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Monetary Policy in Dollarized
Economies:
The Argentine Experience
MIGUEL A. KIGUEL
Universidad Di Tella &
econviews
December 2006
Monetary Policy in dollarized economies: Outline
 General reflections about dollarization
 How does dollarization affect the banking
system
 The experience of Argentina as a
dollarized economy during the hard peg and
after the 2001/02 Crisis
 Final remarks and issues for discussion
Monetary Policy in dollarized economies under
different exchange rate regimes
Fixed exchange rates (currency board):
Little room for monetary policy but the central
bank can affect the amount of bank credit.
Floating exchange rates: room for monetary
policy, the main question is how effective can it be
when dollarization is significant.
 Is it better to target the money supply or
interest rates in highly dollarized economies?
 Is there a difference between dollarization and
currency substitution?
International Comparison
econviews
Argentina is one of the few countries that managed to de-dollarized
Deposit Dollarization in Latin America
Foreign currency-denominated deposits - In % of total deposits
Argentina
Bolivia
Brazil
Chile
Colombia
Ecuador
México
Paraguay
Peru
Uruguay
Venezuela
1990
2001
2004
47.2%
71.5%
10.7%
80.7%
91.5%
85.3%
0.0%
6.1%
6.5%
16.3%
14.0%
11.9%
0.3%
0.5%
2.0%
13.3%
100%
100%
10.1%
8.1%
5.4%
33.9%
66.6%
47.0%
62.5%
74.3%
64.1%
88.6%
83.0%
83.0%
-
0.2%
0.1%
Source: Central banks and IMF estimates
How can dollarization help banking stability?
 Dollarization allows portfolio changes to take
place within the banking system, and hence it
helps financial deepening
 Reduces capital flight
 Interest rates on dollar deposits and loans are
largely insulated from changes in peso interest
rates
 It helps to develop a market for long term
financial instruments (e.g. mortgages)
How can dollarization weaken banking stability?
 Lack of confidence on the currency could lead to
a systemic run of deposits
Lack of lender of last resort could lead to bank
panics
 Regulations do not usually include prudential
regulations to limit convertibility in a panic (circuit
breakers)
Banks could be hedged in dollars for the assetliability management but borrowers might not be
(e.g. personal loans, residential mortgages)
Dollarization and de-dollarization in Argentina
 Dollarization has a long history in Argentina as a
result of high inflation since the 1970s
 The dollar became “the currency” during the
hyperinflation in the 80s
 In the 1990s, with the convertibility regime,
dollarization increased in the banking system and it
survived a critical test: the 1994 Mexican Crisis
 There was an explicit policy to move towards
dollarization in the 1990s
De jure de-dollarization after the 2001 crisis
Some stylized facts of dollarization in Argentina
 Dollarization has been a one way street, very
difficult to reverse
 The payments system has worked mainly in
pesos, even during the crises
 The interest rate differential never disappeared
for deposits in pesos and dollars during the period
of convertibility
 Lending interest rates in pesos remained
extremely high during that period, why?
Argentina
econviews
Dollarization in the banking system increased over time, especially
once deposits stabilized in the late nineties
Private Deposits in USD
As % of GDP - In Current $
35.0
32.5
30.0
27.5
25.0
22.5
20.0
17.5
15.0
12.5
10.0
7.5
5.0
2.5
0.0
Private in USD
2001
2000
1999
1998
1997
1996
1995
1994
Total Deposits
Argentina
econviews
Prior to the crisis they reached 60% of the total
Private Deposits in USD
As % of Total Deposits - In Current $
70%
Private in USD
60%
50%
40%
30%
20%
10%
2001
2000
1999
1998
1997
1996
1995
1994
0%
Argentina
econviews
Checking accounts and most transactional balances have
remained in pesos
Checking Accounts
As % of Total
In Dollars
In Pesos
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
2005
2004
2003
2002
2001
0%
Argentina
econviews
The interest rate differential between pesos and dollars never
disappeared.
