A panel-data analysis of interest rates and dollarization in Brazil

Abstract

We investigate the role of financial dollarization and systemic risks in the determination of real interest rates in Brazil. In a simple currencychoice portfolio model, we show that a strategy of reducing dollarization, if it fails to address fundamental macroeconomic risks, leads to higher domestic real interest rates. We confirm this prediction in an empirical panel-based model, involving systemic risk variables, but find that the effect is small after controlling for the risks of dilution and default. We apply our empirical estimates to the case of Brazil -a natural case study given its low degree of financial dollarization and very high real interest rates. The estimated model is unable to explain the high interest rate levels in the aftermath of Brazil's 1994 inflation stabilization. However, since the adoption in 1999 of inflation targeting and floating exchange rates, Brazil's real interest rates are found to be gradually converging to the model's predicted values. The estimation also shows that further reductions in Brazil's real interest rates could be achieved through sound fundamentals that led to investment-grade status rather than financial dollarization. Analisamos o papel da dolarização financeira e do risco sistêmico na determinação da taxa real de juros no

Financial dollarization and systemic risks: New empirical evidence

“…The domestic currency's loss of value leads to its substitution by a strong foreign currency (e.g., the US dollar). Empirically, the level of inflation is positively correlated with dollarization, as shown in Levy-Yeyati (2006), De Nicoló et al (2005, Rennhack and Nozaki (2006), Bacha et al (2007Bacha et al ( , 2009) and Kokenyne et al (2010).…”

“…2 This variable attempts to capture the governmental uncertainties that financial investors face in countries where institutions are weak. The results of Bacha et al (2007Bacha et al ( , 2009 show that an increase in jurisdictional uncertainty leads to an increase in financial dollarization. The authors also used other variables from the WGI, such as voice and accountability, to indicate institutional quality, but their results were unsatisfactory despite strong correlations.…”

“…Their results indicate negative relationships between the level of dollarization and restrictions on dollarization, initial per capita income and rule of law. The rule of law variable, sourced from the World Bank's World Wide Government Indicators (WGI), was also used by Arida et al (2005) and Bacha et al (2007Bacha et al ( , 2009) as a proxy for jurisdictional uncertainty, a concept proposed by Arida et al (2005). 2 This variable attempts to capture the governmental uncertainties that financial investors face in countries where institutions are weak.…”

Raising Investment in Brazil

“…In the view of Arida et al (2005), insufficient property rights protection increases the country risk premium unnecessarily and thereby exerts upward pressure on domestic interest rates, while International Commission of Jurists (2008) suggests that there is scope for enhancing the efficiency of Brazil's judiciary. Gonçalves et al (2007) test different variants of the jurisdictional uncertainty hypothesis and fail to find much empirical support for it, with similar evidence reported in Bacha et al (2009). Pessoa and Nakane (2011) make the point that even if the evidence does not confirm jurisdictional uncertainty as a major determinant of the level of basic interest rates in Brazil, it does help to explain the high level of intermediation spreads referred to below.…”

Dolarização financeira e liquidez internacional na abordagem pós-keynesiana

“…Sendo assim, argumentamos que em países com regimes cambiais mais rígidos a volatilidade cambial é menor, o que reduz os incentivos para a dolarização financeira, em comparação com regimes mais flexíveis. (2006) e Bacha et al (2009), argumentam que quanto mais desenvolvido for o mercado de títulos em moeda local de determinado país, maior é o aprofundamento financeiro deste país, e menor é a manutenção de depósitos/ativos em moeda externa por parte dos bancos. A variável renda per capita inicial é usada como proxy para o grau de aprofundamento financeiro.…”