1.
History of
Dollarization
Dollarization in
Cambodia Resulted from a series of shocks, experiences and events that eroded
public confidence in capacity of the authorities to maintain the value of national
currency, the Riel. There are already some amounts of US dollars circulating in
Cambodia during the period of the Khmer Republic (1970-1975). However, the Riel
Remained the Currency used normally in domestic transactions. The first shock
occurred from 1975 to 1979 when all financial infrastructure in Cambodia (markets,
trade, money, and banking) were systematically destroyed. There was no place
for financial system under the Khmer Rouge.1 Immediately after they
conquered the capital city, the National Bank of Cambodia’s headquarters was
bombed to the ground2. After the Pol Pot regime in 1979, commercial
transactions were conducted mainly in the form of barter, or using rice and
gold and later also Vietnamese dong.
In 1980 the Central
Bank was re-established under the name of the people’s Bank of Kampuchea and
the Riels was again the country’s legal currency. During the 1980s,
the people Bank of Kampuchea were providing the multitude of services,
including acting as the monetary authority, the cashier of the government, and
the only institution providing banking services, such as deposits, loans, and
payment instruments. The use of US Dollar (USD) and Thai Baht (THB) was
restricted by the centrally planed economy. However, confidence in the Riel remained
low, given the political structure and the security situation, with the
consequence that dollar and baht and above all gold were largely considered as
a refugee as a refuge by Cambodians.
2. Respective Use of Riel and Dollar
The riel is used
by the Government and the National Bank of Cambodia for paying their employees,
and is preferred by the general public for small transactions. It is also more
in use in rural areas. The dollar serves all functions of money since it is
used as:
• a valuation instrument (prices being often indicated in dollar),
• a settlement instrument (transactions being mostly settled in dollar cash), and • a saving instrument. Both residents and non-residents use the dollar. Foreign firms, NGOs, agencies and embassies spend in dollars, including paying their employees.
• a valuation instrument (prices being often indicated in dollar),
• a settlement instrument (transactions being mostly settled in dollar cash), and • a saving instrument. Both residents and non-residents use the dollar. Foreign firms, NGOs, agencies and embassies spend in dollars, including paying their employees.
Banks also
prefer to carry out transactions in foreign currency. In December 2006, out of
18 banks, 8 did not accept deposits in riels although the law as the country’s
legal tender declared the riel. Most loans were also denominated in dollars
(97%). Out of 18 banks, only 4 granted loans in riels, for limited amounts.
3.
Advantages of Dollarization
Given the lack
of public confidence in the riel, dollarization has helped in maintaining
payment capacities in Cambodia.
First, the
introduction of large quantities of banknotes in dollars, at the beginning of
the 1990s, allowed the public to switch from using gold to banknotes for
transactions and to store wealth. Until then, using unproductive physical assets
such as gold was common practice in Cambodia. Subsequently, the progress of
monetization has encouraged savings within the middle class.
Second,
dollarization prevented capital flight and promoted financial deepening. The
elimination of incentives to place savings abroad encouraged domestic financial
intermediation, which resulted in the growth of the financial system. Only over
the past three years, the volume of bank activity has roughly doubled, and the
loan to deposit ratio has grown regularly.
Third,
dollarization lowered the risk of currency devaluation. The demand for riel
remained low and the market very small. Hence there was little incentive for
speculators to try to gain from short-term changes in the price of riel.
Dollarization has protected Cambodia against contagion in the face of the Asian
crisis (1997-2000). It sustained confidence of investors in their operations in
Cambodia.
Fourth,
dollarization promoted awareness by policymakers of the need to avoid bank
financing of public deficits. Eventually, the use of dollar facilitated the
integration process of Cambodian trade in the international economy. Currency
stability promoted macroeconomic stability and a predictable business
environment. It reduced the transaction costs (avoiding currency conversions).
It allowed the boom in the garment industry in Cambodia.
4.
Disadvantages of Dollarization
First, it
undermines the effective conduct of monetary policy. The NBC cannot develop
instruments of monetary policy and its role of lender of last resort for banks
facing liquidity problems is greatly constrained.
Second, the
national currency may appear as a symbol of sovereignty and nationhood.
Third, the
income from seignorage is minimized. The government of the United States gains
seignorage benefit from Cambodia since the dollar denominated money stock held
by Cambodian people does not earn interest. The net annual income foregone is
assessed in the range of USD 20 to 90 million per year.
5.
What to Do Now?
As mentioned
earlier dollarization in Cambodia did not result from policy decisions. Rather
it emerged because public confidence in the riel eroded. Keeping riel in
circulation will depend on the capacity of the government to move forward with
reforms that increase public confidence in the local currency. Removing the use
of dollars cannot proceed by forced conversion of foreign currency deposits
into riel. Such a measure would stimulate capital flight and drive the
dollarized economy underground. Hence, subsidized riel lending or harsh actions
against dollar intermediation are not recommended. Altogether, the immediate
target cannot be to “de-dollarize”, but to promote the use of riel, through an
increase of the general public’s demand for the national currency.
6. How
to Promote the Use of Riel?
