Peru: Selected Issues
Author: International Monetary Fund
Publication Date:
06 Feb 2007
eISBN:
9781451831092
Language:
English
Keywords:
ISCR; CR; Peru; government; Subnational government; transaction dollarization; dollarization risk; dollarization program; foreign currency; inflation expectation; Inflation; Exchange rates; Inflation targeting
Download PDF (476.2 KB)

This Selected Issues paper for Peru explains growth and reform in the country post-1990. As half of the population in Peru still lives below the poverty line, further research should consider how the link between average income improvements and poverty reduction can be strengthened. Although the ongoing decentralization effort in Peru has been based on considerations of fiscal sustainability, more work needs to be done to ensure that the conditions for a successful decentralization are in place. The experience of Peru teaches that sound macroeconomic policies are a precondition for de-dollarization.

Abstract

This Selected Issues paper for Peru explains growth and reform in the country post-1990. As half of the population in Peru still lives below the poverty line, further research should consider how the link between average income improvements and poverty reduction can be strengthened. Although the ongoing decentralization effort in Peru has been based on considerations of fiscal sustainability, more work needs to be done to ensure that the conditions for a successful decentralization are in place. The experience of Peru teaches that sound macroeconomic policies are a precondition for de-dollarization.

III. Peru’s Experience with Partial Dollarization And Inflation Targeting1

A. Introduction

1. Peru has been very successful at maintaining low rates of inflation in recent years. Inflation has remained well within the inflation target band (1.5–3.5 percent). During most of this period, Peru has benefited from a favorable external environment, and the authorities have taken advantage of these circumstances to increase their stock of foreign reserves and use reserve management to smooth out exchange rate variations. In this context, economic growth over the last years has been strong and relatively stable by Peruvian standards. In addition, dollarization—historically high, especially in financial assets—has decreased since inflation targeting (IT) was introduced in February 2002. Given that the financial systems of some of the countries that are considering moving to IT are partially dollarized, this makes Peru a remarkable case study for understanding how to implement an independent monetary policy and maintain price stability in highly dollarized economies.2

2. This paper discusses Peru’s experience and examines its policy agenda on de-dollarization, drawing policy lessons for economies that intend to reduce dollarization and adopt IT. The paper is divided in six sections. Section B defines dollarization and offers a summary of the literature on this topic. Section C reviews the Peruvian experience with dollarization and briefly reviews the policies implemented to promote de-dollarization, at both the macro and micro levels. Section D contains a brief presentation of IT. Section E explains the consequences of dollarization for the transmission of monetary policy. Section F reviews Peru’s de-dollarization agenda. Section G draws more general implications for policy and research.

B. What is Dollarization?3

3. Dollarization is common in many emerging market economies, particularly those that have experienced high and volatile inflation.4 There are three different types of dollarization, which can be partial or total, and different type of dollarization can co-exist. It is common that transaction dollarization is accompanied by financial dollarization and vice versa, although to varying degrees:5

  • Transaction dollarization—also known as ‘monetary substitution’: in this case dollars are accepted as a means of payment. This type of dollarization is typical in economies with high levels of inflation, where there is a great opportunity cost of holding domestic currency. In these economies, dollars can remain the preferred means of payment even when inflation has been reduced to low levels, due to hysteresis and to the fact that once dollars become the most used currency, they continue to be the most convenient currency to carry around for transaction purposes—in turn promoting the use of dollars for all payments.6

  • Real dollarization or dollar indexation—in this case, prices and salaries are indexed to changes in the exchange rate between the domestic currency and the dollar. Real dollarization is a milder form of transaction dollarization because it offers protection against exchange rate volatility without requiring the actual use of dollars as a means of payment or as the currency for price denomination. Real dollarization is related to a high degree of exchange rate pass-through, as agents attempt to isolate the effects of exchange rate changes on their real income levels by linking price and wage contracts to changes in the value of the domestic currency vis-à-vis the dollar. On similar grounds, countries with high inflation and little indexation to consumer price inflation also tend to experience high levels of real dollarization. Real dollarization is also often accompanied by financial dollarization (see below).

