## 1cuwea2021002

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### A. Context and macroeconomic background
- Monetary union and institutions:
  - Curaçao and Sint Maarten formed the monetary union (CSMU) after dissolution of the Netherlands Antilles in 2010.
  - The Bank of Netherlands Antilles became the Central Bank van Curaçao en Sint Maarten (CBCS) with objectives: (i) promoting the stability of the currency; (ii) promoting the health of the financial system; and (ii) promoting safe and efficient payment traffic (CBCS Charter 2010).
  - The CSMU retained the Netherlands Antillean guilder and preserved a peg to the US dollar at 1.79 Netherlands Antillean guilder per dollar since 1971.
  - The three former Netherlands Antilles islands Bonaire, Saba, and Sint Eustatius adopted the U.S. dollar in January 2011.
- Shocks and macro performance:
  - Spillovers from Venezuela’s crisis contributed to recession and a widening current account deficit in Curaçao.
  - Sint Maarten was devastated by hurricanes in 2017.
  - Both countries were hit very hard by the 2020-21 pandemic.
  - Real GDP in 2020 is estimated to be lower than in 2010 in both countries.
  - Curaçao current account deficit (CAD) averaged nearly 22 percent of GDP in 2010-20.
  - Sint Maarten CAD averaged about 3 percent of GDP in 2010-20.
  - Unemployment: since 2010 unemployment has been trending slightly downwards in Sint Maarten while it is higher and has been trending upwards in Curaçao.
  - Youth unemployment: Curaçao almost 30 percent in 2018; Sint Maarten almost 18 percent in 2018.
- Inflation and reserves:
  - Stable peg and low inflation; inflation differential between the two economies within 1.5 percentage points in all years except 2011 and 2019-20.
  - International reserves averaged 4.6 months of imports of goods and services in 2010-20 and exceeded 3 months of imports in any given year, although below the reserve adequacy (ARA) metric (IMF, 2011).
- Purpose:
  - Paper aims to inform authorities’ discussion of official dollarization versus maintaining the current arrangement; choice of exchange rate arrangement is the prerogative of the authorities.

### B. Economic structure, integration, and de facto dollarization
- Structure and asymmetry:
  - Both economies are tourism-oriented and vulnerable to asymmetric shocks due to small size and geographic separation.
  - Curaçao: closer ties to Venezuela, more diversified economic structure.
  - Sint Maarten: predominantly tourism-oriented, mostly tied to the U.S., higher hurricane risk (2017).
- Integration within the union:
  - No customs union; trade between Curaçao and Sint Maarten limited.
  - Labor mobility: unrestricted within the CSMU due to common Dutch citizenship; migration to The Netherlands is relatively easy, creating third-country mobility affecting adjustment and wage flexibility.
  - Capital mobility: free in principle but financial markets are fragmented and underdeveloped; interbank liquidity market practically does not exist.
- Policy coordination and CBCS role:
  - Fiscal framework with the Kingdom of the Netherlands includes a “golden” fiscal rule, 5 percent cap on interest payments of fiscal revenues (averaged over three years), fiscal supervision by College Financieel Toezicht (Cft), and borrowing restrictions (only for capital expenditures except during significant shocks).
  - CBCS is single supervisor for banks/non-bank financial institutions; provides liquidity assistance and operates integrated payments system in local currency and U.S. dollar.
  - Gaps: blurred lines in crisis management and emergency liquidity framework, outdated bank resolution framework, absence of deposit insurance.
  - Macroprudential: CBCS designated authority; no countercyclical capital buffer; instruments include credit caps (currently not active), loan-to-value ratio, liquidity requirements, loans-to-deposit ratio limit, requirement for banks to maintain a positive net open foreign exchange position.
  - CBCS planning Financial Stability Report in 2021.
- De facto dollarization (2020):
  - U.S. dollar circulates freely in both countries.
  - Sint Maarten: financial dollarization 58 percent on the deposit side and 66 percent on the credit side.
  - Curaçao: financial dollarization about 12 percent on the deposit side and 9 percent on the credit side.
  - Dollarization weakens union-wide monetary transmission and creates balance-sheet vulnerabilities; Sint Maarten may face currency mismatch risks given unclear share of borrowers with foreign-exchange income.

