Impact of dollarization in Ecuador, El Salvador, Panama, and Argentina
Introduction
In the middle of the 90’s, different countries faced the financial crises. Some of these crises were severe and of vital importance. These crises majorly include “Tequila crisis”, East Asian crisis, the Brazilian crisis and the Mexican crisis and these hit the whole world leaving a devastating impact on the emerging markets of the world. These crises not only had an adverse effects on the related countries by which these are associated, but they also had affected the growing economy of the other countries. The emerging economies have suffered a serious setback as a result of the meltdowns.
The financial turbulence has disturbed the monetary and the fiscal policies of the nations, leaving grave marks on the local currencies. The treatment which is given to this problem is to maintain the capital flows of the country and avoid the taint affects.
The main purpose of this paper is to explain the impact of dollarization in the Argentina, Ecuador, El Salvador and Panama. It will discuss the economic benefits and the cost of dollarization for these countries. Further, the second aim of this paper is the intense study of the problems and the consequences which were faced by the country while implementing the dollarization.
There are multiple definitions that explain the concept of the dollarization. When the dollar is used then the concept of the dollarization applies to the country, and it is said to be fully dollarized or partially dollarized or unofficially dollarized. The dollar is widely used as a unit of account, means of payment and store of value as well. Partial Dollarization means the holding of the cash and assets of the foreign. The holding of the foreign cash is irrelevant of the fact that either it is legal or illegal. The concept of the partial dollarization is not limited to the asset side, but it has also an implementations on the liability side. The situation of the full dollarization is the concept in which the countries fully apply the dollars in their economy. The country totally abandons the use of the local currency and adopts the dollarization.
Impact of Dollarization in Argentina
First, we will discuss the economic benefit and the cost of dollarization of Argentina. So, to find out the theoretical view of the cost and the economic benefit the literature has studied. According to the literature review, it has found that there are two main groups of the benefits. These groups of benefits are associated with the reduction of the cost of the transaction and the second one is the benefits that are associated with the credible anchoring of the exchange rate of credible currency. The implication of the dollarization also brings the change in the fiscal and the monetary policy of the country. It involves the loosing of the monetary policy of the independence. After considering the various macroeconomic variables, the Argentina dollarizes its economy. Some of the theoretical benefits were made by which the economy of the Argentina was dollarized. The objective of this is to analyze which of the theoretical benefit is in the favor of the Argentina that is: cost relevant (Vernengo and Bradbury 459).
Several issues arose when the dollarization was officially implemented in Argentina. There were majorly two issues which were faced by them to implement it. The first issue which was faced by them is the loss of the capability of collecting the seigniorage revenue. The second issue which was faced by them is the lack of the ability of the central bank to print the money (Vernengo and Bradbury 457).
Benefits and Cost of Dollarization
The concept of the dollarization is better to understand the concept of the cost and benefit analysis. The cost and benefit analysis can be used to apply and check the dollarization. It is to be noted that the dollarization has much more extreme and the lasting character than a fixed exchange regime. These unique characteristics give the dollarization some special qualities while analyzing its merits and demerits.
The fixed exchange regime has mainly the two benefits. The first benefit is the reduction in the cost of the transaction. This reduction in cost is specifically related to the trade and the flows of the investments between the different countries which are involved in the fixed regime. The second benefit is the provision of the nominal anchor to the exchange rate. It alternatively helps the government to reduce the ability to use the exchange rate in a discretionary way (Vernengo and Bradbury 457).
The fixed exchange regime works best in that condition where the participating countries have some goals in common. Its major benefit is to enhance the cost and the benefit.
Issues of Implementation
There are some issues which are arising when the dollarization is implemented. Issues which are face by the Argentina when the dollarization is applied are explained in this section. The two issues are faced by them. The first issue which is faced by them is the loss of the ability to collect the seignior age revenues. And the second big issue was the loss of the central bank’s ability to print money for the last resort (Vernengo and Bradbury 461).