  • Financial dollarization—also known as “asset substitution”: in this case, dollars are the preferred currency for storing wealth. Contrary to transaction or real dollarization, financial dollarization is usually a response to high variability in inflation—not to high inflation levels per se, and interest rate controls or “financial repression”.7 Since it reflects a portfolio choice between domestic-currency and dollar-denominated assets, financial dollarization depends on agents’ consideration of the variability of returns on different currency-denominated assets (risk), as well as on the differential itself (return). If the differential is on average zero or close to zero, the degree of financial dollarization is merely a function of the ratio of the total volatilities of inflation and the real exchange rate (that is, the sum of variances and co-variances). Financial dollarization is also seen as a way to minimize credit risk because it favors the currency that most reduces the probability of capital losses by financial institutions. Likewise, households see it as the safest way to store their savings, in that it avoids losses associated with repressed interest rate levels and protects from sudden and unanticipated bouts in domestic inflation. It follows that, typically, financial dollarization is practiced both by banks and non-bank financial institutions.

C. How Severe is Dollarization in Peru?

4. Peru is one of the most highly financially dollarized emerging market countries (Table 1). Among Latin American emerging market economies, Peru is the third most highly dollarized after Bolivia and Uruguay, excluding those that are fully dollarized (Ecuador, El Salvador, and Panama). Peru is also, by far, the most highly dollarized country among the emerging market countries that target inflation.

Table 1.

Dollarization Ratios in Emerging Market Countries 1/, 2/

(Ratio of foreign currency deposits to total deposits, in percentage)

article image
Source: Ramón-Ballester and Wezen (2004).

Emerging markets countries include all countries included in the JP Morgan EMBI Global index as of September 2006. Dollarization data for Brazil, Colombia, Côte d’Ivoire, and Serbia and Montenegro are not available, and thus these countries are not included in the table. Ecuador, El Salvador and Panama are excluded from the table because there dollarization is the official and government-supported monetary policy regime, rather than a habit among economic agents.

Countries in bold are inflation targeters. Brazil and Colombia are inflation targeters but are excluded from the table because of lack of data on dollarization. The Czech Republic and Israel are inflation targeters and are widely considered emerging market countries, but are not part of the JPMorgan EMBI Global Index and thus are excluded from the table as well.

5. Dollarization of financial assets in Peru is by far the most important form of dollarization. Transaction dollarization is less strong but non-negligible. Figure 1 shows percentages of dollar-denominated private debt, the percentage of cash and check payments made in dollars (a proxy measure of transaction dollarization),8 and, finally, estimates of the percentage of exchange rate pass-through to inflation (a proxy for real dollarization).

Figure 1.
Figure 1.

Degree of Transaction, Real and Financial Dollarization in Peru, 2006

Citation: IMF Staff Country Reports 2007, 053; 10.5089/9781451831092.002.A003

6. Financial dollarization has been steadily declining in Peru in the last few years, although it remains significant (Figure 2). By the end of 2005, 55 percent of broad money and 70 percent of credit to the private sector were denominated in foreign currency. The latter continued to decline in 2006, as domestic agents borrowed more in soles to benefit from the reduction in lending rates in soles relative to lending rates in dollars.

Figure 2.
Figure 2.

Banking and Financial System Dollarization Ratios in Peru, 1993–2005

(In percentage)

Citation: IMF Staff Country Reports 2007, 053; 10.5089/9781451831092.002.A003

7. The decline of dollarization in Peru is the result of macro and micro policies. At the macro level, Peru’s main macro-monetary reform involved adopting a strong and independent monetary policy based on IT in early 2002, with the aim to strengthen its residents’ trust in monetary policy, and thus in the domestic currency. Since the introduction of IT, Peru has enjoyed the lowest inflation in South America without adverse consequences for economic growth—which has been record-high—or for exchange rate or interest rate volatility. Importantly, the switch to IT has been associated with declines in the exchange rate pass-through (Leiderman, Maino and Parrado, 2006).

8. In addition to macro-monetary reforms, Peru has issued a series of micro regulations aimed at increasing the relative attractiveness of the national currency. Peru’s approach has been more gradual and market-friendly than that of other countries, which have directly prohibited the use of foreign currency.9 The most prominent measures include:

  • Regulations directed at non-financial intermediaries. A 2004 law forces retailers and wholesalers to list prices in domestic currency (the law leaves agents free to list prices also in dollars).