### C. Literature findings on benefits and costs of official dollarization
- Main advantages commonly cited:
  - Credible inflation stabilization by rejecting inflationary finance.
  - Elimination of currency risk may reduce country risk premium and interest rates.
  - Lower transaction costs, deeper integration, higher investor confidence.
- Main disadvantages commonly cited:
  - Loss of independent monetary and exchange rate policies.
  - Very limited ability to provide liquidity during financial crises (limited LOLR).
  - Loss of seigniorage.
- Empirical findings summarized:
  - Price stabilization and fiscal discipline: mixed evidence; studies show inflation often lowered or converged to U.S. rates (Quispe-Agnoli 2002; Goldfajn and Olivares 2000) but persistence of volatility and unclear fiscal discipline effects (Berg and Borensztein 2000; Edwards 2001).
  - Interest rates and currency risk: evidence of lower interest rates post-dollarization (Calvo 1999; Berg and Borensztein 2000; Dornbusch 2000) but full convergence to world rates not guaranteed (Eichengreen 2002).
  - Growth and integration: arguments for higher growth via confidence and lower risk exist (Berg and Borensztein 2000; Mendoza 2002) alongside studies finding lower or more volatile growth (Edwards 2001; Goldfajn and Olivares 2000).
  - LOLR and reserves: dollarized economies face constrained liquidity backstops; reserve funds or external lines can help but cannot fully substitute domestic currency issuance.

### D. Timing, institutional patterns, and applicability to Curaçao and Sint Maarten
- Timing and reforms required:
  - Dollarization requires complementary reforms: fiscal policies consistent with a harder budget constraint; strengthened financial system; increased labor market flexibility; economic restructuring to align cyclical fluctuations with target currency area.
  - Evidence that dollarization alone induces reforms is unclear; if full reforms cannot precede dollarization they must be implemented as quickly as possible.
- Institutional patterns in officially dollarized economies:
  - 16 officially dollarized independent economies: six use the U.S. dollar, five use the Euro, four use the Australian dollar, one uses the Swiss franc.
  - Only six (38 percent) have a central bank.
  - Ten are microstates (population up to 250 thousand); only one microstate (San Marino) has a central bank.
  - Prudential supervision exists in all but Nauru; arrangements vary (central bank vs local regulators vs home-country supervision for foreign bank branches).
  - Macroprudential frameworks often underdeveloped.
- Microstates and exchange regimes:
  - Among 23 microstates: 10 are dollarized, 8 belong to a currency union, 5 have local currencies.
  - Maintaining an independent currency/central bank requires resources often unavailable in smallest microstates, explaining prevalence of dollarization or monetary unions.
- Considerations specific to the CSMU:
  - Dollarization would be a major structural change with significant transitional costs; costs higher during the pandemic.
  - Dollarization without supporting reforms would be very risky.
  - CSMU already has low and stable inflation and limited room for independent monetary policy under the long-standing peg.
  - Public sector financing currently uses a special arrangement rather than market issuance.
  - Dollarization by one or both members would effectively imply dissolution of the monetary union and require agreement on a new CBCS mandate/Statute or alternative arrangements for essential functions and division of CBCS assets.
  - For Sint Maarten, small-island constraints pose challenges for continuity of central bank functions.
- Choice of target currency and conversion rate:
  - Two plausible options: US dollar and Euro.
  - Choice could minimize volatility of the real effective exchange rate by favoring the currency of the largest trading partner.
  - Sint Maarten’s dominant ties with the United States suggest the U.S. dollar is a more natural choice; Curaçao is more nuanced with significant Euro Area tourism weight despite most transactions in U.S. dollars.
  - Conversion rate must be credible and aligned with external sustainability; existing CBCS reserves should cover monetary base liabilities denominated in local currency.
  - An incorrect conversion (uncompetitive rate) could trigger protracted adjustment via nominal prices and wages.
- Continuity of central bank functions needed under dollarization:
  - Supervision of financial sector entities including AML/CFT.
  - Macroprudential supervision and policies.
  - An adequate resolution regime for financial institutions.
  - Maintenance of the payment system.
  - Fiscal agent function for government.
  - Analytical support for governments.
  - CBCS could likely continue these in Curaçao; for Sint Maarten, local capacity constraints make continuity challenging and ensuring supervision continuity would be critical.
- Liquidity, reserves, and LOLR constraints:
  - Dollarization elevates need for high-quality supervision and crisis-resolution frameworks.
  - Even with strong supervision, a lender of last resort remains important.
  - Contingency credit lines possible, but first-best in crisis is large reserves.
  - Central bank reserves or government deposits unlikely sufficient for system-wide pressures given current fiscal difficulties.
  - Emergency liquidity arrangements would need to be strict and banks would need significantly higher ex ante liquidity buffers, with potential profitability impacts.
- Operational and fiscal-arrangement interactions:
  - Operational issues: ensuring adequate supply of foreign currency; dollarization saves currency production costs but creates administrative distribution costs.
  - Interaction with current fiscal arrangement: existing access to below-market loans under fiscal supervision reduces immediate fiscal discipline incentives from dollarization alone.
  - Both countries’ vulnerability to external shocks implies continued need for access to external financing; future design of fiscal arrangement is key to dollarization decision.

