DOLLARIZATION AND UNDEVELOPED CAPITAL (FINANCIAL) MARKETS IN TRANSITION ECONOMIES - PowerPoint PPT Presentation

1 / 18
About This Presentation
Title:

DOLLARIZATION AND UNDEVELOPED CAPITAL (FINANCIAL) MARKETS IN TRANSITION ECONOMIES

Description:

... financing becomes more ... Sequential portfolio balance model (Miles, 1978) ... For small DR and RR, one can approximate. Financial Markets Development ... – PowerPoint PPT presentation

Number of Views:95
Avg rating:3.0/5.0
Slides: 19
Provided by: piontk
Category:

less

Transcript and Presenter's Notes

Title: DOLLARIZATION AND UNDEVELOPED CAPITAL (FINANCIAL) MARKETS IN TRANSITION ECONOMIES


1
DOLLARIZATION AND UNDEVELOPED CAPITAL (FINANCIAL)
MARKETS IN TRANSITION ECONOMIES
  • Ruslan Piontkivsky,
  • International Centre for Policy Studies, Kyiv,
    Ukraine
  • and National University of Kiev-Mohyla Academy,
    Kyiv, Ukraine
  • GDN Global Development Conference, December 9-12,
    2001
  • The author is thankful for the support
  • to the Economic Education and Research Consortium
    Russia

2
Definitions
  • Dollarization a situation in which residents of
    a country hold a share of their assets in the
    form of foreign currency and foreign currency
    denominated assets
  • replacing medium of exchange, unit of account,
    and store of value functions of domestic money
  • Currency substitution (CS) (direct currency
    substitution) foreign currency is used for
    payments
  • replacing the medium of exchange function of
    domestic money
  • Asset substitution (AS) (indirect currency
    substitution) foreign currency is mainly used as
    a store of value

3
Objectives of the Study
  • Why it is important
  • Budget deficit financing becomes more
    inflationary
  • Probability of a banking crisis increases due to
    a mismatch of assets and liabilities as well as a
    lower ability to pay of foreign currency
    borrowers
  • The structure of dollarizationwhether it
    represents more CS or ASis crucial in the choice
    of exchange rate regime or monetary aggregate as
    an operating goal of monetary policy
  • Objectives of the study
  • Determine dollarization factors in transition
    economies
  • Test whether financial market developments are
    determinants of dollarization in transition
    economies
  • Draw conclusions regarding policies aimed at
    minimizing adverse effects of dollarization

4
Hypotheses
  • The level of dollarization is determined by
    return and risk characteristics of assets
    denominated in national and foreign currencies
  • The level of dollarization depends on the extent
    of financial markets development

5
Where This Project Fits Existing Literature
  • Early CS models (Calvo and Rodriguez, 1977
    Leviatan, 1981)assume only two assets domestic
    and foreign currency
  • Asset portfolio balance modelsexplicitly assume
    the existence of bonds denominated in each
    currency
  • Sequential portfolio balance model (Miles, 1978)
  • Dynamic optimization model (Bufman and Leiderman,
    1993)
  • Unrestricted portfolio balance model (Branson
    and Henderson, 1985 Cuddington, 1983 Thomas,
    1985)
  • Balance sheet models (Ize and Levy-Yeyati,
    1998)consider dollarization from two sides of
    the financial intermediary the absence of
    foreign currency in circulation among the assets

6
Theory
  • Thomas (1985)
  • Consumers maximize their expected utility by
    choosing real consumption level c and asset
    portfolio structure (f foreign currency,
    bforeign bonds)
  • Optimal choice (dollarization ratio) depends on
    the difference of real returns on foreign and
    domestic bonds (R-R), domestic and foreign prices
    volatility (S and S, prices instantaneous
    standard deviations), and attitude to risk
    (V(A)Arrow-Pratt measure of relative risk
    aversion )

7
Citations
  • Savastano (1996)
  • The relative importance of foreign currency as
    an inflation hedge will be inversely related to
    the economys level of financial development.
  • Cuddington (1989)
  • Extending the Thomas paper to an environment
    where there are goods and capital markets
    imperfections would be one way of yielding an
    appropriate empirical specification on which to
    base tests of the importance of CS in LDCs.