  • Regulations directed at financial intermediaries. In July 2006, the Superintendency of Banks and Insurance Companies (SBS) established that banks have to carry out a routine evaluation of currency risks of their credit in foreign currency, or alternatively, set up a reserve ranging from 0.25 percent to 1 percent of the credit in foreign currency that has not been evaluated. The methodology used to evaluate risk can differ among banks, but needs to be approved by the SBS in all cases.

  • Finally, Peru has been actively developing its domestic debt markets in local currency in the last years.10 Private bond issuances in local currency have increased in the first half of 2006, in line with a trend started in recent years. Although private sector issuances of fixed income securities are still primarily in foreign currency, the percentage of domestic currency securities is rising steadily (Table 3).

D. What is Inflation Targeting?

9. Inflation Targeting (IT) is one of the operational frameworks for monetary policy aimed at attainting price stability. In contrast to alternative strategies which seek to achieve low and stable inflation through targeting intermediate variables, such as the growth rate of a money aggregate or the exchange rate against an “anchor” currency, IT targets inflation directly.

10. The literature offers several definitions of IT.11 In practice, however, IT has two main characteristics that distinguish it from other monetary policy strategies:

  • The central bank is mandated, and commits to a unique numerical target in the form of a level or range of annual inflation. The requirement under IT of a single target emphasizes that monetary policy has a main objective which receives priority over other objectives. The nature and numeric specification of the objective provides a guide to what the authorities ultimate policy objective is—price stability—and what they mean by it in practice.

  • The inflation forecast over some horizon is the de facto intermediate target of policy. For this reason, IT is sometimes referred to as “inflation forecast targeting” (Svensson, 1998). Since inflation is partially predetermined in the short term because of existing price and wage contracts, indexation to past inflation or inertia in inflation expectations, monetary policy can only influence future and expected inflation. By altering monetary conditions (in response to new information), central banks influence expected inflation and bring it in line over time with the inflation target, which eventually leads actual inflation to the target.

11. To date, IT has been adopted by 24 countries—including five in Latin America. In these countries, which include industrial and emerging market countries alike, the experience with IT has been positive (IMF, 2005). The IT framework is one of constrained discretion, where central banks adopt or are mandated a target and can choose the operational strategy that they deem most appropriate to achieve it, taking into account the short-run tradeoffs faced by monetary policy—namely between inflation and output, and between inflation and the real exchange rate. Under dollarization, both tradeoffs are typically harsher, as discussed in the next section.

E. How Does Dollarization Affect Monetary Transmission?

12. In an open economy, monetary impulses affect inflation mainly via three channels: (i) aggregate demand and supply—via the effect that changes in short-term money market rates exert on the disposable income of savers and borrowers, and on firms’ marginal cost of production through changes in the cost of capital; changes in monetary conditions also affect asset prices, which in turn affect agents’ financial wealth, with consequences for aggregate demand; 12 (ii) inflation expectations—through the effect of changes in official interest rates on the future course of real economic activity and on the confidence with which those expectations are held; and finally, (iii) the exchange rate—via changes in domestic relative to foreign monetary conditions.

13. Conducting an independent monetary policy aiming at price stability through IT is more complicated, but still possible under financial and/or real dollarization, given specific conditions. Table 2 summarizes the relationship between different types of dollarization and monetary policy considering extreme cases of dollarization.13

Table 2.

Dollarization and Monetary Policy

article image
Table 3:

Currency Composition of Fixed-Income Securities Issued by the Private Sector 1/

(In percentage)

article image
Source: BCRP.

Includes bonds and short-term paper issued by private financial institutions.

14. Under “full” real dollarization, the exchange rate pass-through to wages and prices becomes complete, since prices and wages are continuously and fully revised to incorporate exchange rate changes. This magnifies the impact of exchange rate shocks onto consumer price inflation following every such shock, if inflation expectations are not anchored. In these circumstances, monetary policy can still offset the impact of such shocks—if prices and/or wages are sticky due, for example, to time or state-dependent contracts, because in this case monetary policy can affect excess demand through the difference between the real consumption wage and the real product wage.

