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Currency Substitution in Cambodia _____________________________________________________________________ KEM REAT VISETH

Currency Substitution in Cambodia _____________________________________________________________________ KEM REAT VISETH Cambodia Institute for Cooperation and Peace, and Office of the Council of Ministers Phnom Penh, CAMBODIA Prepared for the 9th Academic Forum on East Asian Economy

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Currency Substitution in Cambodia _____________________________________________________________________ KEM REAT VISETH

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  1. Currency Substitution in Cambodia _____________________________________________________________________ KEM REAT VISETH Cambodia Institute for Cooperation and Peace, and Office of the Council of Ministers Phnom Penh, CAMBODIA Prepared for the 9th Academic Forum on East Asian Economy Nanning, November 24-25, 2005

  2. OUTLINE • What is currency substitution (CS) and why is it important for economic development • Stylized facts of CS in Cambodia • Model of CS and empirical results • Conclusion

  3. The use of foreign currency (FC) and FC denominated bonds by domestic residents. C The demand for foreign fiat money by domestic residents. B FC serves the three roles of domestic currency in a domestic economy. A 1.a. What is CS?

  4. 1. b. Dollarization and its types • Official dollarization • Semi-official dollarization • Unofficial dollarization

  5. 1. c. Measurements of CS i.Stock concept: • measures the volume of FC in an economy. • Normally, measured by a ratio of FCD/M, called CS or dollarizationratio. ii. Process or behavioral concept: measures the propensity of substituting FC for domestic currency by an economic agent.

  6. 1. d. Importance of CS i. Benefits of CS: • Promote financial reintermediation and financial deepening • Promote confidence in the domestic banks • Impose discipline on the government to finance spending though inflation tax

  7. ii. Costs of CS: • Loss of seigniorage • Limit the conduct of monetary policy • Nominal exchange rate cannot be used to respond to economic shocks • Exacerbate inequality of income distribution

  8. 2. Stylized facts of CS in Cambodia  US dollar is widely used as: • Store of value • Means of payment • Unit of account • Thai baht and Vietnamese dong is used as medium of exchange in main cities and some areas bordering with Thailand and Vietnam.

  9. Foreign Currency Deposit: 1988-2001 Source: Data provided by the NBC

  10. Causes of CS in Cambodia • Low confidence in the “riel”, as a result of the two decades of war • Smuggling activities • UNTAC arrival • Remittances • Under-developed financial market • Inflation, and • Exchange rate depreciation

  11. Monthly Exchange Rates and Inflation Rates: January 1993-April 2001 Source: Data provided by the NBC

  12. 3.a. Model of CS The estimated equation can be written as: This equation states that the ratio of holdings of FC to domestic currency and the change in depreciation rate are positively related.

  13. 3. b. Empirical Results

  14. 4. Conclusions & Future Research • There is strong presence of CS in Cambodia, thus limiting the power of the monetary authority. In view of this, should Cambodia officially dollarized or de-dollarized? • Given preliminary studies, the costs of dollarization in Cambodia seems to outweighs the benefits.

  15. Conclusion (cont’d) • Therefore, the National Bank of Cambodia (Cambodia’s Central Bank) suggests the gradual de-dollarization process. • However, a thorough study ought to be conducted to investigate the quantitative costs and benefits of dollarization. This is a topic for further research.

  16. THANK YOU!!!

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