Financial Dedollarization: Policy Options Eduardo Fernandez-Arias Inter-American Development Bank REGION I

Financial Dollarization Asset substitution, not currency substitution Holdings of residents, not foreigners This focus is highly relevant to the problem of financial dollarization in Region I countries and allows for feasible specific policy options.

Motivation: Financial fragility caused by currency mismatch of assets and liabilities within domestic economy Exposure of peso earning dollar debtors (non- tradeable sector, home mortages) Exposure of banking system (currency risk or credit risk) Fiscal exposure due to all of the above

Financial fragility due to financial dollarization is very dangerous Leads to fear of floating and super-fixed exchange rates (or de jure dollarization) that may end up catastrophically if unsustainable (e.g. Argentina) Imperfections in international capital markets (e.g. sudden stops) lead to large real shocks that also deprive from liquidity: dollarized financial systems are fragile to both Peso domestic financial systems may be a condition for healthy international financial integration

Policy Options Correct/offset market imperfections that may lead to excessive financial dollarization (prudential financial and capital account regulation) –Social cost of financial collapse not priced in domestic dollar rates (payment system, economic networks) –Currency-blind explicit and implicit public guarantees discriminates in favor of dollar markets Conduct consistent macroeconomic policy (XR, fiscal and debt management)

Policy Options Help complete domestic financial markets with peso instrument to substitute dollar instrument –Need long-duration instrument not subject to surprise inflation –Key: Indexation relevant to domestic borrowers and lenders to create attractive item in domestic portfolios –Key: Development of equity and equity-like markets

Policy Options Session II – Experience with policy options to avoid or revert financial dollarization Session III – Analysis of policy options Panel of Central Banks – The policymaker view and what is being done about it

Panel of International Financial Institutions How can IFIs help in fostering local currency markets with lending programs or program conditionality? Help as financial agents? IFIs lending in pesos after selling indexed riskless bonds to dollar saving residents (e.g. pension funds): –Avoid crowding out of peso savings –Easier than convincing foreigners to invest in pesos (original sin) –May pave the way to Eichengreen and Hausmann proposal