15. Under “full” financial dollarization, changes in the exchange rate have an additional (and opposite) effect on the output gap above the standard effect on net trade. This is due to the fact that they also affect firms and households’ balance sheets when these include assets and liabilities in different currencies and not perfectly matched—the open economy financial accelerator. In these circumstances, monetary policy continues to have real and nominal economic effects because it can still affect the amount of base money in domestic currency—although it has now less control on money’s own rate of return, which under full financial dollarization is defined by the interest rate on dollar deposits. In addition, the ability of monetary policy to affect aggregate demand is reduced because exchange rate changes that would stimulate net trade now also have contractionary effects, and the economy is more vulnerable to exchange rate shocks.

16. For big enough depreciating shocks, financial dollarization can lead to severe credit crunches. In turn, these credit crunches can have contractionary effects on real activity as agents who have borrowed in dollars and earn their income in domestic currency may find themselves unable to service their debt. In this case, the effectiveness of monetary policy is reduced further because transmission through the output gap channel is impaired, as a large fraction of agents suddenly becomes credit constrained.

17. Both in the case of real and financial dollarization, inflation expectations are harder to anchor relative to the case of no dollarization. This needs not complicate transmission if monetary policy has a clear commitment toward price stability and acts consistently and transparently in the pursuit of its mandate—although it may require more aggressive and pre-emptive policy responses to keep expectations anchored at times of shocks. For example, following an inflationary shock, monetary policy in a real or financially dollarized economy may have to respond faster (i.e., use shorter feedback horizons) than what is the norm under no dollarization. This is necessary to pre-empt the development of secondary effects on actual inflation because they are larger and harder to control when expectations are not well anchored. Likewise, changes in the policy instrument may have to be larger and/or more sustained in a dollarized economy relative to what is optimum in an economy that is not dollarized, other things being equal.

18. It is considerably more difficult to target inflation successfully with transaction dollarization than with other forms of dollarization. In a theoretical case, in which dollars are the only accepted means of payment, agents hold and spend in dollars. In this case, the relevant interest rate for decisions on intertemporal consumption (and thus aggregate demand) becomes the interest rate paid on dollar saving. Although monetary policy can still determine the interest rate on saving in domestic currency, it cannot affect dollar interest rates. These largely depend on the existing stock of dollars in the economy. Additionally, in this scenario, inflation expectations are disconnected from changes in domestic monetary conditions, depending rather on expectations of exogenously-driven changes in dollar liquidity. Likewise—although monetary policy can still affect the exchange rate by opening interest rate differentials between domestic and dollar denominated assets—changes in the exchange rate no longer have material effects on domestic inflation since all nominal variables are already expressed in dollars. It follows that the only monetary policy regime compatible in the short run with high or full transaction dollarization is a fixed exchange rate.

19. There is now a body of empirical literature analyzing the causes of dollarization and its consequences for policy management. The main finding—in line with Peru’s experience—is that financial dollarization has not been an impediment to achieving price stability. Financially dollarized countries do as well as non-dollarized countries in terms of inflation (Reinhart, Rogoff, and Savastano, 2003; Ize and Levy Yeyati, 2003; and Rennhack and Nozaki, 2006). In non-IT countries, these results appear to be associated with central banks’ extensive use of exchange rate anchors (Morales, 2006; Leiderman, Maino and Parrado, 2006). In Peru, where inflation is targeted directly, low inflation results in part from a timely response to demand and supply shocks, as well as from the success of the central bank at minimizing the adverse impact of exchange rate shocks on agents’ balance sheets (Armas and Grippa, 2006). It also results from the fact that, in Peru, the exchange rate has been relatively stable since IT was introduced, even if the central bank has not committed explicitly to any particular exchange rate parity.14

20. Existing studies suggest that, under financial dollarization, IT with flexible exchange rate is the best option for monetary policy. A policy of fixed exchange rates can exacerbate financial distress because it obliges the monetary authorities to raise domestic interest rates during contractionary episodes (Gertler, Gilchrist, and Natalucci, 2003). By contrast, commitment to an inflation target combined with floating exchange rates plays an insulating role against external real shocks, even when real depreciations alleviate the contractionary impact of the financial accelerator by shifting demand toward domestic goods (Céspedes, Chang, and Velasco, 2004). Similar findings are obtained using models of economies with transaction dollarization (Felices and Tuesta, 2006; Batini, Levine, and Pearlman, 2006). Simulations produced using these models also lend support to the view that under dollarization monetary policy needs to be more aggressive, and that the inflation-exchange rate tradeoff is harsher than under no dollarization.

