Dollarisation in the Former Soviet Union: from Hysteria to Hysteresis

Abstract

This paper reviews evidence of dollarisation in Former Soviet Union (FSU) countries, and finds that it is still very high, the well-known hysteresis effect. However high dollarisation – defined as the use of any foreign currency – is not only due to inertial lack of confidence. There is also some tentative evidence that suggests foreign currency is used – in both cash and deposit form – as one of the very few alternative instruments for portfolio diversification in an embryonic financial market. It is also shown that, contrary to the received wisdom, high dollarisation does not seriously impede effective conduct of monetary policy: money demand in FSU countries is stabilising, and the most important objective, meaningful inflation control, has been widely achieved. Thus, high dollarisation is not per se as damaging as often thought, and in fact has a beneficial dimension in promoting financial market development. Nonetheless, high dollarisation remains a concern since it provides mechanisms for magnifying vulnerabilities in the event of a crisis even if it might not be the direct cause of a crisis. This necessarily implies that some policy options (such as immediate exchange rate devaluation) are not viable or very costly in a crisis. Comparative Economic Studies (2003) 45, 329–357. doi:10.1057/palgrave.ces.8100018

Credit Risk Spreads in Local and Foreign Currencies

“…Even when financing from abroad is not available, there is a widespread practice of denominating capital in foreign currency even when raised locally. Dollarization can become pervasive, most notably in countries that have suffered high inflation (see, e.g., Armas, Ize, and Levy Yeyati 2006, Chan‐Lau and Santos 2006, Havrylyshyn and Beddies 2003). 1 People place their savings in foreign currency assets, and many companies and households even prefer to borrow in foreign currency.…”

Macroeconomic effects on emerging-markets sovereign credit spreads

“…Currency mismatches create currency risk and can contribute to financial crises in firms as well as countries (e.g. Caballero and Krishnamurthy, 2005;Catao and Sutton, 2002;Duffie et al, 2003;Gibson and Sundaresan, 2001;Gray et al, 2007;Havrylyshyn and Beddies, 2003;Hilscher and Nosbusch, 2010;Longstaff et al, 2011;Diaz and Gemmill, 2006). 6…”

Dollarization Traps

“…Feige (2003), Guidotti and Rodriguez (1992), Havrylyshyn and Beddies (2003), Kamin and Ericsson (2003), Sahay and Vegh (1996), Savastano (1996), and Van Aarle and Budina (1996) describe the dollarization experience of various Latin American and East European countries. the very strong macroeconomic fundamentals in several of these countries (including Peru and Russia in the early 2000s).…”