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Financial Dedollarization: Policy Options. Eduardo Fernandez-Arias Inter-American Development Bank REGION I. Financial Dollarization. Asset substitution, not currency substitution Holdings of residents, not foreigners

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Financial dedollarization policy options

Financial Dedollarization:Policy Options

Eduardo Fernandez-Arias

Inter-American Development Bank


Financial dollarization
Financial Dollarization

  • Asset substitution, not currency substitution

  • Holdings of residents, not foreigners

  • This focus is highly relevant to the problem of financial dollarization in Region I countries and allows for feasible specific policy options.

Motivation: Financial fragility caused by currency mismatch of assets and liabilities within domestic economy

  • Exposure of peso earning dollar debtors (non-tradeable sector, home mortages)

  • Exposure of banking system (currency risk or credit risk)

  • Fiscal exposure due to all of the above

Financial fragility due to financial dollarization is very dangerous
Financial fragility due to financial dollarization is very dangerous

  • Leads to fear of floating and super-fixed exchange rates (or de jure dollarization) that may end up catastrophically if unsustainable (e.g. Argentina)

  • Imperfections in international capital markets (e.g. sudden stops) lead to large real shocks that also deprive from liquidity: dollarized financial systems are fragile to both

  • Peso domestic financial systems may be a condition for healthy international financial integration

Policy options
Policy Options dangerous

  • Correct/offset market imperfections that may lead to excessive financial dollarization (prudential financial and capital account regulation)

    • Social cost of financial collapse not priced in domestic dollar rates (payment system, economic networks)

    • Currency-blind explicit and implicit public guarantees discriminates in favor of dollar markets

  • Conduct consistent macroeconomic policy (XR, fiscal and debt management)

Policy options1
Policy Options dangerous

  • Help complete domestic financial markets with peso instrument to substitute dollar instrument

    • Need long-duration instrument not subject to surprise inflation

    • Key: Indexation relevant to domestic borrowers and lenders to create attractive item in domestic portfolios

    • Key: Development of equity and equity-like markets

Policy options2
Policy Options dangerous

  • Session II – Experience with policy options to avoid or revert financial dollarization

  • Session III – Analysis of policy options

  • Panel of Central Banks – The policymaker view and what is being done about it

Panel of international financial institutions
Panel of International Financial Institutions dangerous

  • How can IFIs help in fostering local currency markets with lending programs or program conditionality? Help as financial agents?

  • IFIs lending in pesos after selling indexed riskless bonds to dollar saving residents (e.g. pension funds):

    • Avoid crowding out of peso savings

    • Easier than convincing foreigners to invest in pesos (original sin)

    • May pave the way to Eichengreen and Hausmann proposal