Partial Dollarization in Argentina
The transformation which has made to the Argentina apart from the several macroeconomic variables is based on the external debts, the composition of the currency of the total public bonds, and the currency composition of the total bonds. These include in both the financial and non-financial sectors (Vernengo and Bradbury 461).
Dollarization in Argentina
After getting the stabilized condition and setting the various macroeconomic variable stable, there are still various factors which are there to change the economic conditions of the Argentina from time to time. Argentina had adverse effects on its economy in the mid 90’s. The tequila crisis, the Brazilian crisis, these crisis had no direct link with the country Argentina, but they indirectly played an important role in letting down the economy of the Argentina. They had severe contiguous effects on the financial systems of the Argentina. The major result of this is that the interest rate on the loans is highly unstable. They are not static (Vernengo and Bradbury 458).
Impact of Dollarization on Panama
The Panama is a country which is having a small economy and collecting an overall GDP of $6.9 billion dollars in the year of 1998 with the population of 2.76 million people. It has a small size economy but has a large dollarized economy in the west. It is in the context that the dollar is linked to Panama since 1904 (Cachanosky 433).
The Panama chose to dollarize its economy on the basis of the factors like political and historical rather than the macroeconomics. Panama is considered to be the natural trade crosses for the transit and the deposit. The Panama is a country which is small, and its population is also less as compare to the other countries. Their domestic gross revenue is also less, but they have dollarized their economy. Their searches have proven that the link between Panama and the dollarization is very old (Cachanosky 433).
In the case of Panama, the GDP became more volatile when the monetary and the fiscal policies are absent in the dollarized economy. The provision of the fiscal policies is not acted as the countercyclical. It is relatively more flexible to the exchange regime but comparatively not flexible to the fixed regime. The second impact is the gain in the credibility due to dollarization induced the low rate of inflation and a lower average of variability. The worst impact of this on Panama is the increase in the rate of the taxes on the domestic items. The domestic interest rate is higher in the dollarized economy. The seignior age revenues are not generated on that scale which is to be expected in the non-dollarized economy (Cachanosky 428).
If the lender of the last resort is absent, then the country has to suffer a lot regarding its monetary and fiscal policies. In the lender of the last resort, people put their money in the banks. The banks are required to deposit the fraction of the customer’s money in their reserves. These are made to be a liquid which means if the customers want their money than they can give it to them. A part of these reserves are placed in the central banks. If the banks are failed to provide the money back then, the alternative is to borrow the money from the monetary authority.
The other impact which the dollarization may have on its economy is the usage of the hard currency which is to increase the efficiency of the financial markets. It helps in creating the long run markets and the allocation of the resources which is better than the many of the other fixed exchange regimes. Moreover, the external shares have no preliminary effects on the dollarized economy of the Panama. Dollarization came as a natural result of the external influences which means the international influences in the area and the importance of the Panama (Cachanosky 436).
Impact of Dollarization on Ecuador and El Salvador
Ecuador and El Salvador are the two countries which accept or adopt the dollar currency for the entirely different reasons. In the case of Ecuador, they had to suffer from the severe financial and the banking crisis which led them to the abandon their local currency and adopted the foreign currency that is a dollar. This decrease in the levels of the currency and the tremendous shortfalls of the economy, their currency led to the zero value in 1998. Then, they were left with the only option to dollarize their currency to save their economy. Otherwise, they would be totally ruined.
The case of El Salvador was quite different from the Ecuador. In the case of El Salvador, they dollarize their currency according to the plan. There was a planned conversion of their currency into the dollar as a result of the transformation. After the end of the civil war, the country waited for the good to happen that is they were thinking of growing their economy. Whereas: the rate of dollarization increased in 2001. It received a stimulus in 98 buses started to increase tremendously in 2001 (Swiston 9).
These two countries are giving the great opportunity to study the implementation of the dollarization in their countries for the different reasons.
