Dollarization in cambodia case promote riel and de dollarization master thesis of banking and finance

vii LIST OF TABLES Table 1- Table 1-International Trend of Dollarization...14 Table 2- Table 2 - Evolution of Dollarization in various...15 Table 3- Estimated Losses on Riel Printing 19

MINISTRY OF EDUCATION THE STATE BANK OF VIETNAM AND TRAINING

BANKING UNIVERSITY HO CHI MINH

MARY MENDA

DOLLARIZATION IN CAMBODIA CASE PROMOTE RIEL AND DE-DOLLARIZATION

MAJOR: BANKING AND FINANCE MAJOR CODE: 8 34 02 01

MASTER THESIS

SUPERVISOR: ASSO.PROF.DR ĐOÀN THANH HÀ

HO CHI MINH CITY - YEAR 2020

CONTENTS

ABSTRACT……….……… i

RESEARCH GUARANTEE……… ……… ……iii

ACKNOWLEDGMENTS……….……… iv

TABLE OF CONTENTS……….…… …v

LIST OF TABLES……….… ……vii

LIST OF FIGURES……….… ……vii

LIST OF ABBREVIATIONS……….…… …viii

INTRODUCTION 1 Reason to choose a topic……….…………1

2 Research objectives……… ….…………2

2.1 Overall objective……… ………… ……2

2.2 Specific objectives……….………… …….……2

3 Research questions……….….… ……2

4 Research Methodology……… ….….…3

5 The structure of the thesis……….………….…… 4

CHAPTER 1 LITERATURE REVIEW 1.1 The concept of dollarization……….……6

1.2 Dollarization classification……… ……….……6

1.3 The method of measuring the degree of dollarization……… 7

1.4 The causes of dollarization……….11

1.5 The effects of dollarization on the economy……… ……12

1.5.1 Positive impact……… ……12

1.5.2 Negative impact……… ……… ……13

1.6 International Experiences……… ……14

1.7 Summary Chapter 1………16

CHAPTER 2 CURRENT SITUATION OF DOLLARIZATION OF THE ECONOMY

IN CAMBODIA 2.1 Analyze the current situation of dollarization in Cambodia 2000-2019…………18

2.1.1 The situation of dollarization of the economy in Cambodia …… …………18

2.1.2 The causes of dollarization in Cambodia……….……….28

2.1.2.1 People's faith in the Riel………32

2.1.2.2 Measuring Dollarization in Cambodia……….….35

2.1.2.3 Foreign exchange control 42 2.2 The impact of dollarization on the Cambodian economy………43

2.2.1 Positive impact……… ….… 44

2.2.2 Negative impact………46

2.3 Summary Chapter 2………48

CHAPTER 3 SOLUTIONS TO OVERCOME THE DOLLARIZATION SITUATION IN CAMBODIA 3.1 The Cambodian government's view of dollarizing the economy……….……49

3.2 Solutions to overcome the dollarization of the Cambodian economy……….……51

3.2.1 Riel empowering……… ………51

3.2.2 Interest rate policy………52

3.2.3 Foreign exchange management policy……….52

3.3 Proposals to regulatory agencies……….……53

3.4 Summary Chapter 3……….…56

CONCLUSION………58

RECOMMENDATION ……….………… ………… 59

REFERENCES……….………… … ……i

Dollarization occurs when residents of a country extensively use foreign currency alongside

or instead of the domestic currency

Dollarization can occur unofficially, without formal legal approval, or it can be official, as when a country ceases to issue a domestic currency and uses only foreign currency

Dollarization emerged spontaneously in Cambodia, because public confidence in the riel eroded, following a series of shocks that ranged from the destruction of all infrastructures by the Khmers Rouges to the subsequent mismanagement of the economy

The lack of public confidence in institutions and in the banking system remains high and dollarization is still in progress, in spite of recent improvements in macroeconomic stability and of measures taken by the authorities to restore confidence

If this trend continues, the country may eventually become fully dollarized No harsh action should certainly be taken against the use of the dollar However, there is a need to build up a consensus on how to promote the use of the national currency

There are two priorities Cambodia needs to do in the next 5-10 years The first priority is developing a comprehensive plan to promote Riel and de-dollarization Such a plan would need to be developed by relevant authorities, who would be responsible for the implementation The second priority is the establishment of a task force that has sufficient capacity to respond to the market’s reactions when the de-dollarization plan is enforced

From the experience of countries that have attempted to de-dollarize their economies, the success or failure depends very much on whether the market looks at the plan and the authority who implements the plan that is credible or not Therefore, stronger efforts need to

be made to build the capacities of relevant institutions that would be responsible for the formulation and implementation of the de-dollarization plan This paper is one step in that direction

Keywords: Dollarization, De-dollarization, Riel, Khmers Rouges

Đô la hóa có thể xảy ra không chính thức, không có sự chấp thuận pháp lý chính thức hoặc

có thể là chính thức, như khi một quốc gia ngừng phát hành nội tệ và chỉ sử dụng ngoại tệ

Đô la hóa nổi lên một cách tự phát ở Campuchia, do niềm tin của công chúng vào đồng riel

bị xói mòn, sau một loạt cú sốc từ việc phá hủy tất cả cơ sở hạ tầng của Khmers Rouge dẫn đến sự quản lý yếu kém của nền kinh tế sau này

Sự thiếu tin tưởng của công chúng vào các tổ chức và hệ thống ngân hàng vẫn ở mức cao và tình trạng đô la hóa vẫn đang diễn ra, Bất chấp những cải thiện gần đây về ổn định kinh tế vĩ

mô và các biện pháp mà chính quyền thực hiện để khôi phục niềm tin

Nếu xu hướng này tiếp tục, đất nước cuối cùng có thể trở thành đô la hóa hoàn toàn Chắc chắn không nên thực hiện hành động khắc nghiệt nào chống lại việc sử dụng đồng đô la Tuy nhiên, cần phải xây dựng sự đồng thuận về cách thức thúc đẩy việc sử dụng đồng tiền quốc gia

