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Dollarization in Cambodia is the direct legacy of the destruction of economic and financial institutions after the 1970s, economic mismanagement in the 1980s, and the large inflows of US dollars in the early 1990s. After gaining independence in 1953, Cambodia experienced a peaceful period of steady economic growth for 17 years, with the riel as the main currency used in transactions and assets. In contrast, the period 1970–75 was plagued by a civil war that brought the Khmer Rouge regime to power in April 1975. The radical economic experiments launched during 1975–79 led to bans on private property, money and banking, and trade. Monetary transactions resurfaced in 1979, in the aftermath of a new regime. As a result, the riel was reintroduced as the domestic currency in 1980. A parallel currency, the Khmer riel, was also introduced in March 1993 in areas still under Khmer Rouge control. The period 1980–92 was still affected by the unsettled political structure and the security situation. Substantial monetization of budget deficits during 1988–92 resulted in triple-digit inflation, leading to deep erosion of public confidence in the domestic currency. Large foreign exchange inflows associated with the return of refugees from abroad in the early 1990s and in 1991-92 with extensive operations of the United Nations Transitional Authority in Cambodia (UNTAC) largely fueled soaring bank foreign currency deposits. The cumulative cost of UNTAC intervention was $1.7 billion (that is, about half of estimated GDP in 2001) one of the most costly UN operations. Dollarization has been facilitated by the government’s commitment to an open economy and the existence of an active foreign exchange market managed by licensed money changers that ensured effective access to foreign currency. There are no restrictions on current international transactions and virtually no restrictions on capital transactions. Increasing confidence since late 1998 has been reflected in increased bank foreign currency deposits, with their share in broad money exceeding the pre 1997 level. Three separate phases in Cambodia’s dollarization process are highlighted in chart 1.5. In an initial phase (1991–96), the steady rise of dollarization largely reflected accelerated monetization and formal financial intermediation, against the background of increased capital inflows. In a second phase (1996–97), increased political uncertainties and economic mismanagement led to capital outflows and a decline in foreign currency deposits, resulting in a measured decline in dollarization. In the third phase (1998–2000), dollarization increased again in line with economic recovery. This development reflects the permanent background of continued monetization, increased financial intermediation, and sizable capital inflows. The acceleration of dollarization in recent years, despite successful stabilization, can be explained by a traditional ‘hysteresis’ phenomenon of non-reversibility in the process of dollarization. This phenomenon commonly occurs in dollarized economies, because changing the behavior of individuals regarding the settlement of transactions and holding of financial assets is always a slow process involving deep institutional changes. Moreover, the persistence of capital inflows and a still fragile banking system lacking financial instruments denominated in riels will continue to imply a high degree of dollarization in the foreseeable future. The extent of dollarization, as measured by the share of foreign currency deposits in relation to broad money or total deposits is largely underestimated, owing to the lack of reliable information on foreign currency in circulation and cross-border deposits. As a result, it is difficult to ascertain with precision to what extent dollarization in Cambodia stems from currency or asset substitution Nevertheless, in Cambodia transactions are predominantly in cash and unrecorded foreign currency in circulation — US dollar and, to a lesser extent, Thai baht, is the dominant form of money holding. It is estimated that foreign currency cash holdings are in the range of 85–95 per cent of total currency in circulation, thus implying a money stock significantly larger than measured broad money. In contrast, the domestic currency, the riel, is used only for small cash transactions and mostly in rural areas, and is injected into circulation primarily through government payments for goods and services, including civil service salaries (chart 1.7). 1.6 Foreign currency deposits in Cambodia and neighboring countries
a
measured
as sum of exports and imports
1.8 Ratio of foreign currency deposits to broad money, 1995 and 2000
a
end of June data. 1.9 Ratio of gross official reserves to foreign currency deposits – 2000
a
1999. Benefits and costs of dollarization in Cambodia Dollarization in Cambodia has provided substantial benefits as it has helped cushion the impact of economic and political shocks and supported economic reconstruction in the aftermath of several decades of civil strife, economic mismanagement, and political instability. More specifically, dollarization has facilitated the re-monetization and financial deepening of Cambodia’s banking system and shielded the economy from the spillover effects of the 1997 Asian crisis, as the impact of the riel’s depreciation remained limited (see figures 1.10 and 1.11). Dollarization has also provided a strong protection against exchange rate risks, as the bulk of trade related transactions are effected in US dollars. The costs of high dollarization in Cambodia are both macroeconomic and microeconomic. Macroeconomic costs stem mostly from both the loss of seignorage for the government, and the constraints imposed on monetary policy, because National Bank of Cambodia’s (NBC) operations in riels have almost no impact on monetary aggregates, and control of liquidity growth by the NBC is severely hampered by the limitations of policy instruments available. Currently, in addition to restraint on credit to government and public enterprises, monetary instruments include flexible use of foreign exchange market intervention to influence growth in riel liquidity, changes in reserve requirements, and possible issuance of government or central bank securities. At the microeconomic level, banks hold high unremunerated cash US dollar balances, owing to the lack of a lender of last resort facility in US dollars and Cambodia’s highly cash based economy. One of the main costs of dollarization is forgone seignorage. Seignorage represents the profits accruing to the monetary authorities from their right to issue a legal tender currency, which in turn gives rise to non-interest bearing debt. The monetary authorities can use seignorage revenue either to acquire interest earning assets (that is, foreign currency reserves, government securities, and loans to the banking sector) or to finance a fiscal deficit. The annual flow of seignorage is commonly measured as the increase in the money base net of any interest payments on bank reserves. Using a foreign currency for domestic transactions is equivalent to providing interest-free credit to the foreign country issuing that currency, in the case of Cambodia to the United States and to a lesser extent to Thailand. Forgone seignorage in 2000 is estimated at about 2 per cent of GDP and 17 per cent of total government revenue (table 1.2). Under a fully de-dollarized situation seignorage would accrue to the NBC and would be transferred to the national budget. However, in the event of full de-dollarization, net revenue derived from seignorage would be lower than estimated here, because of profits from unremunerated bank’s required reserves in foreign currency would also be forgone. The loss of an external adjustment mechanism provided by a flexible exchange regime in a de-dollarized environment is also a disadvantage of a highly dollarized regime. However this disadvantage is mitigated to the extent that flexible labor and goods markets are maintained. |
