What is dollarization? Dollar and “ization”. Dollar here can be any dollar, or any currency, but in most cases, this word refers to United States dollar - $. And what does “ization” mean? It means the inhabitants of a country use foreign currency in parallel to or instead of the domestic currency. So, how can we know whether a country is under the state of dollarization? According to IMF, an economy is considered to experience dollarization when more than 30% of its bank deposit is dominated in dollar or foreign currencies.
If we follow the criterion above, it seems that dollarizaion has not occured in Vietnam yet. However, it is worth noting that although Vietnam has not reached the 30% roof, it has passed the 20% level. Moreover, it is common that goods in Vietnam are priced in dollar. So, it is certain that if there is nothing to be done, dollarization in Vietnam is just a matter of time.
But wait! Is dollarization good or bad? If it is good, then it is pointless to get worried. Like everything and phenomenons on Earth, dollarization is good, and bad also. In a country where inflation becomes a big problem like Vietnam, dollarization is good way to hedge from devaluation of the domestic currency and to buy goods in unofficial markets. If a country experience 100% dollarization, which means it does not have its own currency, there is no need to worry about monetary policy. The only concern will be fiscal policy alone. Dollarization helps banks and enterprises integrate with the world better. With so much dollar in deposit account, there is no need for bank to borrow from its foreign counterparts. Dollarization also lowers the transition cost of converting dollar into domestic currency and vice versa. However, the list of arguements against dollarization is long also. First of all, dollarized country looses an important adjustment mechanism, especially in case of external shocks. Severe swings in output and employment due to asymmetric shocks can only be avoided through domestic adjustment mechaninsm, particularly wage flexibility and fiscal policy. Futher, central bank in such countries looses the lender of last resort function. In other words, money supply becomes in elastic, systemic risk in financial sector increases. And if there is a foreign currency existing parallel with the domestic one, for example - USD, the country will financial depend heavily on America. And it will soon lead to political and social dependence. Dollarization is one of the results caused by impossible trinity: a country can only choose to purchase 2 out of 3 policies: a independent monetary policy - a complete control of inflation, exchange rate of its cunrrency, and management of capital flow. Depending on each country with its own characteristics, one can choose to let its currency float while others want to control inflation. It means, dollarization is not always bad. However, if our country has, from the beginning, decided not to depend on a specific foreign currency, dollarization will do more harm than good.
The next question comes to us: if dollarization is bad, to our economy, why is it happening? Before we answer that question, let’s find out the source of the dollars we are using now.
The main source of foreign currency comes from export sector. In 2010, Vietnam collected over $72 billion through export. Bear in mind that GDP of Vietnam is just a little bit over $100 billion to understand how big is that figure. However, we spent nearly $85 billion importing. That resulted in approximately $13billion of trade deficit. Therefore, in Vietnam, export is not a good way to earn dollars, although exporters always hold in hand large amount of dollar in cash and deposit. But there is one thing worth considering about “export”. Though the legal and official exporters do not help much, smugglers can really effect the market. The money they have through smuggling is in cash, and flowing to market quickly and uncontrollably.
It is lucky for Vietnam that we are not in the mercantilism era. The trade deficit can be eased with other sources. One of them is foreign investment. There are many kinds of investment, but mainly there are 3 kinds: Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI) and economic aid such as ODA. In 2010, Vietnam ranked 12th in the list of attracting FDI among countries (about $18 billion). FPI is much lesser, only $1 billion. ODA is promised at the figure of more than $8 billion. Enough to erase the gap between export and import. Oversea remittance can also be an important source. And finally, tourism. There were more than 5 miilion of foreign tourists coming to Vietnam last year. Assuming that each tourist spent $1000, we would have $5 billion totally.
Now that we have found out all the main sources of dollar in the market, we can answer the question why dollarization is existing.
One of the most worth noting characteristics of our economy is its instability and inflation, especially in recent years. Afraid of inflation, many people have chosen to hold USD instead of VND. Inflation has caused record high interest rate of VND while interest rate for USD still remains low. That has led to bigger proportion in borrowing and lending USD. This action is quite comprehensible, though it worsens the situation.
Secondly, Vietnamese people still uses cash in daily trading. This has helped USD to get deepened into the economy because government can hardly control that. Moreover, the most valuable note of VND is 500k VND while $100 is worth more than 2 million. Therefore, many people prefer using USD as a way to trade assets with big value.
It’s only a problem if we have a solution. It is true that there are solutions for the situation. But I am not about to suggest some. In this last part, let’s have a look at an event happening in the current days. 6 moths ago, VND depreciated sharply. At that time, it was predicted by many investors, including me, that sooner or later, 1 USD would equal 25k VND at the end of 2011. However, now, middle of June, 1 USD is only equal to 20.100 VND, and it does not seem to reach the target. What had happened? A quick action from government and central bank has reversed the situation. Money exchange agencies are under strict management. Required reserve of USD is raised up, which leads to lower deposit interest rate and higher lending rate in USD. Bank system attract dollar from the market. Commonly, such actions will result in more appreciation of USD because supply in market does not match demand. However, it is VND whose value rises against USD. It is true that supply has declined. But demand for USD has decreased too, at a greater pace than supply’s. Though these actions will not be effective in the long-run, they have somehow illustrated the power of government. The Government can fix everything. The only question is: Do they want to do that?
