Question

Compare the condition of dollarization between Brazil and Argentina.

Answer 1

Brazil

Brazil is an interesting case study for our findings, because despite past high systemic risks it
managed to avoid financial dollarization and developed a large local-currency-based
financial market. Short-duration is pervasive, but what most calls attention are the country’s
very high real interest rates. Economists investigated whether these phenomena were interrelated: for
given systemic risks, high real interest rates is the price to pay to avoid dollarization.
However, fitted values of our model proved to be largely off mark for Brazil, particularly in
the 1996–98 period, when an exchange rate peg prevailed and monetary policy was mostly
driven by adverse balance of payments considerations.
Even in the period 2000–2006, during which a regular inflation-targeting framework was in
force and the exchange rate was allowed to float, we found actual real interest rates to be
higher than predicted (2002 excepted). Allowing for the fact that in 2003–2006 the central
bank under Lula whished to establish its reputation as an inflation hawk, we devised an
exercise incorporating adverse expectations and central bank prudence in our estimates, thus
being able to reduce Brazil’s high real interest rate mystery to less than we initially
estimated. Although we did not discern a clear trend for the remaining disparity to diminish
after 1999, we noted that this lack of convergence was due to two specific years, 2003 and
2005. Making use of market-based expectations for 2007 and 2008, we observed that Brazil’s
real interest rates are indeed in the process of converging to our model’s estimated real
interest rates for the country, which range from 5.5 to 7.5 percent.

In conclusion, to bring real interest rates further down, the model indicates that Brazil should
implement policies aimed at achieving investment grade status, and not allow deposit
dollarization. From our estimations we conclude that the quantitative real interest rate gains
of the policy of allowing Brazilians to hold dollar deposits domestically (0.011 percentage
points on impact and 0.023 percentage points in the long run for a 1 percentage point
increase in deposit dollarization) would not seem to justify the costs associated to this move.
In fact, the dollarization literature (Armas, Ize and Levy-Yeyati, 2005, for example) provides
many reasons associated to financial stability on why de-dollarization of the type achieved by
Brazil is an object of desire for many emerging market countries. What our model shows is
that much better for Brazil would be, for example, moving towards a strong fiscal
consolidation as a means of speeding up its access to investment-grade status and thus being
able to achieve real interest rate reductions of 2 percentage points or more according to our
estimates.
A weak spot in our analysis is that our sample is short in the time dimension and includes a
limited number of emerging markets. Future research with an expanded sample should thus
endeavor to uncover dynamic relations not contemplated by our results. Furthermore, in our
model we only considered two of the possible financial consequences of systemic risk, i.e.,
domestic financial dollarization and high real local-currency interest rates. Future research
could attempt to incorporate financial shallowness, offshore dollarization, short-termism and
indexation, as alternative systemic-risk-coping mechanisms in emerging economies.

Argentina

As the economic situation in Argentina worsens, more voices appear that propose to resort to dollarization as an effective measure to get out of the crisis. Is this measure capable of saving Argentina or will it only aggravate existing problems?

The Argentine peso has been devalued by 100% so far this year. The US bank Citibank indicated in its report that inflation in Argentina could reach 48.5% in 2018 and reach 50% at the beginning of 2019.

Options against the economic debacle

Argentine economist Guillermo Calvo said in an interview with the Argentine newspaper La Nación that dollarization is something that Argentine authorities would have to think more seriously from now on.

"As long as Argentina does not do the latter, it will not be able to grow," Calvo said, although he added that for now it is premature to make dollarization, which would also not help alleviate the problem of debt and current account deficit.

In addition, Calvo admitted that dollarization would deprive the Argentine authorities of intervening in the exchange rate. The central banks of many countries tend to manipulate the exchange rates of the national currency through interventions to support the commercial activity of the exporting companies.

Why dollarization will not help Argentina?

Despite the voices that advocate for dollarization, there are others who consider it a bad idea. The economist and former deputy economy minister Carlos Rodríguez said in an interview with the Argentine daily Clarín that a country that does not have enough dollars can not dollarize its economy.

The expert believes that dollarization is unable to solve structural problems and is only an "alternative B", which the Argentine authorities can use if the peso collapses.

The journalist Claudio Fabián Guevara highlights in his article for Telesur that the current situation in Argentina is similar to the one that occurred in 1989, which was marked by hyperinflation.

At that time, the Argentine authorities decreed the Convertibility Law of the Austral, which established a fixed exchange rate between the national currency and the United States, at the rate of 1 US dollar per 10.000 australes or later a convertible peso.

Although this measure helped to reduce inflation significantly since 1997, Argentina went on to face problems that were caused by its application.

If in the first years the Argentine authorities could obtain dollars in abundance when going to the privatization of the state companies and retirement funds, once finalized this process they had to accumulate external debt.

They did so because Argentina's agro-export economy was unable to produce sufficient foreign exchange earnings.

According to Fabián Guevara, the approval of this law finally contributed to the December 2001 crisis in Argentina. The columnist thinks that the proposal to dollarize the economy of Argentina can not be explained only by the internal context.

"The imperial need to maintain the hegemony of the dollar has been more important than the exploitation of oil in the history of the last decade," he writes.

The journalist points out that while a block of emerging countries, headed by Russia, China and India, is looking for a way to replace the dollar as an international reference currency, the dollarization of Argentina would be a symbolic conquest for those who are trying to maintain the hegemony of the North American currency.

According to the author, if the authorities decide to replace the peso with the dollar, they will not be able to do so because they will need too many international reserves that are currently losing due to the accelerated exchange rate crisis.

The experience of others

Argentina is not the only country in which discussions about dollarization were held. Ecuador even went beyond simple conversations and adopted dollarization 18 years ago. This measure applied to fight against high inflation worked only at the beginning, according to the Clarín newspaper.

The economist of the consulting firm Maxinver Eduardo Blasco points out to the Argentine environment that despite the positive effects, dollarization did not help to definitively solve the problems facing this country.

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