21. The adoption of the IT framework has certainly helped anchor inflation expectations by clarifying the mandate of the central bank. It has also helped make monetary policy more transparent and target-consistent with an interbank rate as an operative target. However, the central bank’s stronger emphasis on exchange rate stability, relative to non-dollarized inflation-targeting countries, has complemented that on price stability. In particular, Peru has (i) intervened by far more actively in the foreign exchange rate market than central banks in non-dollarized economies; (ii) kept a higher level of international reserves as a self-insurance mechanism against dollarization risks, as well as much higher reserve requirements on dollar than on domestic currency liabilities of financial intermediaries;15 (iii) tended to select interest rate changes compatibly with the inflation target, but taking into account exchange rate pressures—like during the recent presidential election period. Figure 3 shows that foreign exchange rate interventions have been sizeable since the introduction of IT, resulting in a relatively stable exchange rate over the IT period. Peru’s NIRs are also among the highest in the region, independently of how they are measured.

Figure 3.
Figure 3.

Peru’s Real and Nominal Effective Exchange Rate and Central Bank Interventions, 1994–2006

Citation: IMF Staff Country Reports 2007, 053; 10.5089/9781451831092.002.A003

F. Peru’s De-Dollarization Agenda

22. Peru needs to continue implementing policies that reduce dollarization to help reduce vulnerabilities in the economy and make the IT framework more effective. Success in reducing further and permanently the level of dollarization requires an integrated approach that includes strengthening regulations at the micro level as well as promoting markets in local currency and hedging instruments. In this regard, a fast and efficient de-dollarization program requires coordination between the central bank, regulatory agencies, and the Treasury.

23. With dollarization in Peru still high, policy actions on several fronts seem necessary. Since there are important synergies between these actions, it would be important that all are implemented rather than only some. Key policy actions include:

Monetary policy measures

  • The decline in dollarization since the adoption of IT suggests that strengthening its credibility could further promote de-dollarization.

    • ➢ Allowing for increased exchange rate flexibility would strengthen the credibility of IT and promote de-dollarization. A gradual but continuous effort to render the exchange rate more flexible can help agents internalize currency risks and minimize market perceptions of exchange rate “floors”, thus encouraging them to take cover against these, either via hedging or by holding more assets and liabilities in domestic currency.

    • ➢ The central bank should keep steering inflation in a transparent and consistent manner In addition, strengthening the independence of the central bank would further solidify the credibility of the IT framework. For example, reforms could extend the tenures of central bank board members and de-link the appointment of BCRP president and board members from the political cycle—a common practice in many central banks—that can help buttress the anti-inflation credentials of the government and public trust in the domestic currency.

Prudential regulation measures

  • The incentives for banks to lend more in domestic currency need to be strengthened. The provisions required by the recently introduced regulation guarding against banks’ credit risk of foreign currency lending to unhedged borrowers may be set too low to prevent banks to lend in dollars, particularly in the market for mortgages. At their current level, these provisions can cover the expected risk at the micro level—assuming that such a risk has been quantified correctly. However, the regulation may not offer protection against systemic risks or contagion, which would require an additional provision for generic risks. Building higher provisions against loans in foreign currency, particularly long-term loans like mortgages, would provide a more adequate coverage for currency risks and help discourage this type of lending in dollars.

  • Continue evaluating the optimal system of reserve remuneration. The central bank had kept the rate of remuneration on required reserves on dollar-denominated liabilities fixed at 2¼ percent since June 2005, and raised it to 2½ percent in July 2006 and 2¾ percent in December 2006. Taking into account the rise in U.S. interest rates over the past two years, the central bank should continue to assess the tradeoff between efforts to promote de-dollarization and to internalize dollarization risks through the maintenance of a low rate and its possible adverse effects on financial intermediation in dollars. A small but negative spread between the rates of remuneration of reserves in dollars and the U.S. interest rates of deposits abroad may be good for de-dollarization purposes, yet more analysis is needed to understand how small such spread should be.