Có hai ưu tiên Campuchia cần thực hiện trong 5-10 năm tới Ưu tiên đầu tiên là phát triển một kế hoạch toàn diện để thúc đẩy Riel và phi đô la hóa Một kế hoạch như vậy sẽ cần được phát triển bởi các cơ quan có liên quan, những người sẽ chịu trách nhiệm thực hiện Ưu tiên thứ hai là thành lập một lực lượng đặc nhiệm có đủ năng lực để đối phó với phản ứng của thị trường khi kế hoạch phi đô la hóa được thực thi

Theo kinh nghiệm của các nước đã nỗ lực phi đô la hóa nền kinh tế của họ, thành công hay thất bại phụ thuộc rất nhiều vào việc thị trường nhìn vào kế hoạch và cơ quan thực hiện kế hoạch có đáng tin cậy hay không Do đó, cần phải có những nỗ lực mạnh mẽ hơn nữa để xây dựng năng lực của các tổ chức có liên quan chịu trách nhiệm xây dựng và thực hiện kế hoạch phi đô la hóa Bài báo này là một bước theo hướng đó

T ừ khóa: Đôla hóa, Khử đôla hóa, Riel, Khmers Rouges

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RESEARCH GUARANTEE

I hereby declare that all information in this document has been obtained and presented in accordance with academic rules and ethical conduct I also declare that this thesis has never been submitted for a master's degree at any university This thesis is the author's own research, the research results are honest, in which there are no previously published content

or content by others except for fully cited citations in the thesis

Ho Chi Minh City, 25 / 12 / 2020

MARY MENDA

iv

ACKNOWLEDGMENTS

I owe my thesis supervisor Asso.Prof.Dr Đoàn Thanh Hà and co-supervisor Asso.Prof Ph.D Hoang Thi Thanh Hang a debt of gratitude for their close supervision and academic support throughout this study I am also grateful to the examining committee members for sharing their precious contributions and criticisms

I would like to thank the State Bank of Vietnam for giving me the scholarship to study at Banking University Ho Chi Minh

Also, I would like to thank my workplace, the National Bank of Cambodia for giving me a chance to study here too

Last but not least, I express my deepest gratitude to my parents for teaching me everything that makes me who I am today Furthermore, I am grateful to my sister for her close support and encouragement throughout this study

Ho Chi Minh City, 25 / 12 / 2020

v

CONTENTS

ABSTRACT

ACKNOWLEDGMENTS

TABLE OF CONTENTS

LIST OF TABLES

LIST OF FIGURES

LIST OF ABBREVIATIONS

INTRODUCTION

1 Reason to choose a topic……….…………1

2 Research objectives……… ….…………2

2.1 Overall objective……… ………… ……2

2.2 Specific objectives……….………… …….……2

3 Research questions……….….… ……2

4 Research Methodology……… ….….…3

5 The structure of the thesis……….………….…… 4

CHAPTER 1 LITERATURE REVIEW 1.1 The concept of dollarization……….……6

1.2 Dollarization classification……… ……….……6

1.3 The method of measuring the degree of dollarization……… 7

1.4 The causes of dollarization……….11

1.5 The effects of dollarization on the economy……… ……12

1.5.1 Positive impact 12 1.5.2 Negative impact 13 1.6 International Experiences……… ……14

1.7 Summary Chapter 1………16

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CHAPTER 2 CURRENT SITUATION OF DOLLARIZATION OF THE ECONOMY

IN CAMBODIA 2.1 Analyze the current situation of dollarization in Cambodia 2000-2019…………18

2.1.1 The situation of dollarization of the economy in Cambodia …… …………18

2.1.2 The causes of dollarization in Cambodia……….28

2.1.2.1 People's faith in the Riel………32

2.1.2.2 Measuring Dollarization in Cambodia……….….35

2.1.2.3 Foreign exchange control 42 2.2 The impact of dollarization on the Cambodian economy………43

2.2.1 Positive impact……… ….… 44

2.2.2 Negative impact………46

2.3 Summary Chapter 2………48

CHAPTER 3 SOLUTIONS TO OVERCOME THE DOLLARIZATION SITUATION IN CAMBODIA 3.1 The Cambodian government's view of dollarizing the economy……….……49

3.2 Solutions to overcome the dollarization of the Cambodian economy……….……51

3.2.1 Riel empowering……… ………51

3.2.2 Interest rate policy………52

3.2.3 Foreign exchange management policy……….… 52

3.3 Proposals to regulatory agencies……….……53

3.4 Summary Chapter 3……….…56

CONCLUSION………58

RECOMMENDATION ……….………… ………… 59

REFERENCES………60

vii

LIST OF TABLES

Table 1- Table 1-International Trend of Dollarization 14

Table 2- Table 2 - Evolution of Dollarization in various 15

Table 3- Estimated Losses on Riel Printing (1998-2001) 42

Table 4- Evolution of Loan to Deposit Ratio 44

LIST OF FIGURES Figure 1- Composition of Broad Money and the Ratio of Foreign Currency Deposits to Broad Money 18

Figure 2- Trends in GDP growth and per capita GDP 19

Figure 3- Currency Composition of Income by Area (Family Unit) 22

Figure 4- Currency Composition of Total Expenditure (family unit) 23

Figure 5- Currency Composition of Loans by Area 23

Figure 6- Currency composition of revenues (Enterprise) 24

Figure 7 Currency composition of expenditures (Enterprise) 24

Figure 8: Currency composition of revenues 25

Figure 9: Currency composition of expenditures 26

Figure 10: Currency composition of revenues 26

Figure 11: Currency composition of expenditures 27

Figure 12: Foreign direct investment net inflows in Cambodia from 2013 to 2019…… 29

Figure 13: Evolution of Net Claims on the Government (NCG) and Broad Money Supply (M2) 30

Figure 14: Evolution of Inflation and Exchange Rate 31

Figure 15: Evolution of Fiscal Deficit and Broad Money Supply (M2) 31

Figure 16: Assets and Liabilities of Banking System in Foreign Currency 36

Figure 17: Dollarization Ratios 38

Figure 18: Ratio of Foreign Currency Deposits to Broad Money (In Percent) 39

Figure 19: Foreign Currency Doposits in Cambodia, Lao P.D.R, and Vietnam (As percent of broad money) 40

