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Analysis: Dealing with the dollar dilemma

ANALYSIS

James lowrey

Cambodia’s reliance on the greenback may not be the best path to a stable economy
THE function of money in Cambodia is served by the national currency, the riel, and a handful of foreign currencies, including the Vietnam dong, the Thai baht and the US dollar. In fact, approximately 90 percent of all transactions today are conducted in greenbacks.

Cambodia is not on its own as a heavily dollarised economy. Many countries have adopted the US dollar either officially or unofficially, and in  the Asian region it is widely used in Laos, Vietnam and Indonesia.

Some say the arrival of UNTAC forces in 1992 and 1993 led to the dollarisation of Cambodia's economy with an estimated $1.7 billion brought in over the period. This represented a substantial proportion of money supply, with annual gross domestic product estimated at between $2 billion and $3.1 billion through the early to mid-1990s.

A large proportion of the dollar deposits in the country were via net private transfers from abroad. Up until 1996, the annual private US dollar inflows exceeded the country's official foreign exchange reserves.

Monetary dollarisation is often viewed as favourable for economic growth because it can help firms and households protect the value of financial assets from depreciation in local currency terms. However, not all people view it as positive, with critics saying it introduces a mechanism for capital flight from domestic to foreign currencies.

An uncertain or weak currency limits the usefulness

of money

It can also make an economy more vulnerable to both domestic and external shocks and can restrict the ability of local authorities to manage monetary policy. If dollarisation is entrenched, manipulating the local currency or  interest rates has little effect on money supply.
One key advantage of dollarisation is a reduction in transaction costs for international trade. Being able to domestically on-sell imported goods paid for in US dollars  nets out foreign exchange risks. Or does it?

Even when a country is completely dollarised, it is still exposed to foreign exchange risk when exchange rates fluctuate among international currencies. For example, if the US dollar depreciates against the currencies of trading partners, it erodes the purchasing power of the dollar abroad, exposing Cambodia to the risk of importing inflation. Imports to Cambodia are diverse in terms of country of origin, but around 90 percent are paid for in dollars.

On the flipside, a stronger US dollar may hurt exporters. Tourism is a key growth sector for Cambodia, generating much-needed foreign exchange. But as tourists are faced with US dollar expenses, if their currency weakens against the US dollar, a non-dollarised country may become a relatively more attractive holiday destination.

In Cambodia, dollarisation is not an official policy. The government has retained the Khmer riel as the currency of choice for utility payments, government fees, charges and taxes. Riels are also widely used in everyday markets and provinces where the engine room of the economy resides.

However, the US dollar is the predominant currency for business transactions. Imports, exports, retail purchases and property transactions are all conducted in US dollars.

Time for a change?

The question being asked today is whether Cambodia benefits from unofficial dollarisation and whether it should move to official dollarisation. Many would suggest not and would like to see riels more widely used.

It is claimed that dollarisation helps reduce uncertainty and country risk, which in turn reduces interest rates and inflation. Not so in Cambodia where interest rates remain high compared with the US and other main trading partners. Dollarisation also does not necessarily help keep inflation low.

While dollarisation infers the opportunity to share the stability of the dollar with countries that adopt it, this can be a dangerous assumption. The ability to remain flexible and change currency of trade to match the country of origin, in order to maintain purchasing power and deliver better priced goods to market is paramount and can help the government better serve its people.

The benefits of maintaining a flexibile currency position will be measured not just in terms of GDP, but in terms of fulfilling human potential. An uncertain or weak currency limits the usefulness of money, limiting choice, innovation and investment. The accumulation of wealth that a trustworthy currency permits enables children to have better educations, families to take out longer-term mortgages for home ownership and provides retirees protection for their accumulated savings.

Taking leadership to manage a strong currency is imperative to the long term economic prospects of this country.

_________________________________________
James Lowrey is head of corporate and institutional banking at ANZ Royal.

Contact him via james.lowrey@anz.com.

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