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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 Eduardo Fernandez-Arias Inter-American Development Bank REGION I
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 • 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 • 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 Options • 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 Options • 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 • 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