De-dollarization: The case of Peru
Monetary Policy is essential to maintain the stability of the financial system and especially price levels. By using conventional monetary instruments, for instance, Open Market Operations and lending and deposit facilities, Central Banks could anchor inflation expectations and guarantee stability on the price levels and financial system. However, what happens in economies when hyper-inflation periods have produced a permanent distrust of the local currency? Could monetary policy achieve its objectives when a foreign currency is mostly used in the financial system?
Distrust of the local currency could stay for many years even if inflation is under control. Agents would overreact to changes in the exchange rate and they would prefer to do their transactions by using a “hard currency”, for instance by using dollars. Therefore, monetary policy would lose room for maneuver if it is constrained by a dollarized financial system.
Since 2013 the Central Bank of Peru (CBP) has applied the de-dollarization program (DDP) to promote the use of the local currency (soles or PEN) in the financial system. This program - known as unconventional policy - consists in applying additional reserve requirements depending on the limits of the credit balance account of banks denominated in USD. In the last five years, dollarization coefficients (credits in USD over total credits) to private companies diminished from 56% to 39%. The same statistics to households reduced by more than 10% (See Figure 1).
Figure 1. Dollarization Coefficient of Private Credit
Source: Central Bank of Peru, Beyond Ratings
Even if other economic factors could also affect the dollarization of credits, some empirical studies argue that DDP has contributed to the reduction of the dollarization coefficient by 6% to 14% on average. Therefore, DDP has been effective and helped to increase the financial system resilience to external shocks.
Gabriela Aguilera-Lizarazu, Analyst
Source: Beyond Ratings