Firgure 20: Dollars in circulation Outside Banks (In billions of U.S dollars 41

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LIST OF ABBREVIATIONS

UNTAC United Nations Transitional Authority in Cambodia

1

INTRODUCTION

1 Reason to choose a topic

Cambodia during the Dark Ages, the genocide, was completely abolished Only in

1979 did Cambodia begin to regain peace, but it was still not full In 1980, the national currency was reinstated, but the banking system was still weak, and public confidence in the riel was low and slim The problem of inflation and national monetary instability has made use of foreign currencies instead of local currencies in economic operations in Cambodia

The Cambodian economy has been facing high dollarization since the fall of the Khmer Rouge regime According to the International Monetary Fund (IMF) in Cambodia, the dollar is now used to account for more than 80% of the total cash circulation in the market, as opposed to neighboring countries such as Laos There is a decrease in the national currency Looking back at the trend of the use of the dollar in Cambodia, there has been no slowdown, Even though Cambodia has maintained its macroeconomic stability and inflation has not been high Cambodia's economy depends largely on the United States because the United States is a major market for many industries in Cambodia That is why US currencies are widely used in Cambodia for large payments, and even the daily spending of people in the local market depends on the banknote If the US economy were to suffer a crisis, then Cambodia's economy would also be affected by the crisis, since the volume of US dollars in the Kingdom was greater than the local currency

Therefore, the Royal Government needs to work hard to find and prevent measures level of dollarization to promote the Khmer Riel is aimed at maintaining monetary stability, promoting economic growth, promoting national identity, and strengthening nationalism The Riel promotion strategy is an important mechanism that needs to be taken seriously and carefully implemented by relevant stakeholders, especially the National Bank of Cambodia and the royal government

For the above reasons, The research on dollarization in the Cambodian economy has been studied

2

2 RESEARCH OBJECTIVES

The main purpose of this research is to deepen our understanding of the issue of dollarization in Cambodia and measures to promote the national currency by focusing on the study from a few important points:

2.1 Overall objective

- Study the history and status of dollarization in the Cambodian economy

- Eliminate the dollarization of the economy in Cambodia

- Learn about the advantages and disadvantages of using the US dollar for the

Cambodian economy

2.2 Specific objectives

- Study the factors that cause the dollarization in Cambodia

- Analysis of the positive and negative aspects of dollarization

- The effectiveness of promoting the use of the Riel in past and present

- Analyze the situation and find out the causes of dollarization of the economy in Cambodia

- Proposing solutions to eliminate the dollarization of the economy in Cambodia

3 RESEARCH QUESTIONS

The presence of dollarization in Cambodia has caused the country's economy to be overwhelmed by the influx of dollars The National Bank of Cambodia is playing an important role as the country's monetary authority due to a large number of dollars in the economy and the amount of riel is too small, which has resulted in ineffective policy implementation The currency is still limited Given the importance of using the national currency to contribute to sustainable and sustainable economic growth and the US dollar's use in the Cambodian economy is significant, a detailed study of the dollarization situation in Cambodia is provided It is imperative to clarify the pros and cons of using the US dollar in the economy and weigh whether or not to accept dollarization and to better understand the value and value of the Khmer people The benefits of using the riel,

3

and they can also contribute to the riel promotion campaign, which is why I chose the topic of dollarization on the Cambodian economy The following research questions:

- What is the situation of dollarization in Cambodia?

- What are the advantages and disadvantages of dollarization to the Cambodian economy?

- What are the supporting policies of the National Bank of Cambodia? For the implementation of the above strategies to be effective and ensure macroeconomic stability

4 RESEARCH METHODOLOGY

For this research, NBC's strategy is to promote the use of the national currency

+ Data source:

- Researching documents and ideas provided by professors: Through the

knowledge and documents obtained from lecturers in all subject areas of the Royal University of Law and Economics, they have been provided and taught over the past academic year

- Researching the NBC's Policies and documents: A study of the Quarterly

Journal of Law, an annual report, as well as research articles and publications on the topic of the National Bank of Cambodia

- Library research: This is a comprehensive review of the thesis and internship

reports, which is based on the fact that the research is based on the old research

literature of the Royal University of Law and Economics

- Online research (Internet): Research in Khmer language and foreign-language websites by published papers and information relevant to the topic

+ Data collection method:

The study focused on two types of data: baseline and supplementary data

4

- Primary Data: Includes live internships at NBC, annual data, and documents

obtained from explanations through oral interviews, structured questionnaires, and telephone contact with Personnel in various branches of the National Bank of Cambodia, and all information is very specific and very specific

- Secondary Data: Data and reports from the National Bank of Cambodia website,

foreign websites, library searches, books, and articles related to US dollarization and secondary publications Available from NBC and social networks

+ Data analysis method:

In analyzing the data and information obtained, we have selected qualitative and quantitative analysis, which focuses on the quality of information, Analysis of arithmetic, and graph studies to conclude the findings of this study

5 THE STRUCTURE OF THE THESIS

This research work is divided into three chapters that cover the following topics:

+ Introduction

Research Issues Pattern of Research The purpose of the research, the research methodology, the importance of the research, and the structure of the research

CHAPTER 1 LITERATURE REVIEW

Recall the theory of currency-related lessons that will explain in detail the notion of currency, including the reasons for dollarization and the factors that drive the need for currency, as well as the definition of dollarization, the type of dollarisation, and the effect

of dollarization on the economy

CHAPTER 2 CURRENT SITUATION OF THE DOLLARIZATION OF THE ECONOMY IN CAMBODIA

Explain the emergence of the US dollar in Cambodia, the reasons behind the use

of the US dollar in Cambodia, the current dollar situation in Cambodia, and the study of the advantages and disadvantages of dollarization in the Cambodian economy

6

CHAPTER 1 LITERATURE REVIEW

1.1 The concept of dollarization

Schuler 1 defines urbanization as a phenomenon in which citizens of a country choose to use the US dollar or other foreign currencies instead or conjunction with the use of the national currency of that country, urbanization is a phenomenon that is common in emerging or developing countries experiencing macroeconomic and political instability With the US dollar being a strong and stable currency, the government can sometimes solve the crisis of its economy by deciding to accept the US dollar as the official currency of the country, and in some cases, dollarization may It happens because people are beginning to see the value of the dollar and turning to the dollar as an asset and using it for everyday life

1.2 Dollarization classification

The dollar is divided into three major categories: the formal dollar, the semi-formal dollar, and the informal dollar

