{
  "title": "Enhancing Monetary Policy Flexibility Through De-dollarization’",
  "publication": "IMF Blog, September 21, 2016",
  "sourceUrl": "https://www.imf.org/en/blogs/articles/2016/09/21/enhancing-monetary-policy-flexibility-through-de-dollarization",
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  "summary": "Topic: Borrowing and saving in foreign currencies—so-called dollarization—and its implications for monetary policy and financial stability in emerging market economies.",
  "sections": [
    {
      "heading": "Summary and context",
      "content": "- Topic: Borrowing and saving in foreign currencies—so-called dollarization—and its implications for monetary policy and financial stability in emerging market economies.\n- Sample and period analyzed: 33 emerging-market economies, 1997 to 2015.\n- Central trade-off highlighted: Allowing exchange rates to adjust to shocks versus curbing exchange-rate flexibility to protect the financial sector from balance-sheet effects associated with dollar-denominated liabilities."
    },
    {
      "heading": "Key empirical findings on exchange-rate flexibility and dollarization",
      "content": "- Greater exchange-rate flexibility reduces incentives to lend in dollars.\n- Specific empirical observations:\n  - The exchange rate moved more in countries that subsequently experienced a significant reduction in dollar loans (measured as a reduction of loan dollarization of at least 20 percentage points over the sample period, to below 20 percent).\n  - Statistical estimates confirm that more exchange-rate flexibility causes more rapid de-dollarization.\n- Robustness: These estimates hold after controlling for:\n  - the differential in domestic and foreign interest rates,\n  - the macroeconomic framework in individual countries (such as whether the country is an inflation targeter),\n  - measures of external volatility,\n  - the amount of inflation volatility,\n  - other measures of domestic risks.\n- Policy implication from results: Restoring (nearly) full exchange-rate flexibility—and, along with it, the risks of lending and borrowing in foreign currency—would provide incentives to save and borrow in local currency."
    },
    {
      "heading": "Policy trade-offs and risk management",
      "content": "- Policymakers’ dilemma in highly dollarized economies:\n  - Allow full exchange-rate adjustment to external shocks and expose the financial sector to negative balance-sheet effects (borrowers whose liabilities are in dollars but incomes in depreciated local currency).\n  - Or curb exchange-rate flexibility, which may hinder de-dollarization and limit central bank control over economic activity and inflation.\n- Recommendation from research: Allow the exchange rate to adjust fully when facing external shocks if the objective is to reduce dollarization and gain greater control of monetary policy.\n- Remaining challenge: How to manage risks from mismatched balance sheets (corporations and households borrowing in dollars while earning in local currency)."
    },
    {
      "heading": "Case study — Peru",
      "content": "- Historical context:\n  - Following the hyperinflation of the late 1980s and early 1990s, dollarization levels around 90 percent.\n  - Macroeconomic reforms included a fiscal responsibility law and an inflation-targeting regime adopted in 2002.\n  - Result: Peru’s inflation rate, averaging 2¾ percent annually since 2002.\n- Dollarization dynamics:\n  - Dollarization receded but remained around 40 percent in 2014.\n  - To limit financial risks from dollarization, the central bank curtailed exchange-rate volatility for many years—potentially limiting de-dollarization.\n- Recent policy mix and outcomes:\n  - Since 2013, Peru implemented macroprudential measures and explicit de-dollarization targets.\n  - Measures to make foreign-currency lending more expensive and less attractive for banks:\n    - taxing foreign exchange lending,\n    - imposing stricter requirements (such as more stringent loan-to-value ratios) on foreign currency loans,\n    - increasing the percentage of foreign currency deposits banks must maintain with the central bank (higher reserve requirements),\n    - raising costs of dollar lending for banks that failed to meet de-dollarization targets.\n  - Central bank operations to support local currency liquidity: offering currency repos (buying dollars with soles with a promise to reverse the transaction).\n- Outcome:\n  - Loan dollarization declined from 40 percent in 2014 to about 29 percent in recent months without a credit crunch, supporting the growth recovery following the 2014 economic slowdown.\n- Implication for Peru and similar countries: Further exchange-rate flexibility would likely reduce dollarization further and could lessen the need for accompanying macroprudential measures to handle balance-sheet mismatches."
    },
    {
      "heading": "Policy recommendations and takeaways",
      "content": "- To promote de-dollarization and strengthen monetary policy effectiveness:\n  - Allow exchange rates to adjust more fully to external shocks to internalize currency risk and incentivize saving and borrowing in local currency.\n  - Complement exchange-rate flexibility with targeted macroprudential measures to manage balance-sheet mismatches and preserve financial stability during the transition.\n- Country sequencing: Use a combination of policy tools—exchange-rate flexibility, macroprudential measures, and fiscal and monetary credibility—to achieve sustained reductions in dollarization without triggering financial distress.\n\nSource: Enhancing Monetary Policy Flexibility Through De-dollarization’, Marcello Estevão, Greetje Everaert, September 21, 2016.\n\n---\n\n\n References\n\n- study\n\nSource: https://www.imf.org/en/blogs/articles/2016/09/21/enhancing-monetary-policy-flexibility-through-de-dollarization"
    }
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    "Authors: Marcello Estevo, Greetje Everaert",
    "Published: September 21, 2016",
    "Topic: Borrowing and saving in foreign currencies—so-called dollarization—and its implications for monetary policy and financial stability in emerging market economies.",
    "Sample and period analyzed: 33 emerging-market economies, 1997 to 2015.",
    "Central trade-off highlighted: Allowing exchange rates to adjust to shocks versus curbing exchange-rate flexibility to protect the financial sector from balance-sheet effects associated with dollar-denominated liabilities.",
    "Greater exchange-rate flexibility reduces incentives to lend in dollars.",
    "Specific empirical observations:",
    "Robustness: These estimates hold after controlling for:",
    "Policy implication from results: Restoring (nearly) full exchange-rate flexibility—and, along with it, the risks of lending and borrowing in foreign currency—would provide incentives to save and borrow in local currency.",
    "Policymakers’ dilemma in highly dollarized economies:",
    "Recommendation from research: Allow the exchange rate to adjust fully when facing external shocks if the objective is to reduce dollarization and gain greater control of monetary policy.",
    "Remaining challenge: How to manage risks from mismatched balance sheets (corporations and households borrowing in dollars while earning in local currency).",
    "Historical context:",
    "Dollarization dynamics:",
    "Recent policy mix and outcomes:",
    "Outcome:",
    "Implication for Peru and similar countries: Further exchange-rate flexibility would likely reduce dollarization further and could lessen the need for accompanying macroprudential measures to handle balance-sheet mismatches.",
    "To promote de-dollarization and strengthen monetary policy effectiveness:",
    "Country sequencing: Use a combination of policy tools—exchange-rate flexibility, macroprudential measures, and fiscal and monetary credibility—to achieve sustained reductions in dollarization without triggering financial distress.",
    "[study](http://www.imf.org/external/pubs/cat/longres.aspx?sk=44097.0)"
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