8
Model Specification
  • We assume that foreign prices are constant
  • Net relative return on domestic bonds can
    appear to be negative, we change net return into
    gross return
  • For small DR and RR, one can approximate

9
Financial Markets Development
  • The extent of financial markets development
    affects the dollarization level through the
    following channels
  • The change in domestic assets portfolio risk
    characteristics. Let d consist of a set of assets
    n (mainly, bank deposits). As n
    increasesemergence of enterprises stocks and
    bonds as well as government bondsopportunities
    for domestic portfolio diversification increase
  • Banking system development. If banks offer new
    instruments allowing its clients to hedge off
    inflation and/or devaluation (i.e., indexed
    deposits), then inflation volatility becomes less
    damaging, therefore, the dollarization decreases
  • Due to borrowing constraints, CS and
    dollarization are not entirely independent. So,
    the dollarization might depend on the foreign
    trade turnover, as agents are not able to offset
    trade flows with financial instruments

10
Data 1
  • quarterly data for 6 transition
    economiesUkraine, Russia, Czech Republic, Slovak
    Republic, Poland, and Romania
  • Most of the data from the International Financial
    Statistics (IFS)
  • 19911993 until Q42000
  • dollarization ratio
  • ratio of the sum of foreign currency deposits in
    the country to the money supply (to total volume
    of deposits (incl. those in domestic currency)
    and domestic currency in circulation)

11
Data 2
  • Real relative return of domestic bonds
  • difference between weighted domestic currency
    deposit rate and LIBOR on three-months deposits
    in the U.S. dollar, taking into account expected
    devaluation (changes in average quarterly
    exchange rate of the domestic currency to the
    U.S. dollar)
  • Inflation volatility indicator
  • for quarterly data, we calculate it as variance
    of monthly inflation levels (taking monthly CPI
    data)

12
Preliminary Estimation Results
  • Empirical estimations do not support static
    exchange rate expectations. For Russia, Ukraine,
    Poland, and Slovak Republic, the best results
    were achieved for the specification, where
    rational exchange rate expectations are modeled,
    while for Romania and Czech Republic adaptive
    expectations fit better
  • For all the countries in consideration, except
    for Slovak and Czech Republic, inflation
    volatility and relative returns are significant
    and correctly signed at least at 5 (for
    Ukraine), while for Russia, Romania, and Poland
    p-value is less than 1
  • Poland has the best results in the sample
  • Incorporation of the foreign cash in circulation
    into the dollarization ratio, used for
    estimation, leads to different results for
    Ukraine and Russia. In case of Russia, the
    statistical properties of the regression improve,
    while for Ukraine they deteriorate.

13
Policy Implications
  • Relative return on assets and inflation
    volatility are determinants of dollarization in
    transition economies
  • Results of the Thomas model imply an alternative
    explanation of the hysteresis. According to the
    model, the increased relative return on domestic
    assets does not lead to the reduced dollarization
    if it is accompanied with an increase in
    inflation volatility.
  • Estimation results offer a potential to fight the
    dollarization resorting to such instruments as
    high domestic interest rates, predictable
    exchange rate, and stability (not necessarily
    decline) of inflation rate
  • Inflation targeting and sending signals to market
    about exchange rate dynamics seems to be a
    preferred instrument

14
Financial Market Development and dollarization (D)
  • T. Beck, A. Demirguc-Kunt, R. Levine A New
    Database of Financial Development and Structure,
    June 1999
  • Transition economies (8) Russia, Ukraine,
    Poland, Romania, Czech Republic, Latvia,
    Lithuania, Estonia
  • Developing countries (5) Turkey, Egypt,
    Argentina, Bolivia, Chile
  • Averages over the 1990s, when available

15
D and Deposit Money Banks Assets
16
D and Private Credit
17
D and Stock Market Value Traded
18
D and Foreign Trade Turnover
Write a Comment
User Comments (0)
About PowerShow.com