- Official Dollarization

Full-dollarization is a situation in which foreign currencies are officially approved

by the Legal Tonder for use in a country so that not only foreign currency can be legally used by the private sector Also used by the government of that country for payments, such as government expenditure on the development of salaries, civil servants, and tax collection The main reason for official dollarization is due to political or economic factors, such as macroeconomic instability and financial system weakness These currencies are in their own country For example, Angola is a country where the government allows the use of two currencies as legal currency: French Franc and Spanish Peseta

- Semi-official dollarization

The semi-official dollar refers to the situation in which foreign currencies and national currencies are used freely in the domestic economy, with the majority of people saying that the government accepts the use of foreign currencies, even though there is no

1 Kurt Schuler is an economist in the Office of International Affairs at the U.S Department of the Treasury

7

official announcement of recognition Officially The semi-official dollar of the central bank has a hard time working in monetary policy just like the official dollar It is often seen that in those countries, foreign currencies usually cover deposits in the National Bank, most of which are used in the implementation of national budget plans, such as tax payments and payroll On the other hand, people can use foreign currency or currency depending on the experience of the country

- Unofficial Dollarization

Informal dollarization occurs when the citizens of a country store their assets in foreign currency, even if the currency is not allowed to be used in legal settlements, ie not the legal dollar-denominated currency, which is the case Citizens are allowed to store assets in foreign currencies, and cases are not allowed to store assets in foreign currencies

Informal dollarization usually evolves into three stages: the first is when people start to store assets, such as bonds and foreign currency deposits, known as Asset Substitution But they want to protect the value of their assets against the inflation of the local currency In the second phase, people start putting their deposits in local banks in foreign currencies (if allowed by the government), and then They also started using foreign currencies as a means of trading and saving economists to call this phenomenon the Currency Substitution However, wages, taxes, and daily expenses, such as food and utilities, are paid in local currency But for the payment of expensive goods, such as cars, trailers, etc., to be paid in foreign currencies during the final stages of informalization, all citizens begin to charge foreign goods and services, and the payment becomes monetary The domestic market is based on a specific exchange rate

1.3 The method of measuring the degree of dollarization

Measuring the degree to which an economy relies on hard currency or dollarization

is vital before assessing its effect in the economy In finding the extent of dollarization it

is also vital to identify and incorporate the different forms of dollarization that might exist in the economy However, this has been a main shortcoming of the existing literature The majority of the studies have focused on some limited aspect of dollarization in their studies The most commonly used measurement of dollarization,

8

which is the ratio of foreign currency deposit to the broad money, for example tend to neglect other forms of dollarization by focusing on financial dollarization It also fails to incorporate offshore dollar deposit by including only onshore dollar deposit even though

it measures financial dollarization

In sharp contrast to this, this paper adopts a holistic approach to measuring the dollarization based on the incorporation of all major forms of dollarization that exist in the Eritrean economy Most importantly it has captured the extent of dollarization in the black market economy The index demonstrates that dollarization has increased in the Eritrean economy This new approach has significant potential with regard to the study of other less developed economies

To measure the hard currency index, quarterly data on foreign exchange reserves are obtained from the IMF International Financial Statistics (IFS) M2 was considered in lieu of a measurement of broad money However, quarterly data on M2 was also not available for the full study period Therefore, broad money was calculated as the sum total of M1 and quasi money Domestic currency in circulation was deducted from this measure of broad money in order not to understate the weight of dollar loans issued by the banks Quarterly data on domestic currency in circulation were also obtained from the IFS database

Dollarization has elicited a large body of empirical and theoretical studies Despite difficulties related to the measurement of the degree of dollarization, there is an

extensiveempirical literature on this subject (Box 2) Among the dollarization factors investigated by authors, the high degree of openness, low transactions costs for acquiring foreigncurrency, and lingering depreciation concerns are characteristic of Cambodia

Theoretical models focus on the different purposes of demand for foreign currency (means of payment or store of value—Box 3) They have been developed to describe money-demand behavior in countries like Argentina (Kamin and Ericsson, 1993), Latvia (Sarajevs, 2000), or in a group of developing countries (Agénor and Khan, 1996) However, Neither of the two models described applies to Cambodia, as there are no markets offering the possibility of arbitrage among various financial assets

9

The empirical studies can be roughly divided into two main groups: qualitative and quantitative analyses The first group focuses on the costs and benefits of dollarization in terms of economic performance and economic policies—Argentina, Ecuador, Mexico, and Panama are popular references—and so are some transition economies (e.g., the Baltics and the Russian Federation) No consensus has emerged on the performance of dollarized versus nondollarized economies On the one hand, those who reject dollarization point out the loss

of seigniorage, the inability of the central bank to act as a lender of last resort, and—more importantly—the loss of flexibility and independence in monetary and exchange rate policies, On the other hand, those who favor dollarization emphasize that most dollarized countries exhibit low inflation, macroeconomic stability, and enhanced fiscal discipline (e.g., Balifio, Bennett, and Borensztein, 1999; Berg and Borensztein, 2000a; and Edwards, 2001) Covering the period 1970-98, and focusing on IMF member countries with various exchange rate regimes (from pegged to floating, including currency boards), Ghosh, Guide, and Wolf (1998) provide empirical evidence that countries with high levels of dollarization or currency board arrangements may have sacrificed the flexibility of their monetary policy, but gained long-term benefits of lower inflation and a more stable exchange rate As noted by Bogetic (2000), analysis and evaluation for a single country are relatively rare, except for Panama, which seems to have become a benchmark for related works It is with regard to growth performance that studies differ most Edwards (2001) provides evidence that during 1970-98 some dollarized countries (Liberia, Panama, and ten micro-states) experienced: (1) lower inflation; (2) similar fiscal deficits; and (3) lower GDP per capita growth than nondollarized economies (emerging and industrial countries, with a variety of exchange rate regimes, from floating through crawling to pegged but adjustable exchange rates) To emphasize these results, Edwards (2001) takes a closer look at Panama He finds that Panama did not perform better during 1970-98 compared with nondollarized reference economies, and external shocks generated higher costs in Panama—in terms of lower investment and growth Conversely, Ghosh Guide, and Wolf (1998) find that sample economies exhibited faster economic growth than nondollarized ones