### E. Policy recommendations and priorities
- Supporting policies required for dollarization to deliver full benefits (Jacome and Lonnberg, 2010):
  - Strong financial sector reform:
    - Address pockets of vulnerability and strengthen prudential/supervisory functions.
    - Introduce higher capital/liquidity requirements.
    - Establish elements of a financial safety net: special resolution regime for banks and a deposit guarantee scheme.
  - Labor market reform and broader structural reforms to enable adjustment via the wage channel.
  - Public financial management reforms and strengthening overall fiscal policy—especially important if the fiscal arrangement is modified.
- Near-term priorities regardless of exchange rate regime:
  - Allocate capacity to priority reforms improving public finances, reducing financial sector vulnerabilities, and increasing resilience.
  - Promote deeper economic integration between Curaçao and Sint Maarten to improve monetary union functioning.
- Political and procedural recommendation:
  - Any country considering dollarization must carry out a serious, open, and broad public discussion of costs and benefits and proceed only on basis of strong political consensus.

*Source: Curaçao and Sint Maarten Monetary Union: Considerations on Dollarization (July 15, 2021).*

### 1. Officially Dollarized Economies_____________________________________________________________ 9

### 1. Officially Dollarized Economies

### A. Context
- Since the dissolution of the Netherlands Antilles in 2010, Curaçao and Sint Maarten became autonomous countries within the Kingdom of Netherlands and formed a monetary union (CSMU).
- The Bank of Netherlands Antilles became the Central Bank van Curaçao en Sint Maarten (CBCS) with objectives: (i) promoting the stability of the currency; (ii) promoting the health of the financial system; and (ii) promoting safe and efficient payment traffic (CBCS Charter 2010).
- The CSMU has retained the Netherlands Antillean guilder and preserved the long-standing peg to the US dollar. The peg has been preserved at 1.79 Netherlands Antillean guilder per dollar since 1971.
- Political and institutional notes:
  - The three remaining islands of the Netherlands Antilles—Bonaire, Saba, and Sint Eustatius—became special municipalities of the Netherlands and adopted the U.S. dollar in January 2011.
  - The IMF Articles of Agreement allow a member country to adopt an exchange arrangement of its choice within the parameters set forth in Article IV, Section 2; responsibility for compliance with the obligations under the Articles is with The Kingdom of the Netherlands as a Fund member.
- Macroeconomic experience and shocks:
  - Spillovers from the deep crisis in Venezuela affected Curaçao, contributing to a recession and widening current account deficit.
  - Sint Maarten was devastated by hurricanes in 2017.
  - Both countries were hit very hard by the 2020-21 pandemic.
  - Real GDP in 2020 is estimated to be lower than in 2010 in both countries.
  - Curaçao current account deficit (CAD) averaged nearly 22 percent of GDP in 2010-20.
  - Sint Maarten CAD averaged about 3 percent of GDP in 2010-20.
  - Unemployment trends: since 2010 unemployment has been trending slightly downwards in Sint Maarten while it is higher and has been trending upwards in Curaçao.
  - Youth unemployment: Curaçao almost 30 percent in 2018; Sint Maarten almost 18 percent in 2018.
- Inflation and reserves:
  - The CSMU has delivered a stable exchange rate and low inflation; inflation differential between the two economies has been within 1.5 percentage points in all years except 2011 and 2019-20.
  - Inflation closely followed averages for the tourism-oriented Caribbean and the Eastern Caribbean Currency Union (ECCU).
  - International reserves averaged 4.6 months of imports of goods and services in 2010-20 and exceeded 3 months of imports in any given year, although they were below the reserve adequacy (ARA) metric (IMF, 2011).
- Purpose: The paper lays out issues for authorities to consider in discussing official dollarization versus maintaining the current arrangement; the choice of exchange rate arrangement is the prerogative of the authorities and the paper aims to inform the discussion rather than provide policy advice.

