The effect of dollarization on the policy space of policymakers

How is dollarization affecting the policy space of local policymakers in officially dollarized and semi-officially dollarized nations?

Tim Beckers (10554971)

The changing global economic order: rising powers and growing risks

Master thesis Political Science

Specialisation in Political Economy

Supervisor: Jasper Blom

Second Reader: Sebastian Krapohl

22399 words

21-06-2019

Acknowledgements

Before I will start my master’s thesis, I would like to write a few thank words to the people who helped me make this possible. First, I would like to thank my colleagues, Michelle Turney, Kelvin Chua and Abel Ghacham, for putting much time and effort in helping me to get my interviews. I also would like to thank Long Vibunrith for the interview I had with him, providing me valuable information for my thesis. I also want to thank my friends for supporting me during my master’s and during this thesis, they were always there to support me during the good and the bad times. Finally, I would like to thank my mother. Throughout my bachelor’s and master’s degree she has always supported me, and has read and corrected many of my papers, including this thesis, over the years. I would like to thank her for all the hours she spent on correcting my weird sentences and grammar mistakes, as well as supporting me everywhere she could. Without her, I am not sure that I would have been able to make it this far.

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Table of contents 1. Introduction ...... 5 2. Theoretical framework ...... 8 2.1. Understanding dollarization ...... 8 2.2. Understanding policy space ...... 13 3. Methodology ...... 16 3.1. Overall approach ...... 16 3.2. Validity and reliability ...... 18 3.3. Case selection ...... 19 4. Analysis ...... 21 4.1. Analysing the effects of dollarization on policy space ...... 21 4.2. Background information on dollarization in Cambodia ...... 21 4.2.1. History and causes of dollarization in Cambodia ...... 22 4.2.2. Current situation and future strategy of dollarization in Cambodia ...... 24 4.3. Background information on dollarization in Ecuador ...... 27 4.3.1. History and causes of dollarization in Ecuador ...... 28 4.3.2. Current situation and future strategy of dollarization in Ecuador ...... 31 4.4. Analysing the effects of the four mechanisms...... 33 4.4.1. Seigniorage mechanism ...... 33 4.4.1.1 Seigniorage mechanism explained ...... 33 4.4.1.2 Seigniorage mechanism in Cambodia ...... 34 4.4.1.3 Seigniorage mechanism in Ecuador ...... 36 4.4.2. Monetary policy mechanism ...... 38 4.4.1.1 Monetary policy mechanism explained ...... 38 4.4.2.2 Monetary policy mechanism in Cambodia ...... 38 4.4.2.3 Monetary policy mechanism in Ecuador ...... 42 4.4.3. Foreign trade policy mechanism ...... 44 4.4.1.1 Foreign trade policy mechanism explained ...... 44 4.4.3.2 Foreign trade policy mechanism in Cambodia ...... 44 4.4.3.3 Foreign trade mechanism in Ecuador ...... 46 4.4.4. Income distribution mechanism...... 46 4.4.1.1 Income distribution mechanism explained ...... 46 4.4.1.2 Income distribution mechanism in Cambodia ...... 47 4.4.1.3 Income distribution mechanism in Ecuador ...... 49

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5. Discussion and concluding remarks ...... 50 6. Reference list ...... 56 7. Appendix ...... 62 7.1. Appendix 1: Transcription of interview with Long Vibunrith...... 62

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1. Introduction

There are few things that are as globally distinguishable as U.S. dollar banknotes. Since commodities like oil, gold, and agricultural products are mostly traded in U.S. dollars (which attributes to the fact that nearly 70% of the world’s trade is commerced in U.S. dollars), it should come as no surprise that the U.S. dollar is not only recognisable around the world but also used and accepted for day-to-day transactions in many countries. Therefore, due to the dollar being the most important currency in international trade, many countries have no other choice than to trade in U.S. dollars in order to stay connected to the global economy (Norrloff 2014, Mccauley, et all 2015). This can prove challenging for nations, especially ones with strong fluctuations in exchange rates between their domestic currencies and the U.S. dollar. Yet for the United States, having the most predominant currency in the world’s economy has generated enormous amounts of power that reaches beyond its borders throughout all parts of the world (Norrloff 2014, Mccauley, et all 2015). While the U.S. dollar plays a very dominant role in the world economy, some domestic markets trade nationally in U.S. dollars by using the U.S. dollar as a source of payment or as a store of value and therefore replacing the domestic currency. This replacement of a domestic currency by a foreign currency in an economy is called currency substitution (Corrado 2008: 70). In these countries, a foreign currency (often the U.S. dollar) takes over some of the functions of the domestic currency. Nevertheless, there are different levels or stages in which a foreign currency can replace a domestic currency, countries’ economies can be described as dollarized once the U.S. dollar has become a vital facet of their function. Having one’s own currency has always been one of the hallmarks of nationhood (Hymans 2010; Raento et al 2004; Unwin and Hewitt 2001). Through things like currency and stamps, countries can portray to domestic and international audiences their values, ideals, ideologies, and aspirations as a state (Hammett 2014: 901). However, throughout history, many countries have given up this hallmark, their individual currencies, in order to create currency unions (Alesina and Barro 2001: 381). Examples of this are the CFA-franc in West and Central Africa, the Eastern Caribbean Currency Union, and more recently the euro within the European Union. In some cases, countries decide not to form currency unions but rather to substitute their domestic currency with a foreign one altogether. This happened, for example, when Liechtenstein adopted the Swiss franc or when Luxembourg adopted the Belgian franc. Within the last twenty years, we still see this phenomenon in countries like Ecuador and El Salvador which have completely adopted the U.S. dollar as their national currency (Beckerman and Solimano 2002: 1). This is something that the literature describes as official dollarization (Mack 2000: 353). However, not all countries completely give up their national currencies. For example, Cambodia extensively uses the U.S. dollar within its