Both rates increased at times of crises, but peso rates increased more
Time Deposit Interest Rates
Weighted Average - Per cent per annum
20
Differential (P eso M inus Do llar Depo sit Interest Rate)
P eso Depo sit Interest Rate
Do llar Depo sit Interest Rate
18
16
14
12
10
8
6
4
2
2000
1999
1998
1997
1996
1995
1994
0
Argentina
econviews
Ex-post real interest rates in pesos remained very high
Ex-Post Real Interest Rates
Time Deposits - Per cent per annum
20.0
Peso Deposit Real Interest Rate
17.5
15.0
12.5
10.0
7.5
5.0
2.5
2000
1999
1998
1997
1996
1995
1994
0.0
The First test on Convertibility:
The 1994 Mexican Crisis and its impact on
Argentina
 The Mexican devaluation generated fears of devaluation
in Argentina
 Deposits fell by almost 20% in just three months
 Initially the run was stronger on peso deposits (flight to
quality) but then it spreaded to dollar deposits as well
 The central bank provided liquidity to the banking system
and partially insulated the impact on credit to the private
sector
 The bank panic was stopped without restraining
convertibility
econviews
Deposita fell by 20%, initially pesos, then dollars, then free fall for all
Argentina: Total Deposits Evolution in the Banking System
(in millon pesos)
Date
In pesos
In dollars
Total
12/20/94
22,320
22,976
45,296
01/31/95
19,592
23,539
43,131
02/28/95
19,206
22,881
42,087
04/28/95
18,144
19,497
37,641
05/12/95
17,415
19,353
36,768
econviews
The Central Bank financed 70% of the fall in deposits and minimized
the impact of credit
Argentina: Liquidity Assistance
(in millon pesos)
Concept
Rediscounts
Reduction in Reserve
Requirements
Repos
External Credit Lines
Reduction in
Domestic Credit
Others
Assistance
1,700
4,000
300
1,000
1,200
300
The First test on Convertibility:
Implications of “surviving” the Mexican crisis
 It increased the confidence in the hard peg regime as a
policy alternative
 It promoted more dollarization of the economy, and in
the banking system
 It increased the awareness about the importance of
improving the ability of the central bank to act as lender of
last resort
 It created the case for full dollarization in a response to a
possible crisis
Fixed exchange rates and monetary policy in
dollarized economies: Lessons from Argentina
 The quantity of money was demand determined
 The central bank was able to affect the amount of
credit in the banking system through reserve
requirements and the provision of liquidity.
Convertibility did not eliminate the foreign exchange
rate risk, as it remained a differential between similar
deposits in pesos and dollars
 The ability to act as lender of last resort was limited
by the amount of international reserves
The collapse of the banking in 2001/02
 There was a run on the currency and on
deposits could not be contained with international
reserves. No “real” lender of last resort
 The default on public debt weakened the banks’
balance sheet
 Flight to quality meant capital flight
 The devaluation was all but unavoidable, but
had huge impacts on the banks and non-financial
sectors balance sheets.
 Foreign banks were not ready to bring financing
from abroad due to “changes in rules of the game”
econviews
There were no enough financial resources to withstand the attack on
the currency and the bank panic of 2001 and banks reduced credit
Argentina: Crises Financing
Dec-01 /
Jun-01
Jun-02 /
Dec-01
Financing Requirements
Fall in Private Deposits
Other Financial Requirements
22,699
15,618
7,081
23,421
23,836
(415)
Sources of Founds
Assistance from Central Bank
Fall in Loans
Reduction in Reserve
Requirements
Capitalizations
22,699
9,711
7,172
23,421
7,825
10,217
5,716
4,044
100
1,335
Concept
Some stylized facts of dollarization during the
period of the hard peg in Argentina
 Run on the currency became run on banks
Was dollarization a key reason for the crisis?
Was the fixed exchange rate in a dollarized
economy the main problem?
What was missing: A lender of last resort?
A credible deposit insurance?
 Could a floating exchange rate regime have
helped to avert the crisis?
De-Dollarization and Monetary policy
in the aftermath of the crisis
What did Argentina do to de-dollarize the
economy?
 It de jure converted dollar deposits and loans to pesos
(at different exchange rates)
 Contracts in dollars were transformed into pesos at
old the exchange rate (utility rates, rents, etc)
 A large part of the public long-term debt was
converted to pesos and then indexed to the CPI
 New regulations has restricted banks from in offering
new loans in dollars (only to exporters and importers)
 There is still dollarization for many long term
contracts and for financial investments
Argentina
econviews
The “Original Sin” Redemption?
Deposit, Loan and Debt Dollarization in Argentina
Dollar-denominated contracts over total* - In %
Loans
Deposits
Public Debt
Private Debt
* At June 30 for each year
Source: MECON, BCRA & Econviews estimates
2001
2006
69.2%
14.2%
63.5%
10.4%
72.0%
40.7%
77.9%
60.5%
Argentina
econviews
The de-dollarization increased the demand for pesos. Currency
substitution in reverse
M1 as a share of GDP
As % of GDP - In Current $
M1 (In $ and USD)
20
15
10
5
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
0
Argentina
econviews
The banking system now works in pesos for Deposits…..
Private and Public Sector Deposits
As % of GDP - In Current $
35.0
32.5
30.0
27.5
25.0
22.5
20.0
17.5
15.0
12.5
10.0
7.5
5.0
2.5
0.0
In Dollars
In Pesos
2006
2005
2004
Total Deposits
Argentina
econviews
…. And for loans
Private and Public Sector Loans
As % of GDP - In Current $
15.0
In Dollars
In Pesos
Total Loans
12.5
10.0
7.5
5.0
2.5
2006
2005
2004
0.0
Argentina
econviews
But private sector deposits have not recovered their previous levels.
