Dollarisation Does Not Go Hand In Hand With Heightened Financial Market Risks, Study Says

Financial Dollarisation in emerging market economies does not necessarily lead to more vulnerability in the respective financial system, according to a recently published study with the participation of the University of Mannheim. “The common view that financial dollarisation is a source of fragility is over-stated,” the authors said.

Dollarisation means the use of a foreign currency in parallel to or instead of the domestic currency and is widespread in a number of developing and emerging market economies. Deposit dollarisation can be seen as an insurance arrangement, mainly between different people inside individual countries rather than between agents across countries.

The median cross-country flows due to dollar debt are on average around half of the within-country flows, according to the authors, who used different datasets over the period 2000 to 2018 from up to 16 countries.

Insurance of dollar deposits comes from the fact that the US Dollar tends to gain in value when the local economy is in recession. “For many people – mostly the US audience – deposits sound like a trivial instrument but for most countries, specifically emerging market economies, deposits are the main saving device for residents,” the authors explained.

Households who denominate their deposits in dollars are purchasing a business cycle insurance, according to the study.

The ‘price’ paid by the depositors for this insurance is the premium on the local interest rate. The payoff from the insurance is the spike in the dollar return that occurs when the local currency depreciates in a recession.

To the press release