Ecuador
In 1990’s the economy of the Ecuador was very down. There was extreme poverty, and the gross domestic product is not sufficient to run the long or even short run conditions of the country. The amount of 77% was calculated which was considered to be the external debt of the country. The labor market and the other tax markets were showing less transparency. The banking system was completely crashed. There were no regulatory forces which drove the banking systems. Furthermore, due to the intense attitude of the banks, the governments were also giving favors to them that are bailing them out instead of putting them into the witness boss and inquiring. They instead of determining the cause and abolish them they were just giving them favors. This factor and many other factors which are involved in this played an important role in diminishing the per capita income of the country that lowers the gross domestic output of the country. Moreover, the Ecuador is totally dependent on the consumption of the oil. The demand for the oil was increasing, but the resources were not there to fulfill their needs. Their demand of oil had also increased the fluctuations in the world’s oil prices. Lack of money in the banks and lack of trust in the commercial banks led the economy into the dun hills. The inflation was there, and everything is priced very high (Hidalgo).
As consequences of these, the government had decided to dollarize their economy to stable the economic conditions of the country which were fluctuating at a great speed and it was difficult for them to maintain the situation. So the conditions forced them to implement the dollarization (Hidalgo).
El Salvador
The reason for which the economy of Salvador was dollarized is quite different from that of Ecuador. I n the case of El Salvador there was an agreement which was made after the ending of the civil war in 1992 (Swiston 6).
The living condition of the people was started to improve. The pension was given to the employees. The tariffs were decreased on the imports. And the major is the privatization in which the various sectors like banks and many telecommunication departments. This privatization gave an opportunity to the foreign markets to come and implant their businesses and generate them the revenue which ultimately increase their GDP and revenues. The economy of the El Salvador increases steadily, and the interest rates were the lowest in Salvador (Swiston 11).
The second major difference from Ecuador was the inflation. The rate of inflation in Salvador was steady and stable in 1990. The inflation rate was almost constant, and it is about 10%. So, there was no specific reason for the justification that’s why Salvador dollarizes. The major reason which is considered to dollarize is the low-interest rates, an increase in the investments from foreign, and the lower transaction cost. These all factors stimulate the economic growth of Salvador (Swiston 4).
Dollarization and Its Consequences
In the start of the period of 1960, there was an economist Robert Mundell, introduced the theory of the optimum currency area. This theory explained the parameters in which the region can be considered that it must come under the optimum currency area (Hidalgo).
The currency unions can be divided into two groups. The first group involves those who invent the new currency where the second one is those who are adopting the foreign currency as their own. The latter is called the dollarization. The adopting of the foreign currency does not mean the dollarization, but it can be any currency which includes the Australian currency or any other (Hidalgo).
There is dissimilarity in the unofficial and official dollarization. The unofficial dollarization is due to the result of high rate of interest and the high inflation which forces the people to hold the foreign currency side by side to their local currency where the official dollarization is the concept which is not very common, and it happens only when the country itself decided to adopt the foreign currency.
For discussing the concept of the dollarization, we in the whole analysis consider the official dollarization where the country lost their currency value and adopted the foreign currency. The dollarization results due to the three main factors and they had happened to El Salvador and Ecuador for the same reason (Hidalgo).
Conclusion
In this analysis, we discussed the concept of dollarization and its impact on the various countries which specifically include the Ecuador, El Salvador, Argentina, and Panama. For every country, there is a separate reason for the dollarization to be implemented. In the case of Ecuador the major cause behind that is the inflation and in El Salvador, the driving force was the country’s demand.
Bibliography
Cachanosky, Nicolas. "The effects of US monetary policy on Colombia and Panama (2002–2007)." The Quarterly Review of Economics and Finance54.3 (2014): 428-436. Web
Hidalgo, Juan Carlos. "Dollarization Keeps Ecuador Economically Stable Despite Political Instability". Cato Institute. N.p., 2010. Web. 18 June 2016.
Swiston, Andrew J. "Official dollarization as a monetary regime: its effects on El Salvador." IMF Working Papers (2011): 1-25. Web
Vernengo, Matias, and Mathew Bradbury. "The Limits to Dollarization in Ecuador: Lessons from Argentina." Journal of World-Systems Research 17.2 (2015): 457-462. Print
