By Sam Campbell
Economics Today
The Great Recession has brought currency issues—especially the threat of a Euro crisis—to the fore. But for dollarized countries, currency headaches have long been part of the landscape.
With an estimated 90 percent share of money in circulation in Cambodia denominated in dollars, the kingdom is heavily dollarized.
The US dollar is the main alternative currency across Cambodia, Laos and Vietnam, though only in Cambodia is the greenback uncontested top dog. The Cambodian central bank has repeatedly intervened to defend the riel, raising the question of whether Cambodia should try to de-dollarize its economy.
The Asia Development Bank (ADB) is urging closer cooperation on monetary and financial in Cambodia, Laos and Vietnam (abbreviated to CLV) to effectively address challenges arising from the use of multiple currencies in their respective economies. A new book from the Asian Development Bank (ADB), Dealing with Multiple Currencies in Transitional Economies: The Scope for Cooperation in Cambodia, the Lao People’s Democratic Republic, and Viet Nam, claims working closely together on monetary and financial issues would allow the three neighbors to increase economic stability and introduce common best practices and regulatory standards.
Greater regional dialogue on these issues could also help the three countries to improve the effectiveness of their monetary and exchange rate policies, while reaping greater benefits from their increasing economic interdependence, according to the ADB.
Dollarization has costs and benefits. On the plus side, it can impose (sometimes much-needed) discipline on Governments since they cannot easily finance budget shortfalls by printing money and imposing fresh taxes. If dollarization leads to a near fixed exchange rate, prices are also less volatile.
However, the use of multiple currencies can result in economic authorities losing control over monetary and exchange rate policies. It also restricts the power of central banks as the lender of last resort given they print only one of the many currencies that the public is willing to hold, according to the ADB.
Cambodia is, thus, in somewhat of a bind. The Dealing with Multiple
Currencies book notes that dollarization means the NBC cannot directly control the money supply, and “can only partially determine its exchange rate policy through dollar auctions. As a consequence, fiscal policy becomes the main instrument for influencing the country’s macroeconomic adjustments to internal and external shocks.”
“Dollarization blunts the tools for macroeconomic stabilization, especially monetary and exchange rate policy, which countries need to tackle a variety of economic and developmental issues, such as spiraling inflation. The adjustment to external shocks can also be more prolonged and painful in the presence of the multiple currency phenomenon,” said Jayant Menon, Principal Economist in ADB’s OREI and the book’s other co-author, at the July 6 launch in Phnom Penh.
The National Bank of Cambodia (NBC)’s intervention to stabilize the riel means that the state employs exchange rate policy as social protection policy, Menon said. The NBC’s currency trading is quite unusual as it is “almost like trying to run a fixed rate exchange policy without saying it’s a fixed rate policy,” he added.
Defending the riel in such a way against a long term decline is not feasible, Menon said. One consequence of NBC is the eventual increase in dollarization and an associated increased risk in capital flight.
Less Bad
De-dollarizing is possible and has been successful elsewhere; Egypt, Isreal, Mexico, Poland and Turkey all use their own currency where once the greenback was king.
The options range from officially adopting the dollar—as Panama has done—to enforced de-dollarization.
Official dollarization is “a nonoption,” according to Menon, as it is politically unacceptable.
Equally, forced de-dollarization is “unthinkable,” as it is likely to cause a massive loss in value of the country’s own currency against the dollar. Laos’ attempt to enforce de-dollarization in 1997 resulted in the Kip losing value against the greenback.
A single regional shared currency across Asia could be the answer. The CLV area has already had some experience with a shared currency when the colonial French introduced the piastre de commerce in 1885. The shared currency of French Indochina was successful in combating a multiple currency phenomenon similar to that of today.
But Menon said that a CLV single currency is “not a real option [as] there is no political will in the region.”
In any case, a common currency comes with its own risks, he added, pointing out the EU’s current euro issues.