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domestic economy. U.S. dollars are accepted virtually everywhere and are even dispensed through ATM machines throughout the country, though they still maintain the Cambodian riel as their national currency. This is described in the literature as semi-official dollarization, (Mack 2000: 353). Dollarization can be problematic to a country’s sovereignty. Within sovereign states, national governments can implement laws and regulations within their own borders without the interference of another actor (Krasner 1999). In literature, there is a clear relationship between dollarization and a country’s monetary sovereignty. In this thesis, the scope of the sovereignty of this monetary policy will consist of the right to create money; the right to conduct monetary and exchange rate policies; the right to decide upon the appropriate amount of current and capital account convertibility; and the organisation of financial regulation and supervision (Zimmerman 2014: 1). The tension that exists between dollarization and a country’s sovereignty arises from the lack of policy space national policymakers have due to dollarization (Cohen 2003; Minda 2005; Salvatore, et all 2003; Mack 2000). According to Jácome and Lönnber (2010) central banks in dollarized nations become powerless (no policy space), since they no longer have the proper tools or policy space to implement monetary policies. In this thesis, I will argue that dollarized nations still hold some policy space, however, the availability of these tools varies per type of dollarization. In the literature, there is a clear distinction between three types of dollarization: unofficial dollarization, semi-official dollarization, and official dollarization (Mack 2000, Meyer 2000 and Ra 2008). Whilst in all three types dollarization is affecting the ability to make independent monetary policies (the policies in these countries, which I will call policy space), remained unclear to what extent. In this paper, I will analyse four different monetary policy mechanisms (the seigniorage mechanism, the monetary policy mechanism, the foreign trade policy mechanism, and the income distribution mechanism) and how they are affecting the policy space of policymakers in dollarized countries. To generate a better understanding of how the different types of dollarization affect the policy space of local policymakers, I will perform a case study of an officially dollarized nation (Ecuador) and a semi-officially dollarized nation (Cambodia). It is not my aim to prove that there is a difference between the two - since semi-officially dollarized nations innately have more policy space than officially dollarized nations - but to explain how these four mechanisms work through distinguishing how the effects of these four mechanisms differ from one another in both cases. In the end, I intend on contributing to the dollarization debate through my analysis between the policy space of semi- officially dollarized and officially dollarized nations while aiming to answer the following research question: How does the implementation of dollarization affect policy space of policymakers in dollarized nations ?

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What stands out in the literature is how in many dollarized countries there is a constant debate over how to cope with dollarization. This is also the case in Cambodia and Ecuador where dollarization is heavily debated, and this is another critical reason why I have chosen these two countries. In Cambodia, for example, there is an ongoing debate as to whether the government should reduce dollarization within the domestic economy in favour of the Cambodian riel (Sothear 2016, Connor 2017, Kimsay 2018 and Kang 2005). Whilst in Ecuador, the debate is focussed on whether the Ecuadorian government should re-issue its own currency and therefore reverse the dollarization of 2000 (Berríos 2006 and Jameson 2003). Through my analysis and study of the different types of dollarization, I will contribute and add to national debates such as these by not only describing how dollarization is affecting these nations - for better or worse - but by additionally identifying what mechanisms national policymakers still have at their disposal once operating within these dollarized- frameworks. Only through better comprehension of how dollarization directly affects nations can one begin to see how much a dollarized nation is still able to control or regain control of their policy space. By way of this, it should become clear as to whether de-dollarizing would be the most beneficial choice nations such as these could make. In order to answer this question, I will take the following steps. First, I will elaborate on dollarization, explaining what it is and what the debate concerning its impact is. Secondly, I will conceptualise dollarization and ‘policy space’, and then I will describe how these countries became dollarized by providing a background story about both Cambodia and Ecuador. Following this historical overview, I will analyse the current situation in both countries. Finally, in the conclusion, I will describe how these four mechanisms, if any, differ, are creating the difference in the amount of policy space in officially dollarized and semi-officially dollarized nations. I will do this by performing a comparative case study in which I will outline a total of four different mechanisms that stand out most predominantly amongst the literature and my analysis: the seigniorage mechanism, the monetary policy mechanism, the foreign trade policy mechanism, and the income distribution mechanism. Throughout my paper I will attempt to synthesize the following sub-questions in order to guide my thought: • In what way does semi-dollarization affect Cambodia? • How do the four mechanisms influence the policy space of policymakers in Cambodia? • In what way does official dollarization affect Ecuador? • How do the four mechanisms influence the policy space of policymakers in Ecuador? • What is the difference in the effect of the four policy mechanisms in officially dollarized nations and semi-officially dollarized nations?

