreign banks, while reserves for domestic currency deposits must be kept as unremunerated deposits at the CBvS.

6. Loan dollarization was extremely rapid during 2000–03, possibly reflecting the relaxation of institutional constraints. Over this period, foreign currency loans quadrupled in real terms, even as interest rates on U.S. dollar loans declined from 12 percent to 9 percent. This increase in supply occurred as credit ceilings on dollar lending were eliminated, and restrictions on the holding of foreign currency deposits were effectively relaxed. 6 Even with the introduction of the reserve requirement on foreign currency deposits, the effective spread on dollar lending remained favorable relative to lending in domestic currency. 7

uA03fig05

Foreign Currency Deposits and Loans, 1996-2003

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A003

Source: Central Bank of Suriname.

7. The authorities have begun to remove the dollarization incentive in the reserve requirement system. The CBvS raised the reserve requirement for foreign currency deposits from 17.5 percent to 22.5 percent in November 2004, and 33⅓ percent in February 2005. This will help eliminate the incentive for dollarization given that the current reserve requirement for domestic deposits is 30 percent. Notwithstanding these steps, the system still favors dollarized deposits since the required reserves on foreign currency deposits are remunerated, while those on domestic deposits are not.

8. A recent deregulation in gold trade may also have contributed to rising dollarization. In September 2002, a deregulation abolished the mandatory sales of gold to the CBvS and allowed the private sector to engage freely in gold trade. This deregulation increased substantially the officially recorded gold exports from 4.3 tons in 2001 (equivalent to US$35.4 million) to 11.7 tons in 2003 (equivalent to US$128.2 million). It is possible that foreign currency proceeds from the surging gold exports led to increased intermediation in foreign currency and to an increase in foreign currency instruments in the banking system.

9. There are signs that dollarization has increased outside the banking system. In dollarized economies, there is often a distinction between financial dollarization—when financial intermediation occurs in foreign currency—and “real” dollarization—when foreign currencies begin to be used as medium of exchange and a unit of account. 8 In Suriname, there is evidence of real dollarization, e.g., car and real state prices are usually quoted in foreign currency, as well as wages in certain industries. Interestingly, real dollarization in Suriname encompasses two foreign currencies: while high-end real estate is quoted in euros, wages in some industries are quoted in U.S. dollars. Real dollarization is also evident from the high degree of pass-through from movements in the exchange rate to the CPI (Box 1.). 9

uA03fig06

Consumer Price Index and Exchange Rate, 1996-2003

(In logarithmic scale)

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A003

Sources: General Bureau of Statistics; Central Bank of Suriname.

The Exchange Rate Pass-through to the Price Level

Statistical analyses also support the high degree of the pass-through from the exchange rate to the price level in Suriname. Depreciation of the black market exchange rate is positively related to inflation thereafter, as shown by the estimate of the correlation coefficient between depreciation and lagged inflation. In particular, the correlation coefficient estimate of around 0.6 for 1–2 months lags implies that depreciation in a given month is immediately followed by inflation, suggesting quick pass-through from exchange rate to the price level. In addition, a bivariate vector autoregression analysis suggests that the pass-through is almost complete: 1 percent depreciation is estimated to raise the price level by about 0.6 percent within 4 months and about 1 percent within 12 months.1

Correlations between Exchange Rate Depreciation and Inflation 1/

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Source: Fund staff estimates.

Correlation coefficient between monthly percentage changes in the black market exchange rate and lagged monthly percentage changes in CPI.

Significant at a 5 percent confidence level.

uA03fig07

Response of CPI to Exchange Rate Depreciation 1/

(Accumulative percentage change of CPI after 1 percent depreciation)

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A003

Source: Fund staff estimates.1/ Based on a bivariate monthly vector-autoregressive estimation for CPI and the black market exchange rates, with the sample period of 1992–2004.
1These responses are statistically significant. The statistical inference would be strengthened if more variables such as an index of economic activity, the interest rate, and monetary aggregates were available and included in the regression.

