By Catherine Santos Helen Farfan Marcelo Moran By Catherine Santos Helen Farfan Marcelo Moran Dollarization in El Salvador

What is dollarization? Official Dollarization Semi-official dollarization Unofficial dollarization

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%

El Salvador at the beginning of the 21 st 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. 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.

El Salvador at the beginning of the 21 st Century Telephone services were privatized in 1998, and charges have increased 37 percent since 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 Telephone services were privatized in 1998, and charges have increased 37 percent since 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 ServicePrivatizedChangeSince Telephone %1999 Electricity % Over the last decade WaterNot priv 33% Since 2005 Data from 2002 indicate the cost of these basic services amounted to 41% 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 5 th highest Gini coefficient in the world wth a coefficient of 52.3 (World Bank 2002). 40.5% of income is captured by the top 10% of the population It has the 5 th highest Gini coefficient in the world wth a coefficient of 52.3 (World Bank 2002).

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? 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 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 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

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 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 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

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 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 Never attracted influx of Foreign Investment –Foreign Bank presence remains negligible Posting some of the lowest Growth rates in the region

Annual Trends

The Issuing Country Choices: Passive Acceptance Active Encouragement Active Resistance Choices: Passive Acceptance Active Encouragement Active Resistance

The Issuing Country (Cont.) Advantages May lead to increased trade Elimination of exchange rate risk 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. Disadvantages Affected by shocks in other countries Losing control of currency in circulation outside of the U.S.