Instead, Menon personally advocated “muddling through with accelerated reforms,” a set of short, medium and long term responses to boost confidence in a country’s own currency. A gentle and gradual de-dollarization, in other words.
Wages could be paid in riel, Menon suggested. As riel is already used in transactions, the consumption expenditure portion of wages (perhaps around 30 percent) could be paid in riel, leaving the remainder in dollars, the preferred currency for saving.
In the short term, increased incentives could boost confidence in riel as a value store. A higher interest rate would help offset the perceived devaluation in riel, as long as the fluctuation rate is less than the interest rate, Menon said.
Offering stock market listings in riel could be another choice, Menon stated, though he said his personal preference would be to leave the option open.
In the medium term, a currency board arrangement—a monetary authority required to maintain a fixed exchange rate with a foreign currency (in this case the dollar)—could be a transitional measure. Hong Kong, Malaysia and Singapore have all sucessfully used a currency board arrangement.
Reducing currency risk and improving confidence will be important, said Menon, “but key is credibility.” To be sustainable and truly beneficial, a country’s economy must be ready for de-dollarization, he underlined.
Institution building, financial sector development and effective implementation of laws and regulatory mechanisms will be needed.
Pragmatic Intervention
Dr. Hang Chuon Naron, secretary general of the Supreme National Economic Council and secretary general of the Ministry of Economy and Finance, said that Cambodia’s ultimate goal is de-dollarization. But he stressed that the Government would be pragmatic and measured in its response, and allow economic actors to choose which currency to use.
Jayant Menon advocated just such a strategy. “We must recognize that dollarization is not the problem, but a symptom,” he said. “The problem, or the cause, is a lack of confidence in the local currency, whilst the symptom, or the effect, is the use of another currency, such as the US dollar. Addressing the symptom, rather than the problem, is unlikely to work.”
The best advice may come from Gresham’s law. “Bad money drives out good,” famously said the English financier Sir Thomas Gresham (1519-79). He did qualify, however, that the rule works only “if their exchange rate is set by law,” something modern economists often conveniently forget.
Even if Cambodia can eventually dedollarize, the kingdom will face a whole new set of challenges.
As Menon pointed out: “Current uncertainties remind us that having your own currency presents problems too.”
The Asia Development Bank (ADB) is urging closer cooperation on monetary and financial in Cambodia, Laos and Vietnam (abbreviated to CLV) to effectively address challenges arising from the use of multiple currencies in their respective economies. A new book from the Asian Development Bank (ADB), Dealing with Multiple Currencies in Transitional Economies: The Scope for Cooperation in Cambodia, the Lao People’s Democratic Republic, and Viet Nam, claims working closely together on monetary and financial issues would allow the three neighbors to increase economic stability and introduce common best practices and regulatory standards.
Greater regional dialogue on these issues could also help the three countries to improve the effectiveness of their monetary and exchange rate policies, while reaping greater benefits from their increasing economic interdependence, according to the ADB.
Dollarization has costs and benefits. On the plus side, it can impose (sometimes much-needed) discipline on Governments since they cannot easily finance budget shortfalls by printing money and imposing fresh taxes. If dollarization leads to a near fixed exchange rate, prices are also less volatile.
However, the use of multiple currencies can result in economic authorities losing control over monetary and exchange rate policies. It also restricts the power of central banks as the lender of last resort given they print only one of the many currencies that the public is willing to hold, according to the ADB.
Cambodia is, thus, in somewhat of a bind. The Dealing with Multiple
Currencies book notes that dollarization means the NBC cannot directly control the money supply, and “can only partially determine its exchange rate policy through dollar auctions. As a consequence, fiscal policy becomes the main instrument for influencing the country’s macroeconomic adjustments to internal and external shocks.”
