Financial Dollarization: The Policy Agenda

349 Pages·2006·0.25 MB·English

by  Adrián Armas

Financial Dollarization
Financial Dollarization
The Policy Agenda
Edited by
Adrian Armas
Alain Ize
and
Eduardo Levy Yeyati
* © International Monetary Fund 2006
Softcover reprint of the hardcover 1st edition 2006 978-1-4039-8759-4
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Library of Congress Cataloging-in-Publication Data
Financial dollarization : the policy agenda / edited by Adrian Armas, Alain Ize, and
Eduardo Levy Yeyati.
p.cm.
Includes bibliographical references and index.
ISBN 978-1-4039-8759-4 (cloth: alk. paper)
1. Monetary policy - Developing countries. 2. Currency question - Developing
countries. 3. Developing countries - Economic policy. I. Armas, Adrian, 1965- II. Ize,
Alain. III. Levy Yeyati, Eduardo.
HG1496.F562006
332.4' 564-dc22 2006041757
10 9 8 7 6 5 4 3 2 1
15 14 13 12 11 10 09 08 07 06
Transferred to Digital Printing in 2007
Nothing contained in this book should be reported as representing the views of the /MF, its
Executive Board, member governments, or any other entity mentioned herein. The views
expressed in this book belong solely to the authors.
Contents
List of Tables vii
List of Figures ix
List of Boxes xi
List ofA bbreviations xii
Notes on the Contributors xiv
Acknowledgments xvi
Foreword by Oscar Dancourt and Stefan Ingves xvii
1 Financial Dollarization: An Overview 1
Adrian Armas, Alain Ize and Eduardo Levy Yeyati
Part I Financial Dollarization: Roots and Dynamics
2 Financial Dollarization Equilibria: A Framework
for Policy Analysis 15
Alain Ize
Comments on Chapter 2 35
Olivier Jeanne
3 Financial De-dollarization: Is It for Real? 38
Alain Ize and Eduardo Levy Yeyati
Comments on Chapter 3 61
Roberto Chang
4 Financial Dollarization in Latin America 64
Robert Rennhack and Masahiro Nozaki
Comments on Chapter 4 90
Kevin Cowan
Part II Monetary Policy
5 Inflation Targeting in Dollarized Economies 99
Leonardo Leiderman, Rodolfo Maino and Eric Parrado
6 Inflation Targeting in a Dollarized Economy: The
Peruvian Experience 115
Adrian Armas and Francisco Grippa
v
vi Contents
Comments on Chapters 5 and 6 139
Klaus Schmidt-Hebbel
Part III Prudential Policy
7 To Hell and Back - Crisis Management in a Dollarized
Economy: The Case of Uruguay 147
Julio de Brun and Gerardo Licandro
8 Towards the Effective Supervision of Partially Dollarized
Banking Systems 177
Jorge Cayazzo, Antonio Garcia Pascual, Eva Gutierrez,
and Socorro Heysen
Comments on Chapter 8 213
Julio de Brun
9 Managing Systemic Liquidity Risk in Financially
Dollarized Economies 216
Alain Ize, Miguel A. Kiguel and Eduardo Levy Yeyati
Comments on Part III 238
Philip Turner
Part IV De-dollarization Policy
10 Can Indexed Debt Absolve Original Sin? The Role of
Inflation-indexed Debt in Developing Local Currency Markets 243
Allison Holland and Christian Mulder
11 De-dollarizing the Hard Way 273
Daniel C. Hardy and Ceyla Pazarbasioglu
Comments on Part IV 299
Augusto de la Torre
Comments on Part IV 304
Luis O. Herrera
Comments on Part IV 306
Claudio Irigoyen
Part V Looking Ahead
12 Currency Mismatches and Domestic Liability Dollarization 311
Philip Turner
13 Round Table: Policy Options and Strategies for
Dollarized Economies 318
Index 329
List of Tables
4.1 Dollarization by region, 1995 and 2001 65
4.2 Average inflation by region (in per cent per year) 66
4.3 Selected Latin American countries: deposit and loan dollarization 67
4.4 Indicators of macroeconomic stability, 1980-2003 67
4.5 Summary of free-fall events, 1980-2003 68
4.6 Deposit dollarization: results of cross-country regressions 73
4.7 Deposit dollarization: results of panel data regressions 74
4.8 Latin America: indicators of exchange rate policy 77
4.9 Risk management arrangements in selected highly dollarized
economies, 2004 79
4.10 Corporate sector dollar-denominated liabilities, 2001 81
4.11 Latin America: indicators of currency mismatch, 2000-4 81
4.12 Deposit dollarization: effect of exchange rate policy 82
5.1 Alternative monetary frameworks 102
5.2 Volatility of selected variables 102
5.3 Peru, Granger causality: BCRP rate vs. banking interest rates 109
5.4 Reaction functions (based on GMM), 1993-2005 111
6.1 Inflation targets in some inflation-targeting countries 117
6.2 Peru: average annual inflation rates, 1900-2004 118
6.3 Peru: interbank interest rate 120
6.4 Slope of the IS curve, various countries 124
6.5 Peru: financial dollarization indicators 129
6.6 Peru: treasury bond interest rates in the local capital market 130
6.7 Peru: securities balances and average bond terms 131
6.8 Composition of fixed-income securities issued by the
private sector 132
6.9 Peru: international liquidity indicators 133
6.10 Peru: exchange rate variability 134
6.11 Peru: interest rate variability 135
6C.1 Estimations of Taylor rules for Brazil, Chile and Mexico 142
8AL1 Foreign exchange risk practices for selected countries 198