If we follow the criterion above, it seems that dollarizaion has not occured in Vietnam yet. However, it is worth noting that although Vietnam has not reached the 30% roof, it has passed the 20% level. Moreover, it is common that goods in Vietnam are priced in dollar. So, it is certain that if there is nothing to be done, dollarization in Vietnam is just a matter of time.
But wait! Is dollarization good or bad? If it is good, then it is pointless to get worried. Like everything and phenomenons on Earth, dollarization is good, and bad also. In a country where inflation becomes a big problem like Vietnam, dollarization is good way to hedge from devaluation of the domestic currency and to buy goods in unofficial markets. If a country experience 100% dollarization, which means it does not have its own currency, there is no need to worry about monetary policy. The only concern will be fiscal policy alone. Dollarization helps banks and enterprises integrate with the world better. With so much dollar in deposit account, there is no need for bank to borrow from its foreign counterparts. Dollarization also lowers the transition cost of converting dollar into domestic currency and vice versa. However, the list of arguements against dollarization is long also. First of all, dollarized country looses an important adjustment mechanism, especially in case of external shocks. Severe swings in output and employment due to asymmetric shocks can only be avoided through domestic adjustment mechaninsm, particularly wage flexibility and fiscal policy. Futher, central bank in such countries looses the lender of last resort function. In other words, money supply becomes in elastic, systemic risk in financial sector increases. And if there is a foreign currency existing parallel with the domestic one, for example - USD, the country will financial depend heavily on America. And it will soon lead to political and social dependence. Dollarization is one of the results caused by impossible trinity: a country can only choose to purchase 2 out of 3 policies: a independent monetary policy - a complete control of inflation, exchange rate of its cunrrency, and management of capital flow. Depending on each country with its own characteristics, one can choose to let its currency float while others want to control inflation. It means, dollarization is not always bad. However, if our country has, from the beginning, decided not to depend on a specific foreign currency, dollarization will do more harm than good.
The next question comes to us: if dollarization is bad, to our economy, why is it happening? Before we answer that question, let’s find out the source of the dollars we are using now.
The main source of foreign currency comes from export sector. In 2010, Vietnam collected over $72 billion through export. Bear in mind that GDP of Vietnam is just a little bit over $100 billion to understand how big is that figure. However, we spent nearly $85 billion importing. That resulted in approximately $13billion of trade deficit. Therefore, in Vietnam, export is not a good way to earn dollars, although exporters always hold in hand large amount of dollar in cash and deposit. But there is one thing worth considering about “export”. Though the legal and official exporters do not help much, smugglers can really effect the market. The money they have through smuggling is in cash, and flowing to market quickly and uncontrollably.
It is lucky for Vietnam that we are not in the mercantilism era. The trade deficit can be eased with other sources. One of them is foreign investment. There are many kinds of investment, but mainly there are 3 kinds: Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI) and economic aid such as ODA. In 2010, Vietnam ranked 12th in the list of attracting FDI among countries (about $18 billion). FPI is much lesser, only $1 billion. ODA is promised at the figure of more than $8 billion. Enough to erase the gap between export and import. Oversea remittance can also be an important source. And finally, tourism. There were more than 5 miilion of foreign tourists coming to Vietnam last year. Assuming that each tourist spent $1000, we would have $5 billion totally.
Now that we have found out all the main sources of dollar in the market, we can answer the question why dollarization is existing.
One of the most worth noting characteristics of our economy is its instability and inflation, especially in recent years. Afraid of inflation, many people have chosen to hold USD instead of VND. Inflation has caused record high interest rate of VND while interest rate for USD still remains low. That has led to bigger proportion in borrowing and lending USD. This action is quite comprehensible, though it worsens the situation.
Secondly, Vietnamese people still uses cash in daily trading. This has helped USD to get deepened into the economy because government can hardly control that. Moreover, the most valuable note of VND is 500k VND while $100 is worth more than 2 million. Therefore, many people prefer using USD as a way to trade assets with big value.
It’s only a problem if we have a solution. It is true that there are solutions for the situation. But I am not about to suggest some. In this last part, let’s have a look at an event happening in the current days. 6 moths ago, VND depreciated sharply. At that time, it was predicted by many investors, including me, that sooner or later, 1 USD would equal 25k VND at the end of 2011. However, now, middle of June, 1 USD is only equal to 20.100 VND, and it does not seem to reach the target. What had happened? A quick action from government and central bank has reversed the situation. Money exchange agencies are under strict management. Required reserve of USD is raised up, which leads to lower deposit interest rate and higher lending rate in USD. Bank system attract dollar from the market. Commonly, such actions will result in more appreciation of USD because supply in market does not match demand. However, it is VND whose value rises against USD. It is true that supply has declined. But demand for USD has decreased too, at a greater pace than supply’s. Though these actions will not be effective in the long-run, they have somehow illustrated the power of government. The Government can fix everything. The only question is: Do they want to do that?
Kz
June, 2011.
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