“Dollarization blunts the tools for macroeconomic stabilization, especially monetary and exchange rate policy, which countries need to tackle a variety of economic and developmental issues, such as spiraling inflation. The adjustment to external shocks can also be more prolonged and painful in the presence of the multiple currency phenomenon,” said Jayant Menon, Principal Economist in ADB’s OREI and the book’s other co-author, at the July 6 launch in Phnom Penh.
The National Bank of Cambodia (NBC)’s intervention to stabilize the riel means that the state employs exchange rate policy as social protection policy, Menon said. The NBC’s currency trading is quite unusual as it is “almost like trying to run a fixed rate exchange policy without saying it’s a fixed rate policy,” he added.
Defending the riel in such a way against a long term decline is not feasible, Menon said. One consequence of NBC is the eventual increase in dollarization and an associated increased risk in capital flight.
Less Bad
De-dollarizing is possible and has been successful elsewhere; Egypt, Isreal, Mexico, Poland and Turkey all use their own currency where once the greenback was king.
The options range from officially adopting the dollar—as Panama has done—to enforced de-dollarization.
Official dollarization is “a nonoption,” according to Menon, as it is politically unacceptable.
Equally, forced de-dollarization is “unthinkable,” as it is likely to cause a massive loss in value of the country’s own currency against the dollar. Laos’ attempt to enforce de-dollarization in 1997 resulted in the Kip losing value against the greenback.
A single regional shared currency across Asia could be the answer. The CLV area has already had some experience with a shared currency when the colonial French introduced the piastre de commerce in 1885. The shared currency of French Indochina was successful in combating a multiple currency phenomenon similar to that of today.
But Menon said that a CLV single currency is “not a real option [as] there is no political will in the region.”
In any case, a common currency comes with its own risks, he added, pointing out the EU’s current euro issues.
Instead, Menon personally advocated “muddling through with accelerated reforms,” a set of short, medium and long term responses to boost confidence in a country’s own currency. A gentle and gradual de-dollarization, in other words.
Wages could be paid in riel, Menon suggested. As riel is already used in transactions, the consumption expenditure portion of wages (perhaps around 30 percent) could be paid in riel, leaving the remainder in dollars, the preferred currency for saving.
In the short term, increased incentives could boost confidence in riel as a value store. A higher interest rate would help offset the perceived devaluation in riel, as long as the fluctuation rate is less than the interest rate, Menon said.
Offering stock market listings in riel could be another choice, Menon stated, though he said his personal preference would be to leave the option open.
In the medium term, a currency board arrangement—a monetary authority required to maintain a fixed exchange rate with a foreign currency (in this case the dollar)—could be a transitional measure. Hong Kong, Malaysia and Singapore have all sucessfully used a currency board arrangement.
Reducing currency risk and improving confidence will be important, said Menon, “but key is credibility.” To be sustainable and truly beneficial, a country’s economy must be ready for de-dollarization, he underlined.
Institution building, financial sector development and effective implementation of laws and regulatory mechanisms will be needed.
Pragmatic Intervention
Dr. Hang Chuon Naron, secretary general of the Supreme National Economic Council and secretary general of the Ministry of Economy and Finance, said that Cambodia’s ultimate goal is de-dollarization. But he stressed that the Government would be pragmatic and measured in its response, and allow economic actors to choose which currency to use.
Jayant Menon advocated just such a strategy. “We must recognize that dollarization is not the problem, but a symptom,” he said. “The problem, or the cause, is a lack of confidence in the local currency, whilst the symptom, or the effect, is the use of another currency, such as the US dollar. Addressing the symptom, rather than the problem, is unlikely to work.”
The best advice may come from Gresham’s law. “Bad money drives out good,” famously said the English financier Sir Thomas Gresham (1519-79). He did qualify, however, that the rule works only “if their exchange rate is set by law,” something modern economists often conveniently forget.
Even if Cambodia can eventually dedollarize, the kingdom will face a whole new set of challenges.
As Menon pointed out: “Current uncertainties remind us that having your own currency presents problems too.”
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