### B. Economic Structure of the Monetary Union of Curaçao and Sint Maarten
- Size, specialization, and asymmetric shocks:
  - Both economies are tourism-oriented but vulnerable to asymmetric shocks due to small size and geographic separation.
  - Curaçao: closer ties to Venezuela, more diversified economic structure and linkages.
  - Sint Maarten: predominantly tourism-oriented, mostly tied to the U.S., higher hurricane risk (2017 example).
- Degree of integration despite currency union:
  - No customs union; trade in goods and services between Curaçao and Sint Maarten is limited and likely marginal.
  - Labor mobility is unrestricted within the CSMU due to common Dutch citizenship; migration to The Netherlands is also relatively easy, creating "third country" mobility which affects adjustment and wage flexibility.
  - Capital mobility is free within the CSMU in principle, but financial markets are fragmented and underdeveloped (e.g., interbank liquidity market practically does not exist); financial linkages between Curaçao and Sint Maarten are limited to intercompany relationships within financial institutions.
- Policy coordination frameworks:
  - Fiscal arrangement with the Kingdom of the Netherlands provides de facto fiscal coordination:
    - Features include the “golden” fiscal rule (current expenditure must be equal or lower than current revenue in any given year), a cap of interest payments to 5 percent of fiscal revenues (averaged over three years), and fiscal supervision by College Financieel Toezicht (Cft).
    - Deviations from the rule are allowed only for major shocks and require approval by the Kingdom Council of Ministers.
    - Borrowing is permitted only for capital expenditures except during significant shocks; the standing subscription arrangement provides access on the terms set at the Dutch capital markets and does not include a risk premium.
  - Banking union and CBCS role:
    - The CBCS is a single supervisory authority for banks and non-bank financial institutions with powers to provide liquidity assistance.
    - There is an integrated payments system providing clearing and settlement services to both countries in both local currency and the U.S. dollar.
    - Gaps exist in crisis management and financial safety net frameworks: blurred lines between monetary policy operations and emergency liquidity framework, outdated bank resolution framework, absence of a deposit insurance system.
    - CBCS is the designated macroprudential authority, but the macroprudential policy framework is in early stages: no countercyclical capital buffer; existing instruments include credit caps (currently not active), loan-to-value ratio, liquidity requirements, limit on loans-to-deposit ratio, and a requirement for banks to maintain a positive net open foreign exchange position.
    - CBCS has developed a financial sector reform program and is planning to launch the Financial Stability Report in 2021.
- Degree of de facto dollarization:
  - The U.S. dollar circulates freely in both countries.
  - Sint Maarten financial dollarization in 2020: 58 percent on the deposit side and 66 percent on the credit side.
  - Curaçao financial dollarization in 2020: about 12 percent on the deposit side and 9 percent on the credit side.
  - Dollarization weakens transmission of union-wide monetary policy and creates vulnerabilities to balance sheet effects in case of exchange rate adjustments; Sint Maarten may face currency mismatch risks given unclear share of borrowers with foreign-exchange income.