  • The system of deposit insurance could better internalize dollarization risks. At present, the cost of this insurance is equal for soles and dollars and insurance premium is differentiated by overall bank risk. The latter should incorporate dollarization risks on the grounds that dollar deposits carry higher risks.16

  • The government-sponsored MiVivienda mortgage program could serve as a potential vehicle for de-dollarizing mortgage lending. However, the efficiency and costs of MiVivienda should be carefully considered before more funding is arranged or efforts to securitize its assets are made. Under Peru’s de-dollarization plan, MiVivienda will lend progressively more in domestic currency. However, MiVivienda own funds are relatively low due to large demand, and MiVivienda co-lending programs with private banks have become less attractive. As a result, private banks have preferred to proceed alone in expanding their secured lending in domestic currency. Now that banks are offering credit in Nuevo Soles to low income/high-risk borrowers, MiVivienda could complement the banks’ credit supply in soles by targeting lower income borrowers to whom banks will not lend, including by expanding its operations in soles under the Techo Propio program. In either case, the government would have to recapitalize MiVivienda, and plans to do so should take into account the value added of MiVivienda in today’s loan market in soles, as well as the opportunity cost of recapitalization.

  • Regulation should be created to discourage or prohibit pricing of credit in soles at “fixed-but-readjustable” rates. Currently all fixed-rate lending contracts are accompanied by clauses giving banks discretion to readjust rates with no cause or anticipation—i.e., are “fixed-but-readjustable”—which impedes the writing of hedge contracts both by borrowers and lenders. This creates interest rate uncertainty among borrowers—and more so among borrowers in soles, since the trust in the long-run stability of the domestic currency is not yet total.

  • The central bank, together with banks and the SBS, should develop a marketing strategy to teach unhedged agents the risks of lending and borrowing in dollars. It would be appropriate to do this through a professional marketing company that can explain such financial risks in simple terms to large audiences with various education levels. Lenders in dollars should be obliged by the SBS to have their clients sign a form stating that they understand the currency risk they will be facing if borrowing in foreign currency. The SBS should mandate lenders in dollars to market SBS-approved anti-dollarization campaigns within their branches and online.

Financial markets measures

  • Develop markets for instruments to hedge currency risks. So far this market has been dominated by agents that hold domestic currency and want to cover themselves against a possible depreciation of the domestic currency going forward (forward venta). One way to boost the supply of forward venta (or equivalently, the demand of forward compra) is to ensure that private pension fund (AFPs) with foreign currency exposed portfolios take cover through the purchase of forwards, as is done, for example, in Chile (lifting or raising limits for AFP investment abroad would also help in this respect). Exporters are another category that should naturally be supplying forwards, although their participation in this market so far has been scant. More exchange rate flexibility would produce symmetric expectations and would encourage the development of a market for financial hedges; in particular, more exporters would seek cover in this market to avoid exchange rate risks.

  • Domestic bond markets in soles should be deepened further. This includes measures to: (i) continue the process of solarization and lengthening of maturities of the public debt in Nuevo Soles; (ii) develop the interbank market for repurchase agreements, imposing uniform repo contracts and reforming the fiscal treatment of interest rates accrued on repos; (iii) publish the yield curve for private paper to help guide prices in the secondary bond market; (iv) continue developing market infrastructure, including the ongoing central bank project to set up a delivery versus payment system; and (v) reduce or eliminate limitations for issuance of paper in the capital market.

  • Finally, more research is needed both at the macro and at the micro level. This would help continue support the design of optimal macro-monetary, prudential, and financial policies in the face of high dollarization.

G. Conclusions

24. Dollarization is a widespread phenomenon in many emerging market countries. It is often a legacy from past episodes of high (or hyper) inflation and can persist long after inflation has been controlled.

25. Although it does not necessarily prevent a central bank from running an independent monetary policy, dollarization can severely affect the transmission of monetary policy. In particular, it can harshen the inflation-output variability trade-off—and pose serious vulnerability risks. The ultimate effects of dollarization depend on whether it is of the transaction, real or financial form, and/or whether these forms coexist but one of them predominates. Inflation targeting has been successful in better anchoring inflation expectations and lessening the inflation-output variability trade-off in Peru.