Prerequisites
The first and
foremost condition to promote the use of riel is to maintain peace and
institutional stability, since uncertainty was the main incentive for the
public to keep cash in dollars at home. The only real long-term fix to
dollarization is to stabilize inflation in a credible way. Fiscal prudence is
key element that needs to be conducted in proper way. In view of the inertia in
strengthening credibility, stabilizing inflation will only have an impact on
dollarization over time. Anything that can strengthen confidence in the banking
system, including bank supervision, must be encouraged. Similarly, anything
that can be done in terms of strengthening the capacity, independence, and
credibility of the central bank is welcome.
Measures Already
Implemented
Several measures
have already been implemented, to increase the demand for riel, and improve the
quality of supply. Since 2000 an increasing proportion of public sector
transactions have been required to be paid in riels (public utilities such as
water and electricity, and tax liabilities are paid in riels). In addition,
Government employee salaries are denominated and paid in riels. The NBC has
made efforts to replace old, dirty bank notes with new ones. New types of notes
have been issued periodically. Requesting that taxes be paid to the NBC has
facilitated the withdrawal of old notes. The NBC has also issued notes with
high face value (up to 100 000 riels). However those notes are not much used by
the public and, because there are limited channels by which bank notes can
return to the NBC, very old notes remain in the circulation. Exchange rate
stability is important in maintaining price stability in a highly dollarized
country. Hence, the NBC’s policy has aimed at maintaining the value of riel,
through foreign exchange interventions (direct sales of dollars, to absorb cash
in riels from the public, and to accommodate the demand of utilities
companies). The demand for micro-loans from the poor to microfinance
institutions (MFIs) is mostly denominated in riels. However, MFIs have access
to international funding in dollars, not in riels. To avoid taking foreign
exchange risk, they are forced to extend a significant part of their loans in
dollars (34% of their loan portfolio as of end-2005). The NBC is willing to
encourage their funding in riels, to support rural areas that are not used to
making transactions in dollars. Hence, in 2005, the NBC has tempted a pilot
experience of direct funding to a microfinance institution in riel, in order to
enable it to grant loans denominated in riel. However, the central bank
considers that market mechanisms are preferable, such as recycling riels
deposited in commercial banks. A new Law on Negotiable Instruments and Payment
Transactions was issued in 2005. It improved the payment system framework, and
also reinforced the role and authority of the central bank on interbank
payments, clearing, and information. This is a significant achievement for the
credibility of the Cambodian financial system. Despite these measures, the
trend remains towards increased dollarization and, if sustained, the Cambodian
economy may eventually become fully dollarized.
Further Options
A series of new
measures may be considered to support the demand for riel, increase supply, and
improve the quality of market mechanisms. All prices of goods and services
should be indicated in riel. The
government may expand its riel requirement to the collection of
non-tax revenue. It should also settle more domestic expenditures in riel,
since only 74% of expenses are paid in riel (2001). The government could also
consider requesting all international organizations in Cambodia do so. Paying
public employees through a deposit into a bank account (instead of through
cash) may encourage bank intermediation in riel, and discourage public workers
from changing their riels into dollars as soon as they get paid. Commercial
banks would also benefit from larger intermediation. According to the Public
Financial Management Reform Program (PFMRP), all Government’s accounts must be
centralized in the NBC. These funds should be converted into riel, according to
the Central Bank Law (article 21-2). The quality of payment services in riel
must also be improved to enhance the credibility of the national currency.
Bank
intermediation in local currency needs to be developed.
Although the
banking system is globally highly liquid, some banks have difficulties to
access liquidity. There is a need for an interbank market and also for a
stronger payment system. Microfinance institutions (MFIs) have special
difficulties to access resources in riel. This should be addressed given the
large number of people who use only riels in rural areas; MFIs should not
provide them with dollars that they do not demand for. Hence, there is a need
to organize a wholesale market for the funding of microfinance. The support of
commercial banks will be critical in this field. In addition, banks would accept
more riel deposits if they could find other riel-denominated assets, such as
treasury bills bearing an attractive interest rate. However, the National
Treasury currently does not need to borrow from the market. Hence the NBC may
consider revising the structure of its interest rates. Instead, market interest
rates for bank loans and deposits in riels are higher than in dollars by at
least 2 or 3%. Together with commercial banks interested in the process, the
authorities could consider promoting price indexation to facilitate the
growth of financial instruments in riels. However, preconditions must be met,
such as a sufficiently sophisticated financial system, a credible price level,
etc.
• Increase Supply Passively
The NBC is
encouraging commercial banks to install ATMs that distribute banknotes in riel,
and to promote credit cards in riel. The central bank also intends to pay even
greater attention to improving the quality of bank notes circulating throughout
the country, including through a greater commitment of its branches. The NBC is
considering a reform of its activity in provinces, to enhance the performance
of its branch network.
• Improve Market Mechanisms
The wholesale
payment system needs to be dramatically improved. The NBC has initiated the
process, with the support of international expertise. Commercial banks have
also taken several initiatives. The interbank market should be developed,
through the introduction of secured transactions. The legal base is already in
place, but the market still lacks tradable securities, to be used as
collateral.
The Cambodian
authorities do not support a full dollarization of the economy. On the
contrary, the Government thinks disadvantages of full dollarization outweigh
the benefits and prefer to reduce gradually the level of dollarization.
However, in spite of various measures that were taken in the past to
“de-dollarize” the country, the trend is still towards even greater
dollarization. No harsh action should be taken against the use of dollar.
However, there is a need to build up a consensus regarding dollarization and on
how to promote the use of the national currency. This paper is only one step in
that direction.