The second group of empirical studies attempts to examine the factors that may explain the emergence of dollarization in a group of countries Econometric studies investigate the contribution of two sets of variables to dollarization: institutional factors and economic factors

 Box 2 Empirical Models of Dollarization

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Giovannini and Turtelboom (1994) provide a useful survey of the theoretical literature

on dollarization, which takes money demand in a multicurrency environment as its starting point The bulk of the analysis can be divided into two broad avenues: cash-in-advance models, and transactions costs models

In the cash-in-advance models, as reviewed for instance by Giovannini and Turtelboom (1994) and Sarajevs (2000), two currencies exist in the economy, with or without legal restrictions Both domestic and foreign currencies are used as a medium of exchange Moreover, the following underlying assumptions are posed: there is perfect substitution between the two currencies and financial assets (to avoid idle cash balances), and the acquisition of foreign currency is costless Agents are maximizing their utility function (which is increasing in consumption and foreign currency holdings), subject to budget and cash-in-advance constraints, by choosing between domestic and foreign currencies, and domestic and foreign bonds with positive returns It is assumed that prior to any consumption purchase, agents must acquire domestic or foreign currencies The return on bonds in foreign currency expressed in domestic currency depends on the expected exchange rate depreciation and will positively affect the demand for foreign bonds and negatively affect the demand for domestic assets In fact, the differential of real return (nominal return minus inflation rate) from domestic and foreign currencies determines the demand for domestic and foreign currencies Bogetic (2000) asserts that foreign currency holdings are closely linked to domestic and foreign inflation rates and the credibility of legal restrictions

Vetlov (2001) identifies the following institutional factors as possibly leading to dollarization: an open economy, great depth and large size of the domestic financial market, and relatively low transaction costs for acquiring foreign currency He notes that key economic factors arc the interest rate spread (between domestic currency and foreign currency deposits), the inflation rate differential (between domestic and foreign inflations), and devaluation expectations Other variables, which can signal an expected devaluation, are also considered: the real exchange rale, the current account deficit, international reserves, and other related factors To explain dollarization, most studies arc moneydemand models,

in which the explanatory variables usually include a combination of the aggregates noted above Agenor and Khan (1996) find that foreign interest rates and the expected depreciation

of the exchange rate can be important factors leading to dollarization

 Box 3 Theoretical Models of Dollarization

In the transactions costs models, developed by Poloz (1986) and Marshall (1987), it is time consuming to acquire cash (both domestic and foreign) to purchase goods The inability

of agents to acquire cash instantaneously forces them to build up cash balances The assumptions in this model are as follows: two currencies circulate simultaneously, there are available financial assets, and there are transactions costs, which reduce the agents' disposable income The transactions costs function takes into account the time and resources required to acquire cash (i.e., time consumed increasing cash balances decreases the working time and consequently income) Agents maximize their utility function (which is increasing

in consumption solely) subject to a budget constraint This framework differs in two ways from the previous one First, foreign currency holdings do not appear in the utility function Second, there are transactions costs that reduce the disposable income of agents By assumption, the transactions costs function is increasing in domestic and foreign goods consumption and decreasing in real money balances (domestic and foreign) In other words, agents need money (domestic and foreign) to purchase goods; consequently, they will bear transactions costs in converting their assets into cash in both currencies The "liquidity" of different assets in the agents' portfolios will determine the demand for different currencies to permit the purchase of goods Given the specific form of the transactions costs function, this framework leads to different equilibria, depending on consumption levels and transactions costs If these levels and costs are high, agents will hold foreign assets for the purpose of payment and as a store of value, and thus, currency substitution will occur Conversely, if consumption levels and transactions costs are low, agents will prefer to use the domestic currency

1.4 The causes of dollarization

Dollarization usually occurs in developing countries with a weak central monetary authority or an unstable economic environment It can occur as an official monetary policy or as a de facto market process Either through official decree or adoption by

12

market participants, the U.S dollar comes to be recognized as a generally accepted medium of exchange for use in day-to-day transactions in a country's economy Sometimes the dollar assumes official status as legal tender in the country

The main reason for dollarization is to receive the benefits of greater stability in the value of currency over a country's domestic currency For example, the citizens of a country within an economy that is undergoing rampant inflation may choose to use the U.S dollar to conduct day-to-day transactions, since inflation will cause their domestic currency to have reduced buying power

Another aspect of dollarization is that the country gives up some of its ability to influence its economy through monetary policy by adjusting its money supply The dollarizing country effectively outsources its monetary policy to the U.S Federal Reserve This can be a negative factor, to the extent that the U.S period monetary policy

is set in the interest of the U.S economy and not the interests of dollarized countries However, it can be beneficial if it helps takes advantage of an economy of scale in monetary policy that allows the dollarizing country to economize on resources that would need to be devoted to supplying and managing its money supply It may also be the case that domestic authorities have proven themselves incompetent to manage their monetary policy Giving up an independent monetary policy can move the dollarizing country closer to an optimal currency area with the dollar Small countries that engage in a relatively large volume of trade with and have strong economic ties to the U.S will especially benefit

1.5 The effects of dollarization on the economy

Dollarization offers both benefits and implications for a country's of benefits and effects depends on the economic and political context of each country, but generally, dollarization has the following advantages and disadvantages:

1.5.1 Positive impact

Typically, countries that are dollarized are often countries with monetary instability (high inflation), and economic instability to restore their economic status, valuable and strong currencies like the US dollar Adopted as the legal currency or people of those countries to adopt as a means of payment, savings, and scale for

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valuation Consequently, the use of the US dollar can help stabilize an economy and bring inflation back to low levels by replacing the monetary function of that economy Besides, the US dollar has also linked the country's financial, banking, and economic systems to the US financial, banking, and economic systems The introduction of the Federal Reserve's monetary policy will have an impact on the economy of the US dollar, sometimes benefiting from the policy For example, if the US Federal Reserve decides to cut its benchmark interest rate, then the dollar rate of urbanization will be lower, which could encourage more domestic investment to contribute to economic development Internationally, most of these activities are conducted in US dollars, which can reduce exchange rate risks and avoid currency mismatches (Currency Mismatch), Such as earning a different currency than the one used to pay