26. The experience of Peru teaches that sound macroeconomic policies are a precondition for de-dollarization. Committing to an explicit inflation target and gradually moving away from exchange rate fixity can help agents internalize currency risks. If monetary policy is successful through such strategy at keeping inflation low and stable, inflation targeting can increase economic agents’ trust in monetary policy and thus in the domestic currency, inducing them to move out of dollars. However, recent practice in Peru and other dollarized countries also shows that monetary policy alone is not necessarily sufficient to eradicate high levels of dollarization.

27. Success in reducing the level of dollarization requires an integrated approach that includes regulations at the micro level, as well as the promotion of markets in local currency and for hedging instruments. In this regard, a fast and efficient de-dollarization program requires coordination between the central bank, regulatory agencies and the treasury.

28. Dollarization in Peru is still strong and more coordination is required on various policy fronts to reduce it to low levels, and thereby reduce the vulnerability of the economy to exchange rate shocks.

References

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1

Prepared by Adrián Armas (Manager, Economic Studies Department, Banco Central de Reserva del Perú), Nicoletta Batini (IMF Resident Representative in Peru), and Vicente Tuesta (Research Chief, Banco Central de la Reserva del Perú). The views expressed in this paper are those of the authors.

2

Batini and Laxton (2005), Batini and others (2005), and IMF (2005).

3

In what follows we refer to “dollarization” as a phenomenon related to preferences for holding or storing dollars. In practice, the same phenomenon occurs with other currencies, e.g. euros, as is the case in several countries in Central and Eastern Europe.

4

Reinhart, Rogoff and Savastano (2003), and Batini and others (2005).

5

Ize (2001).

6

For an early discussion see Goldfeld (1976). More recent analysis includes Guidotti and Rodriguez (1992), and Uribe (1997), among others.

7

Ize and Levy Yeyati (1998 and 2006); and Ize (2001).

8

This percentage approximates the share of transactions in dollars relative to total transactions by combining data on (i) ATM dollar withdrawals; (ii) dollar checks; (iii) dollar interbank transfers; and (iv) direct debits in dollars.

9

Hardy and Pazarbaşioğlu (2006) compare market-friendly with aggressive de-dollarization micro-policies, contrasting the case of Peru with that of Bolivia.

10

This is also true on the public debt front. In recent years, Peru has been pre-paying external debt and lengthening maturities of government-issued paper to 20 years. The longest maturity available two years ago was five years, while five years ago the longest available maturity was just two years ago.

11

See, among others, Leiderman and Svenson (1995); Mishkin (1999); and Bernanke and others (1999).

12

See Kohn (2006) for a discussion.

13

Most countries for which Peru’s experience is useful have high but only partial dollarization. From a didactic point of view it is easier to describe the impact of extreme types of dollarization on monetary policy relative to a case of no dollarization, also because the effects of partial dollarization lie in between these two extreme cases, and are closer to one or the other depending on the degree of dollarization.

14

However, Peru is also a good example of bringing inflation rates down under floating exchange rate regimes during the 1990s.

15

The reserve requirement for deposits in Nuevo Soles is 6 percent, while that for dollar deposits is 30 percent. Reserves in dollars beyond 6 percent are remunerated at a rate of 2.5 percent per year.

16

Levy and Broda (2003) analyze the distortion of setting equal insurance costs for both foreign and domestic currency deposits.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Peru: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2007: Issue 053
Publisher:
International Monetary Fund
ISBN:
9781451831092
ISSN:
1934-7685
Pages:
69
DOI:
https://doi.org/10.5089/9781451831092.002
  • View in gallery

    Degree of Transaction, Real and Financial Dollarization in Peru, 2006

  • View in gallery

    Banking and Financial System Dollarization Ratios in Peru, 1993–2005

    (In percentage)

  • View in gallery

    Peru’s Real and Nominal Effective Exchange Rate and Central Bank Interventions, 1994–2006

Degree of Transaction, Real and Financial Dollarization in Peru, 2006

Banking and Financial System Dollarization Ratios in Peru, 1993–2005

(In percentage)

Peru’s Real and Nominal Effective Exchange Rate and Central Bank Interventions, 1994–2006