Less financial deepening
Total and Private Deposits
As % of GDP - In $ and USD
35.0
32.5
30.0
27.5
25.0
22.5
20.0
17.5
15.0
12.5
10.0
7.5
5.0
2.5
0.0
Total Deposits
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
Private Deposits
Monetary Policy
Where does Argentina stand today?
 Is Argentina is trying to target
Inflation?
 The real exchange rate?
 The level of International reserves?
 Interest rates?
The central bank sets a target for M2.
Prices
econviews
Inflation is under control but remains in the two digits
Inflation
Yoy variation
16%
Core
14%
CPI
Regulated
12%
10%
8%
6%
4%
2%
oct-06
jul-06
abr-06
ene-06
oct-05
jul-05
abr-05
ene-05
oct-04
jul-04
abr-04
ene-04
0%
Monetary Program
econviews
The Central Bank targets the growth of M2
Evolution of Monetary Aggregates
% var. YoY
50%
Private M2
Total M2
45%
40%
35%
30%
25%
20%
15%
10%
5%
Oct-06
Jul-06
Abr-06
Ene-06
Oct-05
Jul-05
Abr-05
Ene-05
Oct-04
Jul-04
Abr-04
Ene-04
0%
Monetary Program
econviews
Money supply is controlled by issuing Central Bank bills
Sources of Monetary Base creation
in million pesos
40,000
35,000
2005
2006
30,000
25,000
20,000
15,000
10,000
5,000
Monetary
Base
Reverse
Repos
Goverment
financing
-15,000
BCRA
intervention
-10,000
Lebacs
-5,000
Banking
financing
0
econviews
The stock of central bank debt is rising
Stock of Lebacs in pesos
in million pesos
Ene-05
Ene-05
Feb-05
Mar-05
Abr-05
May-05
Jun-05
Jul-05
Ago-05
Sep-05
Oct-05
Nov-05
Dic-05
Ene-06
Feb-06
Mar-06
Abr-06
May-06
Jun-06
Jul-06
Ago-06
Sep-06
Sep-06
40,000
38,000
36,000
34,000
32,000
30,000
28,000
26,000
24,000
22,000
20,000
18,000
16,000
14,000
12,000
10,000
8,000
Interest Rates
econviews
Policy interest rates have been rising, but they are still relatviley low.
Reverse Repos
in % - 7 days loans
10
9
8
Interbank Loans
Reverse Repos
7
6
5
4
3
Ene-05
Feb-05
Mar-05
Abr-05
May-05
Jun-05
Jul-05
Ago-05
Sep-05
Oct-05
Nov-05
Dic-05
Ene-06
Feb-06
Mar-06
Abr-06
May-06
Jun-06
Jul-06
Ago-06
Sep-06
Oct-06
Nov-06
2
Argentina
econviews
Real interest rates are now very low
Nominal and Ex-Post Real Interest Rates
Time Deposits in Pesos - Per cent per annum
20.0
Nominal
17.5
Real
15.0
12.5
10.0
7.5
5.0
2.5
-7.5
-10.0
2005
-5.0
2004
-2.5
2003
0.0
Monetary Policy
econviews
The appears to be undervalued
Exchange Rate- Multilateral-Bilaateral (EEUU)
2001=100
300.0
3
Multilateral (izq.)
Bilateral (der.)
250.0
2.5
200.0
2
150.0
1.5
100.0
1
50.0
0.5
ene-06
ene-05
ene-04
ene-03
ene-02
ene-01
ene-00
ene-99
ene-98
ene-97
0
ene-96
0.0
Implications for Monetary Policy:
Where does Argentina stand?
 Flexibility in the exchange rate (dirty float), with
a band for the nominal exchange rate
 The central bank sets a target for M2.
 Central bank controls the money supply (M2)
through sterilization combined with capital controls
 Policy interest rates have been gradually rising
though they remain below inflation
 Monetary policy basically accommodates
inflation
Lessons from Argentina’s dollarization and dedollarization processes
 Dollarization is largely related to inflation and
macroeconomic policies, but governments can affect it
through policies,
 Restrictions on dollar deposits and lending
 Use of indexation as “quasi-currency”
 The Argentine de-dollarization process has not yet
extended to saving instruments
 …and it has not been tested since the crisis, so far it is
still smooth sailing
 Currency substitution could be reversed if
macroeconomic conditions change.
Implications for and questions about Monetary
Policy in Dollarized Economies
 Argentina so far has managed to use monetary
policy by targeting the money supply
 Low interest rates have helped the
recovery from the crisis
 The exchange rate remains competitive
 Inflation is under limited control
 But less dollarization in the banking sector does
not necessarily imply that there is less currency
substitution in the economy.
 And the long term capital market still works
largely in dollars
Thank you!