### C. Benefits and Costs of Official Dollarization: Literature Review
- Overview:
  - Main advantages commonly cited: (i) rejecting inflationary finance by the central bank leads to credible inflation stabilization and may incentivize fiscal discipline; (ii) elimination of currency risk reduces country risk premium and interest rates; (iii) lower transaction costs and greater policy credibility promote deeper integration into the world economy; (iv) higher investor confidence promotes investment and growth.
  - Main disadvantages commonly cited: (i) loss of independent monetary and exchange rate policies; (ii) very limited ability to provide liquidity during financial crises (limited LOLR); (iii) loss of seigniorage.
  - Net benefits and costs depend on existing exchange rate regime and country-specific circumstances; supporting policies are required to realize benefits while minimizing disadvantages.
- Benefits (literature findings):
  - Price stabilization and fiscal discipline:
    - Quispe-Agnoli (2002): inflation lowered or remained low after dollarization in Panama, El Salvador, and Ecuador.
    - Edwards and Magendzo (2001): broader support for inflation reduction under dollarization.
    - Goldfajn and Olivares (2000): inflation rates tend to converge to the U.S. rate when the U.S. dollar is adopted.
    - Berg and Borensztein (2000) caution that some volatility can persist as the U.S. dollar fluctuates against other currencies.
    - Edwards (2001) and Goldfajn and Olivares (2000) find mixed evidence on whether dollarization leads to stronger fiscal discipline.
  - Elimination of currency risk and lower interest rates:
    - Kokenyne et al. (2010): lending in foreign currency may reduce cost of credit, supporting consumption and investment.
    - Calvo (1999), Berg and Borensztein (2000), Dornbusch (2000): interest rates decline after dollarization.
    - Goldfajn and Olivares (2000): unclear whether lower interest rates reflect dollarization or stronger global financial integration.
    - Eichengreen (2002): reduction of currency risk does not eliminate sovereign default risk, so full convergence to world interest rates is not guaranteed.
  - Deeper integration in the world economy:
    - Dollarization eliminates need for hedging currency risk and lowers transaction costs, potentially boosting trade and investment (Kokenyne et al., 2010; Morandé and Schmidt-Hebbel, 2000; Panizza and others, 2000; Berg and Borensztein, 2000).
  - Stronger economic growth:
    - Many studies argue dollarization can lead to higher growth via increased investor confidence and lower exchange rate risk (Berg and Borensztein, 2000; Mendoza, 2002).
    - Countervailing studies: Edwards (2001) and Edwards and Magendzo (2001) find dollarized economies have lower growth; Goldfajn and Olivares (2000) find growth may be more volatile without monetary and exchange rate buffers.
- Costs (literature findings):
  - Loss of monetary and exchange rate policies:
    - Dollarizing economies give up independent monetary and exchange rate policies (Berg and Borensztein, 2000), losing tools to absorb shocks; adjustment rests on prices and wages, potentially causing protracted recessions.
    - Calvo (1999) notes devaluations can be very disruptive depending on currency composition of liabilities; trade policy could be used to address misalignments.
  - Limited lender of last resort (LOLR):
    - A dollarized economy cannot create domestic currency to backstop banks; liquidity support options are constrained.
    - Calvo (1999): central banks can play coordination roles or rely on international liquidity; Berg and Borensztein (2000): reserve funds or lines of credit with international lenders can help with non-systemic short-term liquidity needs.
    - The significance of lost LOLR capacity may be limited because central banks’ ability to create money to deal with crises is typically constrained.
  - Loss of seigniorage:
    - Dollarization eliminates seigniorage revenue; this loss can be offset by lower borrowing costs (Dornbusch, 2000).

*Source: Curaçao and Sint Maarten Monetary Union: Considerations on Dollarization (July 15, 2021).*

### 10.      The literature has also debated the important issue of the optimal timing of

### 10–E. Dollarization: timing, institutions, and considerations for Curaçao and Sint Maarten

### Timing and need for supporting reforms
- Dollarization needs strong complementary policies to deliver full benefits and minimize risks (Eichengreen, 2002).
- Key supporting reforms required:
  - Fiscal policies consistent with a much harder budget constraint.
  - Strengthened financial system to reduce crisis risk in the absence of a lender of last resort.
  - Increased labor market flexibility to allow adjustment to shocks.
  - Economic restructuring to minimize differentials in cyclical fluctuations with the target currency area.
- Evidence that dollarization itself incentivizes these reforms is unclear; dollarization “delivers quick gains in monetary credibility and price stabilization, it does not automatically enhance the credibility of other policies” (Eichengreen, 2002).
- If full implementation of complementary reforms before dollarization is not feasible, reforms “need to be implemented as quickly as possible to minimize risks” (Jacome and Lonnberg, 2010).