1.5.2 Negative impact

On the downside, dollarization can put the country at a disadvantage from printing money because of the sheer size of the currency demand, and the low against the dollar demand, or in the case of the country With the dollar being the legal currency, the country will lose its money from printing paper money completely Also, the dollar can lose its independence and sovereignty over monetary policy and monetary policy due to the US dollar being published and controlled by the Federal Reserve When the Federal Reserve decides to impose a restrictive policy by raising interest rates, the dollar will be affected by rising interest rates in US dollars and rising US dollars, which could have a negative impact Investment and exports of that country

At the same time, the dollar is also vulnerable to the financial or economic crisis that has occurred in the United States, and the dollar economy is likely to be adversely affected by a lack of adequate and effective policy tools to combat the crisis Like the loss of the central bank's last lender position, the banking and financial institutions could not find sufficient and timely liquidity to deal with the financial crisis Not only is the currency a national symbol, but the abandonment of its economy and the use of other countries' currency is also akin to abandoning one's own national identity and valuing other nationalities

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1.6 International Experience

Cambodia is far from being isolated in its experience of dollarization2

• Increasing Trend of Dollarization

Dollarization has been on the rise in the past two decades, all over the World (see the following table)

Percentage of foreign currency deposits to broad money

Group of countries (number of countries) 1980-85 1988-93 1996-01

Table 1-International Trend of Dollarization3

Source: National Bank of Cambodia ( Research Papers by Tal Nay Im and Michel Dabadie in 2007)

In Asia, only a few countries were able to contain dollarization, since they did not experience high inflation or severe macroeconomic instability (for example India, Sri Lanka, Bangladesh, and advanced economies such as Singapore, Malaysia, Taiwan)

• De-Dollarization Policies

Three categories of de-dollarization policies have been experimented

First, to arrest inflation expectations, macroeconomic policies were aimed at maintaining exchange rate and price stability Inflation targeting is one of these policies

Second, regulatory and legal reforms have intended to create incentives to use the national currency, through regulatory differential reserve requirements or remuneration rates, provisioning standards, liquidity requirements, etc For example, a premium was paid on dollar-indexed local currency deposits over dollar deposits (Nicaragua); a tax was introduced on checks paid in dollars (2% in Peru); domestic transactions were required to

be paid in local currency (Lao); several countries also implement higher reserve requirements for foreign currency deposits (Bolivia, Honduras, Nicaragua, and Peru)

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Some countries barely escaped dollarization by introducing financial indexation that helped contain the erosion of financial savings in domestic currency (Chile, Colombia) Third, administrative enforcements were implemented in some countries, such as a ban

on direct transfers of foreign currency deposits among residents (Israel), limitations of foreign currency lending (Lebanon, Vietnam, Malaysia, Philippines), forced conversion

of dollar deposits to local currency (Peru, Bolivia, Mexico in the 1980s) and prohibition

or limitation of foreign currency deposits (several African countries) Several countries relied on financial repression and capital controls (Venezuela, Nigeria, sub-Saharan Africa); these measures led to capital flight, financial disintermediation, and high levels

of dollarization

• Successful De-Dollarization Experiences

Only 4 out of a sample of 85 countries succeeded in de-dollarization Only 2 had lasting reversals with minimal side effects (Israel, Poland); for the other 2, it is too early to tell if de-dollarization will be sustained (Mexico, Pakistan)

Table 2 - Evolution of Dollarization in various countries 4 Source: Based on data in De Nicoló, Honohan and Ize, (2005); Levy-Yeyati (2006)

4 Source : IMF Working paper: wps4172

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Both Poland and Israel implemented successful disinflation programs, built on a strong exchange rate anchor Israel also used indexed assets, which proved to be an effective substitute for dollar deposits High interest rates were applied to local currency deposits

in Poland It is unclear that these conditions can be replicated, especially since the initial level of dollarization was not too high in these two countries

• Unsuccessful Attempts at De-Dollarization

Many attempts involved administrative enforcements, without fully restoring confidence

in the local currency In some countries forced conversion led to an increase in cross border deposits, capital flight, and reduced financial intermediation Eventually, after the failure of these policies, foreign currency deposits increased further In other words, administrative enforcements actually increased dollarization

• Intentional Dollarization

Several countries have intentionally opted to maintain a high level of foreign currency as part of their broad money: Euro area, Bhutan (Indian rupee), Brunei (SGD), Namibia (South African rand), Bosnia (euro), Haiti and Bahamas (USD) A few countries opted to full dollarization: Panama, Salvador, and Timor-Leste In brief, international experience shows that, once an economy is highly dollarized, it is hard to reduce dollarization

1.7 Summary Chapter 1

All in all, dollarization is a complex enough problem to think that simple rules are going to be the solution for every country On the one hand, one could argue that macroeconomic solutions should be needed in as far as dollarization clearly has macroeconomic causes On the other hand, The so-called “hysteresis” behind the dollarization process point to government intervention as an important tool

More generally, economic authorities may want to think in terms of setting up the right incentives for residents to be willing to transact and hold local currency Both market forces and government intervention should reinforce each other in that regard

As regards market forces, reducing price uncertainty seems key as it would reduce the need of consumers and firms to insure against inflation surprises

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One important measure in this regard includes strengthening the institutional setting of the institutions which promote monetary stability The European experience shows that a clear focus on price stability and central bank independence are very important improvements on the institutional side On the one hand, the first challenge that policy makers confront is the difficulty in measuring dollarization because of its several dimensions and the lack of reliable data

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CHAPTER 2 CURRENT SITUATION OF DOLLARIZATION OF THE ECONOMY IN CAMBODIA

2.1 Analyze the current situation of dollarization in Cambodia 2000-2019

2.1.1 The situation of dollarization of the economy in Cambodia

Since its presence in the Cambodian economy, the dollar has become increasingly recognized and has played a key role in the three currencies: currency, exchange, and keeping prices In fact, in commercial centers, markets and supermarkets, and some goods and services markets, the US dollar is used to set dates and payments, and the use

of the riel in those markets has been at a disadvantage as they have set rates The exchange rate itself is higher than the market rate The job market also consumes a lot of dollars, especially in industry and tourism The survey of the ASEAN + 3 Macroeconomic Research Office (AMRO) also shows that about 70% of Cambodian companies offer salaries In finance, about 85% of deposits in the banking and financial sector are in dollars, and dollar-denominated loans make up 81% of total loans Besides, dollarization does not only cover the physical and financial fields but is deeply rooted in the mindset of the people The use of the dollar is linked to the daily lives of the people due to its ease of use, pricing, and saving against the national currency