C. Consequences of Dollarization

10. Dollarization has reduced the authorities’ access to seigniorage. Revenues from seigniorage reached about 5–6 percent of nominal GDP during 1998–2000, equivalent to about 25 percent of annual tax revenue of the central government.10 Real seigniorage—i.e., the seigniorage that was over and above the amount simply gained from inflation—was also substantial during 1996–98, ranging from 1 to 4 percent of GDP. However, seigniorage has declined in recent years, falling from 6 percent of GDP in 2000 to 0.3 percent in 2003, with an even more pronounced decline in real seigniorage (Box 2).

uA03fig08

Seigniorage and Dollarization, 1996-2003

(In percent)

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A003

Sources: General Bureau of Statistics; Central Bank of Suriname; and Fund staff estimates.

Seigniorage

Seigniorage is a source of revenue that a national government can raise by issuing a currency, and is usually defined as an increase in the monetary base divided by the price level. Specifically, seigniorage is defined as

St=Mt-Mt-1Pt

where the monetary base Mt is the monetary base at period t and Pt is the price level at period t.

Seigniorage can be decomposed into two components: real seigniorage and inflation tax. To see this, let mt=MtPt be the real holding of the monetary base by residents (so-called the t P t real balance). Then, seigniorage St can be transformed into:

St=(mt-mt-1)+mt-1pt-pt-1pt.

The first term in the right hand side is referred to as real seigniorage, since it equals the increase in residents’ money holding originating from their money demand. The second term is referred to as inflation tax, calculated as the real balance times the inflation rate (it resembles regular tax revenue as it equals the tax base times the tax rate). The inflation is regarded as “tax” because it reduces the government’s liability to residents with regards to the issued domestic currency. Accordingly, if the real balance is small, higher inflation is needed to raise inflation tax.

In Suriname, the increasing dollarization has eroded revenue from seigniorage. The negative effect of dollarization on seigniorage was even more pronounced when we distinguish between real seigniorage and inflation tax. Seigniorage was generated mainly from inflation tax during 1999–2001, when inflation averaged 66 percent. This was followed by a pickup in dollarization and a decline in the real demand for the domestic currency during 2001–03. The contraction in the real demand in turn reduced real seigniorage, and thereby the base on which an inflation tax could be levied. Inflation therefore brought about a temporary increase in seigniorage, but inflation created an incentive for dollarization, which in turn reduced the demand for domestic currency and eroded the future tax base for seigniorage.

11. Dollarization has also reduced the scope for the exchange rate to buffer the effects of external shocks. With a flexible exchange rate, changes in the nominal exchange rate can help offset the effects of adverse external shocks—including to world commodity prices—by crowding in external demand. Dollarization limits the scope for this type of adjustment device, as domestic prices are denominated in foreign currency.

12. Dollarization implies a loss of monetary policy independence, but may increase policy credibility. The monetary authority in a fully dollarized economy can influence neither domestic interest rates nor the quantity of money circulating in the economy, limiting the scope for policy action.11 At the same time, however, the reduced access to seigniorage and counter-cyclical policy may improve the credibility of the authorities’ willingness to avoid inflation.

D. Dollarization and the Financial System

13. Dollarization coincided with a deepening financial intermediation. During 1996–2003, there was a clear trend towards financial deepening, defined as a rising ratio of broad money to GDP. This was almost entirely the result of growth in foreign currency deposits (FCD), with a similar trend in commercial banks’ assets.

14. However, dollarization also raises important issues for the management of liquidity and solvency risks in the banking system. Liquidity risks arise from the central bank’s reduced capacity to act as a lender of last resort, given its limited access to foreign exchange. It is therefore crucial that a dollarized banking system holds sufficient international reserve assets to cover deposit liabilities. 12 Solvency risks stem from the impact of changes in the exchange rate on banks’ balance sheets, either through a currency mismatch between bank assets and liabilities or through the effect on borrowers of foreign currency whose income stream is denominated in domestic currency.

uA03fig09

Monetary Aggregates, 1996-2003

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A003

Source: Central Bank of Suriname.
uA03fig10

Credit to the Private Sector, 1996-2003

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A003

Source: Central Bank of Suriname.

