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Financial sector development and dollarization in emerging economies

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  • Marcelin, Isaac
  • Mathur, Ike

Abstract

This paper discusses important features of financial dollarization and its implications for the macro economy and financial sector deepening. Despite the need to slow down the rate of inflation and keep exchange rates under control, to achieve growth and economic development, monetary policies may permit increases in the base money to keep pace with real GDP growth. In heavily dollarized economies, during periods of sharp devaluations of the domestic currency, financial assets and liabilities shift toward foreign currency, exacerbating downward pressure on the exchange rate. When central banks face pressures to keep the exchange rate steady in nominal terms, interest rates in the domestic currency are set at levels substantially higher than those on dollar assets. In such states of the world, banks prefer to lend to the government sector at these higher rates than to the private sector. Although private firms may benefit from lower rates on dollar loans, they also face significant exchange rate or currency risk due to the currency mismatch emerging from their dollar debt while their receivables may tilt toward domestic currency denominated instruments. This weakens their balance sheet, which in turn increases the exposure of the banking sector to a variety of risks.

Suggested Citation

  • Marcelin, Isaac & Mathur, Ike, 2016. "Financial sector development and dollarization in emerging economies," International Review of Financial Analysis, Elsevier, vol. 46(C), pages 20-32.
  • Handle: RePEc:eee:finana:v:46:y:2016:i:c:p:20-32
    DOI: 10.1016/j.irfa.2016.04.010
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    More about this item

    Keywords

    Financial dollarization; Financial development; Exchange rate; Interest rate; Monetary policy;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • O1 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development
    • O2 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy

    Statistics

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