### Institutional arrangements in officially dollarized economies
- There are 16 officially dollarized independent economies; the majority are microstates.
  - Six use the U.S. dollar, five use the Euro, four adopted the Australian dollar, and one uses the Swiss franc.
  - Only six officially dollarized economies (38 percent of the set) have a central bank.
  - Ten dollarized economies are microstates, defined here as independent states with population of up to 250 thousand.
  - Only one of the microstates (San Marino) has a central bank.
- Supervision and oversight patterns:
  - Prudential supervision of banks and non-bank financial institutions exists in all but Nauru.
  - Of six dollarized economies with central banks, four (Kosovo, Montenegro, San Marino, Timor-Leste) place prudential supervision with their central banks.
  - Five dollarized economies (Andorra, Liechtenstein, Ecuador, El Salvador, Panama) use local regulatory authorities for supervising banks and non-bank financial institutions.
  - Several Pacific microstates rely on supervision of foreign banks by home regulators of parent banks (example: U.S. banks operating in Micronesia, Marshall Islands, Palau supervised directly by the FDIC); in Monaco, banks are supervised by the French Commission Bancaire.
  - All states have arrangements for financial integrity supervision—at minimum financial intelligence/financial transactions units.
- Macroprudential surveillance and policies:
  - In dollarized economies with central banks, macroprudential supervision/policies are implemented by central banks (San Marino: development in progress).
  - In many dollarized economies, the macroprudential function is not well-developed.

### Financial system oversight — table highlights (as presented)
- Table 1 lists 16 countries with currency and central bank presence (Ecuador, El Salvador, Panama, Kosovo, Timor Leste, Montenegro, Kiribati, Micronesia, Andorra, Marshall Islands, Monaco, Liechtenstein, San Marino, Palau, Nauru, Tuvalu).
- Table 2 summarizes supervisory authorities and AML/CFT arrangements across regions, showing diversity of institutional setups and many gaps in macroprudential frameworks and supervisory capacity.

### Microstates and exchange rate regimes
- Among 23 microstates (population up to 250 thousand):
  - 10 are dollarized.
  - 8 belong to a currency union.
  - 5 have local currencies (found in larger microstates with population close to 100 thousand or more).
- Maintaining an independent currency and central bank requires resources and qualified personnel often not available in the smallest microstates—hence prevalence of dollarization or monetary unions.

### Considerations specific to Curaçao and Sint Maarten
- A hypothetical dollarization would be a major structural change with significant transitional costs; costs would be much higher during the current pandemic.
- Dollarization without supporting reforms would be a very risky strategy.
- Existing context:
  - Curaçao and Sint Maarten already benefit from low and stable inflation and limited room for independent monetary policy under the long-standing peg of the CSMU.
  - Public sector financing is currently done through a special arrangement rather than the market.
- Monetary-union and small-island constraints:
  - Dollarization by one or both members would effectively imply dissolution of the monetary union and require agreement on a new CBCS mandate/Statute or alternative arrangements for essential functions.
  - Agreement on division of CBCS assets between the two governments would be required; complexity increases if only one country dollarizes.
  - Small-island constraints (especially in Sint Maarten) pose challenges for continuity of essential institutional functions currently fulfilled by the CBCS.
- Choice of target currency and conversion rate:
  - Two plausible options: US dollar and Euro.
  - Choice could be based on minimizing volatility of the real effective exchange rate by giving preference to the currency of the largest trading partner.
  - Sint Maarten: dominant trade and economic ties with the United States suggest the U.S. dollar is a more natural choice than the Euro, though Saint Martin (other side of island) uses the Euro.
  - Curaçao: choice is more nuanced—Euro Area has large weight among Curaçao’s tourism markets, even though most international transactions are conducted in US dollars.
  - Conversion rate must be credible and in line with external sustainability; existing international reserves of the CBCS should cover monetary base liabilities denominated in local currency.
  - Setting the conversion rate at the equilibrium level is important to avoid protracted adjustment through nominal prices and wages; locking in an uncompetitive exchange rate could trigger protracted painful adjustment.