Figure 1: Composition of Broad Money and the Ratio of Foreign Currency Deposits

to Broad Money

Source: National Bank of Cambodia Survey conducted in 2014-2015)

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The dollarization is monetary plurality because, besides the US dollar and the riel, the neighboring countries' currency (Thai baht and Vietnamese dong) are also circulating along the border with Thailand and Vietnam and among traders Some have direct or indirect payments on goods imported from those countries, however, the use of the Thai baht and the Vietnamese dong is still low in terms of volume and extent against the riel and the dollar

Besides, the dollarization situation in Cambodia is considered completely dollarized as the national currency is still in circulation It should be noted that while the dollarization rate has been rising and has been at an all-time high over the last two decades, the growth of the national currency in circulation and national currency deposits has increased at an average rate of around 17% and 24% per year This growth indicates that the dollarization in Cambodia is not caused by currencies substitution or Asset Substitution, which is the reason for dollarization in other countries Therefore, the dollar does not completely replace the role of the national currency

non-Past studies and surveys have shown that the riel is used and popular in agriculture, making small payments in everyday life such as food costs Overall, in the countryside, the riel plays an important role in people's economic activity, while the dollar is used more in key economic areas and the payment of goods and services of great value

The ongoing activity of the riel's use and importance is an important factor in supporting the promotion of the riel in Cambodia

Figure 2: Trends in GDP growth and per capita GDP

Source: National Bank of Cambodia Survey conducted in 2014-2015

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It is noteworthy that, despite the high dollarisation of the economy, Cambodia has experienced economic growth of about 7.7% over the last two decades, placing Cambodia sixth Among the countries with the highest economic growth in the world The situation shows that dollarization has not hampered economic development, but has played a part in the development process This contribution can be seen through the stabilization of macroeconomics, the integration of the Cambodian economy into the global economy, while the level of Cambodian integration is still low, helping to develop the financial sector while the Cambodian people Loss of confidence in the early financial and monetary system and attracting investment and capital to the economy Looking at financial depth (M2 / GDP) has increased from 28% in 2008 to 78.5% in 2018, and the financial environment has been steadily improving, bringing more and more people Uses formal financial services It should be noted that the ratio of currency deposits to general currencies (FCD / M2) and total deposits reflecting the dollarization situation remained high at 84% and 95% respectively over the last 10 years

In the last 10 years, with the introduction of continuous use of the riel, the currency

in circulation has increased by an average of 16.3% and deposits in riel have increased by

an average of 31.2% per annum However, dollarization also limits the effectiveness of the monetary policy, causing Cambodia to lose revenue from printing money, lose its role

as the last lender, and exchange policy play an important role in the economy Prevent crisis NBC currently has only two main policy instruments: intervention in the foreign exchange market and setting reserve requirements Foreign exchange market intervention

is not completely independent because NBC needs to stabilize the exchange rate against the US dollar, and changing the reserve requirement rate frequently is not an easy task NBC has not yet been able to determine a benchmark interest rate that could affect market interest rates, which would have prevented the implementation of monetary policy On the other hand, according to the International Monetary Fund (IMF), Cambodia has lost its average revenue of the printing press (between 0.4% and 2.4% of GDP) GDP per annum during 1994-2001 and increased to approximately 5% of GDP in

2010

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Table 3: Estimated Losses on Riel Printing (1998-2001)

Depending on the benefits, disadvantages, and risks of globalization, sharp dollarization or administrative measures can affect macroeconomic and financial stability and overall economic development Thus, promoting the use of the riel properly Depending on the market mechanism, this is the best way to overcome the dollar problem

in Cambodia

Recently, NBC has collaborated with the Japan International Cooperation Institute's Research Institute to investigate the behavior of the riel and currency used in Cambodia in 25 provincial capitals while obtaining micro-level data On existing data on the dollarization situation in Cambodia and for the development of more accurate and comprehensive use of the riel The first survey was conducted from October 2014 to January 2015 on 2273 family units, 85 enterprises, 10 banks, and four microfinance institutions There was also a second survey during the period 2017 to 2018, which looked at the same family unit and enterprise but added the survey to all branches of 15 banks and 12 financial institutions

Source: IMF working paper: wp0292

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+ Family unit survey results

National currencies (the riel) are widely available in all areas of the Kingdom, especially in rural areas where the dollar is most prevalent in urban areas such as Phnom Penh and Siem Reap, among all the sources of income families Most salaries are from the United States, with an average foreign exchange rate of 383%, while business income and agricultural incomes are 16.9% and 5% respectively

In particular, the cost of the family unit is only a fraction of the US dollar, especially the telephone and rental costs This has also led to the family unit has to exchange US dollars to get their riel to pay for other expenses often Most family units still save themselves in cash rather than savings in financial institutions, especially savings in riel Family unit loans are increasing and some loans are made in Khmer riel Looking at some people who are financially aware, they often try to avoid the risk of a low exchange rate, requesting a loan in a currency or currency that matches their source

of income

Figure 3: Currency Composition of Income by Area (Family Unit)

Source: National Bank of Cambodia (Survey conducted in 2014-2015)

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Figure 4: Currency Composition of Total Expenditure (family unit)

Source: National Bank of Cambodia (survey conducted in 2014-2015)

Figure 5: Currency Composition of Loans by Area

Source: National Bank of Cambodia (survey conducted in 2014-2015)

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+ Enterprise Survey Results

For enterprise use of cryptocurrencies, dollarization has been found to vary by region, size of enterprise, and sector Areas of high economic activity such as Phnom Penh, Siem Reap, and the Northwest have about 65% higher dollar income, while middle income has a higher currency ratio (35% while 56%)

Usage of FX currencies by areas

Figure 6: Currency composition of revenues (Enterprise)

Source: National Bank of Cambodia (Survey conducted in 2014-2015)

Figure 7: Currency composition of expenditures (Enterprise)

Source: National Bank of Cambodia (Survey conducted in 2014-2015)

