Dollarization in the Philippines: The way in; the way out Cayetano W. Paderanga Jr. Okinawa, Japan 8 April 2005

Outline I.Determinants of dollarization II.Dollarization and the growth of the financial sector III.Dollarization, sudden stops & economic consequences

I. Determinants of dollarization in the Philippines Background: -In 1970 Peso’s exchange rate was allowed to “float” -During the late 1970’s, monetary authorities allowed foreign currency denominated deposits in offshore banking units of foreign banks and foreign sections of local banks -The Philippine Dealing System was introduced in the late 1980s -Full deregulation of foreign exchange earnings was fully accomplished in 1992

The Philippines has experienced two large foreign exchange episodes in the last 20 years

Government deficits were substantial during the 1980s and the current account deficit worsened Sudden stop: Capital flowed out of the ASEAN countries during the Asian Crisis. In case of the Philippines, capital flows also dropped in 1983.

- Although inflation rate has dropped significantly, dollarized deposit ratio still persist - Inflation rates rose substantially during the 1980s

Almost 50 percent of the total NG debt are foreign currency denominated, 60 percent of which are in US$ …

Dollarization accelerated starting 1992 to This is partly explained by the full deregulation of foreign exchange earnings in The post-crisis period saw a steeper decline in FCDU loans, relative to decline in deposit liabilities, as domestic borrowers shifted away from this type of loan in favor of local currency borrowings to minimize foreign exchange risk.

II. Dollarization and the growth of the financial sector

III. Dollarization, sudden stops & economic consequences 1.Effects on the banking & corporate sector 1.Asset-liabilities mismatch – currency risk masquerading as credit risk 2.Sudden stop leads to capital adequacy & balance sheet effects 2.Dollarization & government debt 1.Foreign liabilities of government held by domestic banks 2.Fiscal deficits, ratings downgrades & balance sheet effects 3.Banking contraction leads to credit crunch

Bank Assets and Dollar Loans and Discounts

Dollarization and Capital flow

Deficit Debt

III. Dollarization, sudden stops & economic consequences 3.Dollarization & market bubbles 1.Dollarization & short-term capital inflow 2.Stock prices 3.Sudden stops & credit crunch

Stock market index

Latin America Adopted from “Unlocking Credit” Philippines, 1984 and 1997

Dollarization in the Philippines: The way in; the way out Cayetano W. Paderanga Jr. Okinawa, Japan 8 April 2005