By Catherine Santos Helen Farfan Marcelo Moran Dollarization in El Salvador By Catherine Santos Helen Farfan Marcelo Moran
What is dollarization? Official Dollarization Semi-official dollarization Unofficial dollarization Official Dollarization: The dollar is the only legal tender; there is no local currency. Examples of this can be seen in Panama, El Salvador and Ecuador. For example, since independence in 1903, Panama has only used the U.S. dollar. Surprisingly, the U.S. government does not have to provide approval for another country to use its currency as legal tender. Semi-Dollarization: A country will use both its own currency and the U.S. dollar interchangeably as legal tender. Lebanon and Cambodia are good examples of this. Unofficial Dollarization: For many countries in the developing world, the dollar will be widely used and accepted in private transactions, but it is not classified as legal tender by the country's government.
El Salvador
Facts about dollarization When do we implement dollarization in a country? The inflation rate in 2001 was around 4%. Real GDP was around 3% International economic analysts recommend dollarization to countries that are experiencing hyperinflation as a way of bringing about fiscal and budgetary discipline. In the year 2000, El Salvador's economy was not experiencing a crisis; but the government justified the decision to dollarize by stating the expectation that the policy would lower interest rates, increase foreign investment, and decrease transaction costs in international trade, thereby sparking economic growth.
El Salvador at the beginning of the 21st Century Implementation of neoliberal economic policies. External debt was manageable. The economy is strongly tied to the United States. The real source of foreign exchange was remittances from the U.S. -----privatizing the banking system, telecommunications, public pensions, and electrical services; lowering import tariffs; eliminating most price controls; and attempting to attract foreign investment through infrastructure improvements and greater enforcement of intellectual property rights -----total external debt was manageable, at about 23 percent of GDP in 2001 -----US receives about $1.6 billion, or 60 percent, of El Salvador's exports annually. This close trade with the United States does not increase El Salvador's stock of dollars, however, because imports from the United States are about $2.1 billion, resulting in a rather large trade deficit (U.S. Department of State 2002. -----it reached the hefty sum of $1.9 billion in 2001 (U.S. Department of State 2002, 7). This is equivalent to almost 15 percent of GDP.
El Salvador at the beginning of the 21st Century Service Privatized Change Since Telephone 1998 37% 1999 Electricity 1992 221% Over the last decade Water Not priv 33% Since 2005 Data from 2002 indicate the cost of these basic services amounted to 41% of a minimum wage earner's salary Telephone services were privatized in 1998, and charges have increased 37 percent since 1999. Electricity was privatized in 1992, and prices have risen 221 percent over the last decade. Water service, not privatized, has also seen a 33 percent increase in cost over the last three years. Data from 2002 indicate that the cost of these thre basic services amounted to 41 percent of a minimum wage earner's salary
Gini Coefficient 40.5% of income is captured by the top 10% of the population It has the 5th highest Gini coefficient in the world wth a coefficient of 52.3 (World Bank 2002). Lorenz curve is a graphical representation of the cumulative distribution function of a probability distribution; it is a graph showing the proportion of the distribution assumed by the bottom y% of the values. It is a curve that illustrates income distribution
Effects of Dollarization in El Salvador Dollarization ensures that El Salvador’s fortunes will rise & fall with America’s. El Salvador faced several shocks initially Increasing oil prices, US economy slowdown The effects are both positive and negative Would El Salvador be better off having not Dollarized?
Positive and Negative Effects of Dollarization Positive Effects Negative Effects Currency Risk Eliminated A more stable currency Lower Country Risk Premiums Lower transaction costs between former currency & the US dollar Gains in policy credibility Encourages competition Boosts productivity & innovation Predicted benefits that never materialized Prices have increased rather than dropping Wages only rose minimally Distrust of Gov’t by some of its constituents Monetary Integration Law Policy Credibility & economic stability (brought by dollarization) can encourage reforms to promote competitiveness and productivity to overcome internal & external shocks. (refer to wall street journal example*- guy with sewing business in El Salvador) * Encouraging competition refer to Wall street article on guy with his business finding new solutions to still be able to compete Negative Like that of foreign investment, and mention the theoretical benefits that never came about Taxi cab driver The cost of basic products rose and wages didnt rise as much as prices 4. Monetary Integration Law – the decision to fully dollarize instead of having both currencies as legal tender was seen as a violation of MIL
Banking Positive Effects Negative Effects Regulations were restructured & tightened Improved transparency Small Banks can compete with larger banks Initially Lower Interest Rates on Mortgage and Personal Loans Corporate borrowing rates are low Elimination of True Central Bank No Lender of Last Resort Lost control of their own money supply Lost income through Seigniorage Currently Interest Rates are almost as high as before dollarization Nearly impossible to reverse Positive Dollarization supported the performance of an already established banking system. Regulators were given more power to take preventive measures against banks that showed signs of instability (ie political funding) Also brought banking system closer to Int’l standards Have benefited as their funding costs have converged with those of their larger competitors. Negative Elimination of a True Central Bank means no lender of last resort, they cant print their own money (#1, 2 & 3, 4)
Global Financial Integration Positive Effects Negative Effects Banks have improved their performance Gaining competitiveness in the Central American Region Better integration into the Int’l financial system Higher credibility among foreign investors Easier access to cheaper Int’l borrowing Never attracted influx of Foreign Investment Foreign Bank presence remains negligible Posting some of the lowest Growth rates in the region
Annual Trends
Annual Trends
Annual Trends
The Issuing Country Choices: Passive Acceptance Active Encouragement Active Resistance
The Issuing Country (Cont.) Advantages May lead to increased trade Elimination of exchange rate risk
The Issuing Country (Cont.) Disadvantages Affected by shocks in other countries Losing control of currency in circulation outside of the U.S.