### Continuity of critical central bank functions under dollarization
- Authorities would need to maintain continuity of critical CBCS functions:
  - (i) supervision of financial sector entities (banks and non-bank institutions), including financial integrity (AML/CFT);
  - (ii) macroprudential supervision and policies;
  - (iii) an adequate resolution regime for financial institutions;
  - (iv) maintaining the payment system;
  - (v) fiscal agent function for the government;
  - (vi) providing analytical support for the governments.
- CBCS could presumably continue to provide these in Curaçao; for Sint Maarten, capacity constraints and potential dissolution of the banking union make local setup very challenging.
- Ensuring continuity of supervision of Sint Maarten financial institutions would be critical.

### Liquidity, reserves, and lender-of-last-resort constraints
- Dollarization places premium on quality of micro- and macro supervision and crisis-resolution frameworks due to limitations of the lender of last resort.
- Even strong supervision cannot completely eliminate the need for a lender of last resort.
- Securing contingency credit lines could be an option, but in crisis the first-best solution is large reserves.
- If the central bank is replaced, reserves could be held as government deposits; building an adequate stock of deposits does not appear feasible in the near to medium term given difficult fiscal positions in both countries.
- Central bank reserves or government deposits are unlikely to be sufficient for system-wide pressures.
- Emergency liquidity arrangement (ELA) frameworks would need to be very strict and banks would need to hold significantly more ex ante liquidity buffers than in other regimes—potential profitability implications.

### Operational issues and fiscal arrangement interactions
- Operational issues include arrangements to assure adequate supply of currency (Jacome and Lonnberg, 2010).
  - Example: supply of U.S. dollar currency on Bonaire is responsibility of the DNB; banks on Saba and St. Eustatius are supplied by head offices.
  - Dollarization saves on costs of production and management of a separate national currency but entails administrative costs of supplying a foreign currency.
- Interaction with current fiscal arrangement:
  - Curaçao and Sint Maarten have a fiscal arrangement providing access to loans at below-market interest rates subject to fiscal supervision.
  - If this arrangement remained unchanged, dollarization alone would not strengthen incentives for institutional/policy improvement nor necessarily improve fiscal discipline.
  - Both countries remain exceptionally vulnerable to external shocks (examples cited: 2017 hurricanes in Sint Maarten; 2020 pandemic), implying continued need for access to external financing during abnormal negative shocks.
  - Future setup of the fiscal arrangement is a key factor in the dollarization decision.

### Policy recommendations and priorities
- Supporting policies required to obtain full benefits of dollarization (Jacome and Lonnberg, 2010):
  - Strong financial sector reform to minimize banking/financial sector crisis risk in absence of lender of last resort:
    - Address pockets of vulnerability; strengthen prudential/supervisory functions.
    - Introduce higher capital/liquidity requirements.
    - Establish other elements of financial safety net: special resolution regime for banks and a deposit guarantee scheme.
  - Labor market reform and broader structural reforms to enable adjustment via the wage channel (external adverse shocks may require downward adjustments in nominal wages and prices).
  - Public financial management reforms and strengthening overall fiscal policy—especially important if the fiscal arrangement is modified.
- Near-term priorities regardless of exchange rate regime:
  - Allocate available capacity to priority reforms improving the Union’s public finances, reducing financial sector vulnerabilities, and increasing resilience.
  - Deeper economic integration between Curaçao and Sint Maarten could improve monetary union functioning.
- Political and procedural recommendation:
  - Any country considering dollarization must carry out a serious, open, and broad public discussion of costs and benefits and proceed only on basis of strong political consensus.

*Source: 1cuwea2021002 (IMF chapter/section).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1cuwea2021002.pdf_