Next Steps for Promoting De-Dollarization in Uruguay¹

1. Uruguay has a long history of financial dollarization. Between December 2001 and May 2017, credit dollarization in Uruguay averaged 57 percent, with a peak of 75 percent during the crisis in 2002, while deposit dollarization averaged 78 percent, peaking at 90 percent in 2002. The latest data (from mid-2017) show a slight dip in both credit and deposit dollarization—to 52 percent and 75 percent, respectively—relative to the historical average as well as to levels observed in early 2016 (57 percent and 79 percent, respectively). This paper highlights key findings of empirical studies on de-dollarization, and lessons from the case of Peru, in an attempt to explore what measures Uruguay could take to advance the process of de-dollarization.

2. Many studies have found macroeconomic stabilization, especially lower inflation, to be a necessary ingredient for de-dollarization. Empirical work by Kokenyne et al (2010), Garcia-Escribano and Sosa (2011), Rodriguez and Manookian (2014), and Catao and Terrones (2016), all depicted that solid macroeconomic fundamentals, particularly by way of low and stable inflation and fiscal deficits, were prerequisites for lowering dollarization levels. In addition, Escribano and Sosa, and Catao and Terrones found that nominal appreciation of the exchange rate was also a strong contributor to de-dollarization, particularly for deposits; a trend that can be clearly mapped and confirmed in the case of Uruguay (see chart).

Uruguay: Dollarization and the Exchange Rate

(Percent of total)

Citation: IMF Staff Country Reports 2018, 024; 10.5089/9781484339824.002.A002

Sources: BCU and Fund Staff calculations.

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Uruguay: Dollarization and the Exchange Rate

(Percent of total)

Citation: IMF Staff Country Reports 2018, 024; 10.5089/9781484339824.002.A002

Sources: BCU and Fund Staff calculations.

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Uruguay: Dollarization and the Exchange Rate

(Percent of total)

Citation: IMF Staff Country Reports 2018, 024; 10.5089/9781484339824.002.A002

Sources: BCU and Fund Staff calculations.

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3. However, necessary does not imply sufficient; additional policies are likely needed to drive de-dollarization, on top of sound macroeconomic fundamentals. Multiple studies, including those mentioned above, have found that dollarization is a persistent phenomenon and can remain entrenched even after countries have stabilized their economies and inflation has come down. In order to successfully de-dollarize, complementary policies must be put in place once macroeconomic fundamentals are conducive. In particular, these studies contend that macroprudential policies that help internalize the risks of dollarization, and the development and deepening of local currency capital markets, can help in the process.

4. In the case of Peru, for example, it took a series of prudential, supervisory, and “forced” de-dollarization policies, to complement the macroeconomic environment, and successfully de-dollarize. Between 2001 and 2012, deposit dollarization in Peru decreased from 67 percent of total deposits to 35 percent, while credit dollarization was reduced from 77 percent of total loans to 45 percent. Today, deposit dollarization remains at 35 percent, while credit dollarization has dropped further to 30 percent. Peru’s road to de-dollarization did not happen overnight. Prudential policies to better internalize the risks of dollarization were put in place in the 1990s (such as higher reserve requirements and more stringent liquidity requirements on foreign currency deposits). In addition to these, between 2000–05, the Peruvian authorities introduced a requirement for prices of goods and services to be listed in domestic currency. These measures, together with the introduction of inflation targeting in 2002 and the development of the domestic capital market, all played a role in the gradual de-dollarization of the Peruvian economy—which, until today, still depicts relatively high financial dollarization.

Uruguay and Peru: Dollarization

(Percent of total)

Citation: IMF Staff Country Reports 2018, 024; 10.5089/9781484339824.002.A002

Sources: BCU and Fund Staff calculations.

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Uruguay and Peru: Dollarization

(Percent of total)

Citation: IMF Staff Country Reports 2018, 024; 10.5089/9781484339824.002.A002

Sources: BCU and Fund Staff calculations.

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Uruguay and Peru: Dollarization

(Percent of total)

Citation: IMF Staff Country Reports 2018, 024; 10.5089/9781484339824.002.A002

Sources: BCU and Fund Staff calculations.

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5. Macroeconomic fundamentals in Uruguay now appear to be ripe for a push towards de-dollarization. Inflation has decreased and remained within the BCU’s target band for several months, while the nominal exchange rate has enjoyed a steady appreciation since May 2016. In addition, the authorities have taken advantage of favorable market conditions to further develop the peso debt market, with landmark issuances of nominal peso bonds in global markets this year at medium term tenors.

6. More could be done on the microeconomic and prudential regulatory front to capitalize on current conditions in favor of de-dollarization. Uruguayan authorities could do more to help foster de-dollarization by implementing macroprudential regulations that better internalize foreign exchange risks and other market policies.

• For example, higher reserve requirements (RRs) and lower remuneration on foreign exchange relative to local currency deposits at the central bank (since April 2016, RRs on local currency and foreign exchange have been equivalent), together with higher provisioning and capital requirements on foreign exchange loans, could help internalize the costs of dollarization.

• In addition, similar to Peru and other countries, the authorities could consider stipulating the mandatory listing of prices (and potentially even transacting) of goods and services in local currency. Even if payments continued to be permitted in foreign exchange, listing the prices in local currency could start the long process of de-dollarizing the “mentality” of agents.

• Further development of the domestic capital market to increase opportunities to invest in local currency-denominated securities, including through the establishment of a well-functioning secondary market, and the development of derivatives instruments to hedge interest rate risk, would also help.