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In total, the costs of enterprises in all of the regions studied had a higher to-revenue ratio The larger the enterprise, the higher the current ratio In terms of currency, the proportion of large enterprises' revenue is 70%, while the smallest enterprises account for only 39%, while the monetary ratios of SME spending are 67% and 55%, respectively The wholesale and retail sector has a high monetary flow gap (46% of revenue, while spending at 71%), which requires a Riel-to-US exchange for operating costs This puts most enterprises at risk of Currency visually, especially in rural areas, large enterprises, and those in the wholesale and retail business Enterprise dollar has been higher compared to the family unit, but the share of national currency in enterprise income and expenditure is still increasing between 2014 and 2017 Currently, some enterprises have applied for loans in KHR from commercial banks, as before 2014 there were no enterprises that applied for loans in KHR from commercial banks

currency-+ Survey results of branches, banks and microfinance institutions

Depository banks and microfinance institutions tend to allocate excess capital to underprivileged branches, but for banks, the distribution of capital in KHR is relatively small, Although the head office has a capital surplus in the riel

Figure 8: Currency composition of revenues

Source: National Bank of Cambodia (Survey conducted in 2014-2015)

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Figure 9: Currency composition of expenditures

Source: National Bank of Cambodia (Survey conducted in 2014-2015)

The percentage of currencies in deposits and loans is lower in rural areas than in Phnom Penh, although the percentage of currencies in rural credit has increased steadily Deposits have decreased in both rural and suburban areas Banking and microfinance institutions receive remittance hedges to prevent exchange rate risk by taking high-interest rates on credit

Usage of FX currencies by business types

Figure 10: Currency composition of revenues

Source: National Bank of Cambodia (Survey conducted in 2014-2015)

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Figure 11: Currency composition of expenditures

Source: National Bank of Cambodia (Survey conducted in 2014-2015)

The banking sector is a major catalyst for the US dollar booming across the country

by mobilizing capital in Phnom Penh to provide services in areas where most of them are

in US dollars

Although the riel deposit in Riel Deposit Microfinance Institution (MDI) has increased rapidly, it has been observed that the share of Riel deposit has not changed from 2013 to 2017 This stability is due to the fact that foreign currency deposits are growing as fast as riel deposits, and the inflow of capital from abroad to the local banking system is also increasing

Nevertheless, the growth rate of remittance has been increasing in rural areas in both commercial banks and microfinance institutions, although there has been an increase

in deposits in commercial banks However, it has been noted that the process of promoting the use of the national currency appears to have been less active

Many microfinance institutions are actively providing loans, but most of their capital sources are from US dollar-denominated loans This has triggered a Currency mismatch on microfinance institutions that are already very active lending in Riel

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This picture of the National Bank of Cambodia’s headquarters was taken in January 1979 after the defeat of the Khmer Rouge

2.1.2 The causes of dollarization in Cambodia

Dollarization in Cambodia resulted from a series of shocks, experiences and events that

eroded public confidence in the capacity of the authorities to maintain the value of the

national currency, the Riel

There were already some amounts of US dollars circulating in Cambodia during the

period of the Khmer Republic (1970-1975) However, the Riel remained the currency

used normally in domestic transactions The first shock occurred from 1975 to 1979,

when all financial infrastructures in Cambodia (markets, trade, money, and banking)

were systematically destroyed There was no place for a financial system under the

Khmer Rouge regime5 Immediately after they conquered the capital city, the National

Bank of Cambodia’s headquarters was bombed to the ground6

After the end of the Pol Pot regime, in 1979, commercial transactions were conducted

mainly in the form of barter, or using rice and gold and later also Vietnamese dong

5

Initially, the Khmer Rouge leadership had every intention of issuing its own currency and establishing a banking system of its

own In January 1975, new banknotes, printed in China, were brought down the Ho Chi Minh Trail In May 1975, it was decided

that Riels should be put progressively into circulation Nong Suan was appointed National Bank Chairman; in August he was

replaced by Pich Chheang Supplies of notes were sent to provinces in August 1975, and the new currency was effectively

circulated in the Northern Zone, north-west of Kompong Cham But the Central Committee and Pol Pot himself considered that

the question of whether or not to use money concerned the essence of the Khmer Rouge state On September 19, 1975, the

Central Committee of the Communist Party of Kampuchea (CPK) resolved not to issue the new currency, a decision confirmed at

the CPK’s Fourth Congress four months later (Pol Pot, the History of a Nightmare, Philip SHORT, John Murray 2005)

6

More than a deliberate decision of the regime, the destruction of the National Bank of Cambodia headquarters appears to be due

to pillage by men from Easter Zone’s headquarters: perpetrators allegedly made off with 200 kilos of gold and then blew up the

building to make the theft appear to be the work of gangsters profiting from the confusion (ibid)

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In 1980 the Central Bank was re-established, under the name of the People’s Bank of Kampuchea and the Riel was again the country’s legal currency During the 1980s, the People’s Bank of Kampuchea provided a multitude of services, including acting as the monetary authority, the cashier of the Government, and the only institution providing banking services, such as deposits, loans, and payment instruments

The use of US dollar (USD) and Thai baht (THB) was restricted by the centrally planned economy However, confidence in the Riel remained low, given the political structure and the security situation, with the consequence that dollar and baht and above all gold were largely considered as a refuge by Cambodians

• Dollar Flows and the Start of Dollarization of the Economy

Cambodia was transformed from a planned economy to a market economy in the late 1980s, when its borders started to open to trade and when economic and political relations with western countries resumed

In 1991-1992, the United Nations Transitional Authority in Cambodia (UNTAC) was one

of the largest and most expensive operations in UN history, at a cost of USD 1.7 billion

US dollars flooded the economy, creating a new shock against the national currency,

which the NBC was not prepared to cope with Subsequently, the central bank and the unique commercial bank (namely Cambodian Commercial Bank, established in 1991 as a joint venture with Siam Commercial Bank), handled all the UNTAC operations and received growing foreign currency deposits

This was the start of huge inflows of capital in the Cambodian economy

Figure 12: Foreign direct investment net inflows in Cambodia from 2013 to 2019

Source: www.statista.com (Statistics/607449/cambodia-foreign-direct-investment-net-inflows )