8AL2 Credit risk regulations for selected countries 200
8AL3 Credit management and stress-testing practices 202
8AL4 Liquidity risk management practices 204
8A2.1 Estimates of annual NPL growth rates in selected
banking systems 207
8A2.2 Peru: estimates of annual provision to loan growth rates 208
8A2.3 Effect of an exchange rate shock (ERS) on NPLs'
and provisions' annual growth rate 208
vii
viii List of Tables
9.1 International reserves, various countries 222
10.1 Market value of inflation-linked bonds 245
10.2 Bid-ask spreads 249
10.3 Latin American inflation experience, 1999-2004 252
lOAl.1 Proportion of index-linked issuance 265
lOAl.2 Sterling inflation-linked issuance 266
lOA2.1 Summary of key characteristics 268
List of Figures
2.1 Interest rates without credit risk 19
2.2 Interest rates with credit risk 22
2.3 The dollarization risk map with an exogenous monetary policy 24
2.4 The dollarization risk map with an endogenous monetary policy 26
4.1 Yield curve for deposit interest rates, 2004 70
4.2 Sectoral composition of commercial bank loans, various countries 80
4.3 Deposit dollarization: out-of-sample forecast 83
4C.1 Mismatch in bank lending in Latin America
and the Caribbean 93
4C.2 Liability dollarization in the tradable and
non-tradable sectors 94
5.1 Peru: interbank rate, 2002-5 103
5.2 Peru: exchange rate and BCRP intervention, 2002-5 104
5.3 Bolivia: exchange rate crawl, inflation and real effective
exchange rate, 1996-2005 105
5.4 Bolivia and Peru: financial dollarization 105
S.Sa Chile: response of inflation to one SD nominal exchange rate
innovation, 1993:01-2005:07 107
S.Sb Peru: response of inflation to one SD nominal exchange rate
innovation, 1993:01-2005:07 107
S.6a Peru: response to one SD innovation :+:2 SE, 1993:01-1998:12 108
S.6b Peru: response to one SD innovation :+:2 SE, 1999:01-2005:07 108
S.7a Chile: real effective exchange rate (year on year) and NPLs,
1993-2004 109
S.7b Peru: real effective exchange rate (year on year) and NPLs,
1993-2004 109
S.8a Chile: response of NPLs to one SD REER innovation 110
S.8b Peru: response of NPLs to one SD REER innovation 110
6.1 Evolution of the operational target interest rate 119
6.2 Interest rate pass-through by loan type, 1999-2004 121
6.3 Interbank, benchmark (ceiling) and overnight deposits (floor)
interest rates (percentage points) 122
6.4 Quarterly projection model: headline inflation path after a
1 per cent transitory domestic currency depreciation shock 123
6.5 Peru: consumer price index 127
6.6 Monetary policy framework in Peru 128
6.7 Peru: inflation target and expectations, 1995-2005 130
6.8 Peru: interest rates for domestic currency Treasury bonds 132
6C.1 Ratio of exchange rate and international reserve volatilities
in six countries 141
ix
x List ofF igures
6C.2 Monetary policy response to the exchange rate in Brazil,
Chile and Mexico 143
7.1 Uruguay: fiscal balance, 1991-2002 150
7.2 Uruguay: currency mismatch across sectors 151
7.3 Uruguay country risk, 1994-2003 153
7.4 Banco de Galicia: total deposits, 2000-2 155
7.5 Uruguay: country risk and bank deposits,
August-November 2002 156
7.6 Uruguay: rate of change of bank deposits,
August-November 2002 162
7.7 Uruguay: spread between LIBOR and the deposit rate, 2002-4 163
7.8 Uruguay: share of sight deposits in the banking
system, 2002-5 164
7.9 Uruguay: exchange rate and inflation, 2002-4 167
7.10 Uruguay: short-term peso interest rate, 2002-5 167
7.11 Uruguay: maturity profile of the domestic and external
public securities 170
8A1.1 Financial dollarization (FD) and capital requirements
(CAR) for selected countries, 2004 199
8A1.2 Financial dollarization (FD) and international reserves
(minus gold) for selected countries, 2004 206
8A2.1 Peru: effect of currency-induced credit risk on the
solvency of the banking system 209
9.1 Liquidity premium 228
10.1 Peru: break-even inflation (for the seven-year bond) 251
10.2 Inflation experience of selected Latin American countries,
1995-2004 258
lOA1.1 Proportion of inflation-linked bonds in portfolio 265
lOA1.2a Five-year UK break-even inflation rate 266
lOA1.2b Ten-year UK break-even inflation rate 267
11.1 Bolivia and Peru: share of foreign currency deposits, 1975-2004 276
11.2 Pakistan: stock of FCDs 281
11.3 Pakistan: contributions to broad money growth 281
11.4 Pakistan: balance of payments and international reserves 282
11.5 Pakistan: cumulative returns on local and foreign
currency assets 283
11.6 Argentina: share of foreign currency loans and deposits,
1994-2004 286
11.7 Argentina: total banking system deposits, 2001-5 287
11.8 Argentina: total bank deposits 288
11.9 Argentina: bank deposits, 1994-2005 289
11.10 Argentina: financial intermediation and financial
deepening 290
12.1 Currency mismatches and reserves coverage ratio 314
13.1 Peru: financial dollarization ratio 323
13.2 Peru: dollarization ratios in the payments system 324