15. In recent years, the liquid reserves coverage of foreign currency deposits has declined. International liquid reserve assets of commercial banks comprise deposits held with correspondent banks abroad and include the required minimum reserves holdings on foreign currency deposits. As share of foreign currency deposits, these assets decreased from 194 percent in 1996 to 74 percent in 2003. However, total banking system international reserves—including CBvS reserves—still exceed 100 percent of foreign currency deposits. While this is more than sufficient to prevent a liquidity crisis, there would be little margin in case of a sustained shock to the balance of payments.

International Reserve Coverage of Foreign Currency Deposits, 1996-2004

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Source: Central Bank of Suriname.

16. With regard to solvency risks, Suriname’s prudential regulations are geared toward containing balance sheet exposures. Limits are placed on open positions in commercial banks’ balance sheets and their net foreign currency position has been positive during 2003–04. However, these prudential norms are typically not adequate to account for the exposure of bank clients to exchange rate shocks. This underscores the importance in dollarized economies of prudential regulations that ensure strong risk analysis for foreign currency lending.

Commercial Banks’ Net Foreign Currency Position, 1996-2004

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Source: Central Bank of Suriname.

Excludes net unclassified assets.

Sector Decomposition of Commercial Banks’ Foreign Currency Loans 1/

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Source: Central Bank of Suriname

All figures are preliminary.

Figures as of end-September.

E. Conclusion

17. The increase of dollarization in recent years is a response to inflationary bouts and a reserve requirement scheme that encouraged financial intermediation in foreign currency. While the central bank’s recent steps to redress this imbalance should slow down the process of dollarization, other countries’ experiences suggest that high dollarization may persist, especially given evidence that dollarization is also widespread outside the banking system.

18. Dollarization has consequences for macroeconomic management and the financial system in Suriname. It has reduced exchange rate flexibility and seigniorage revenue. At the same time, there are signs that the liberalization of foreign currency banking transactions, combined with a stable macroeconomic environment, has led to a deepening of financial intermediation. However, dollarization has made the financial system more vulnerable as the central bank cannot function as a lender of last resort for the dollarized component of financial intermediation. In addition, foreign currency lending has increased the possibility of balance sheet shocks in the private sector and the banking system.

References

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1

Prepared by Masahiro Nozaki, Tobias Roy, and Mariana Torres.

2

In the literature, “real dollarization” refers to the widespread use of foreign currency among residents for transaction purposes, or quotation or indexation of local prices and wages.

3

Reinhart, Rogoff, and Savastano (2003) studied eighty-four dollarized countries and found that only four succeeded in reducing dollarization during 1980–2001. The four countries are Israel, Mexico, Pakistan, and Poland.

4

This pattern has been observed in other dollarized economies; see Savastano (1996) and IADB (2004). Also, Ize and Levy Yeyati (2003) provided a theoretical model under which both deposit and loan dollarization ratios are related to uncertainties about inflation and the real exchange rate.

5

See Baliño, Bennett, and Borensztein (1999), page 22.

6

In May 2002, foreign exchange surrender requirements for all exporters except from the bauxite and oil sector were abolished, enabling them to hold export proceeds in foreign currency deposits.

7

The interest rate spread between U.S. dollar loans and deposits shrank from 10 percent in 2001 to 7 percent in 2003, whereas the spread between domestic currency loans and deposits remained unchanged at around 12 percent.

8

See Guidottti and Rodriguez (1992) and Feige et al (2003) for Latin American countries’ experience. Fritz-Krockow (2001) portrayed the ratchet effect for dollarization in Haiti.

9

Cross-country studies found that the higher the dollarization was, the more intense the pass-through was. See Reinhart, Rogoff, and Savastano (2003) and Honohan and Shi (2002).

10

Although commercial banks’ domestic currency deposits at the CBvS are a component of reserve money, they have been highly volatile and hence excluded from the estimation of seigniorage.

11

Adhin (2000) suggests that dollarization might promote fiscal discipline in Suriname.

12

Broda and Levy Yeyati (2003) explore alternative approaches to substituting the lender of last resort: private insurance, international bank branching, and an international lender of last resort.

Suriname: Selected Issues
Author: International Monetary Fund