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By answering these questions, I aim to describe the effects of the four mechanisms on the policy space of policymakers in dollarized nations. Finally, I will conclude that all four mechanisms explain the differences in the amounts of policy space between policymakers in semi-officially dollarized nations and officially dollarized nations. Three of the mechanism (the seigniorage mechanism, the monetary policy mechanism, and the foreign trade policy mechanism) explain why policymakers in semi-officially dollarized nations have more policy space than in officially dollarized nations. The fourth mechanism (the income distribution mechanism) actually shows that policymakers in officially dollarized nations have more policy space, than policymakers in semi-officially dollarized nations due to this mechanism. However, I will conclude that, when combining the effects of all four mechanisms together they clearly show and explain why policymakers in semi-officially dollarized nations still have more policy space than policymakers in officially dollarized nations.

2. Theoretical framework

2.1. Understanding dollarization In the heart of dollarization lies a political economic debate, since it is a political choice whether a country’s economy is dollarized or not (Frieden 2001: 2-4). Discussion about dollarization usually concerns the internal debate between having a fixed exchange rate for anti-inflationary credibility, and the countervailing value of a flexible exchange rate to allow monetary policy to respond to exogenous shocks (Frieden 2001: 308). When reading Frieden (2001), it becomes clear that the Mundell-Flemming trilemma lays in the centre of this debate. This trilemma tells us that a country can only accomplish two of the following three things: financial integration, exchange rate stability and monetary autonomy (Aizenman 2010: 2). Dollarization revolves around this trilemma and making this decision is not only an economic choice, but also a political one. When studying dollarization, one should understand the political and economic trade-offs and their weighing in the political process (Frieden 2001: 2-4). In the end, a government decides whether to go through with dollarization or to keep its own currency. When choosing dollarization, countries choose for financial integration and exchange rate stability but must give up their monetary policy. In this paper, I will analyse how much of this monetary policy countries must give up. Therefore, I will argue that dollarization is a political choice of a national government. This chapter will be structured as follows. First, I will explain briefly the history of exchange rate policies and conceptualise what dollarization is. Then I will argue that there are three different types of dollarization: unofficial dollarization, semi-official dollarization and official dollarization and explain how these types differ from each other. Finally, I will explain why dollarization occurs, and explain what the main causes are. This will give this paper the guidance on what

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dollarization is and how it will be conceptualised throughout this paper. The question of whether to dollarize or not, starts with the question of what kind of exchange rate regime to follow and what is best suited for a specific country. This has long been debated between economists, politicians, and policymakers (Salvatore at all 2003: 3). In 1945, this discussion led to the introduction of the Bretton-Woods system, in which most free-market floating currencies were pegged to each other. However, in 1973, this system collapsed and countries had no other choice than to use a (somewhat) free-floating system. In 1979, most Western-European countries decided to introduce the European Exchange Rate Mechanism (ERM), which meant going back to a fixed exchange rate regime (Iannizzotto 2001: 511). At the same time, there was an extensive debate about what to do with the exchange rates of the countries outside of Europe. In the 1980s, the IMF decided that other countries would be best served by fixed, or at least strongly managed, exchange rate policies. This was opted to reduce instability and generate a more stable world economy (Salvatore, et all 2003: 3). Opponents of this opted for fully flexible exchange rates, which would be more beneficial, since fluctuations in exchange rates could function as a buffer against exogenous shocks such as foreign inflation (Salvatore, et all 2003: 3). Once again, the trilemma plays an important role in this. When lifting the trilemma to the world’s economy, countries can only have two of the following things: a pegged exchange rate, capital mobility, and monetary independence (Bleaney, et all 2013: 878). There is a debate on which combination is best for most countries. On the one side, there is the argument that pegged exchange rates are a recipe for a crisis (Salvatore, et all 2003: 3). There is such high capital mobility in the current financial system, that pegs are difficult to manage. Therefore, most countries have adopted a more free-floating exchange rate policy over the years. On the other hand, certain areas have decided to fully eliminate all exchange rate risks by adopting the same currency; the most extreme example is the introduction of the euro in 2002, therefore setting monetary policies for a number of countries instead of a single country (Bleaney, et all 2013: 878-879). Dollarization is an example of eliminating exchange rate risks by adopting one’s other currency (Shi and Xu 2010). What makes dollarization so interesting is, that a country adopts another countries currency, therefore giving up their freedom to make its own policies (Cohen 2003; Minda 2005; Salvatore, et all 2003; Mack 2000). Dollarization creates a different tension between monetary policy and policymakers, than in places where more countries decide to introduce a new currency (like the euro), since policymakers in a place like the eurozone have the mandate to create monetary policies that are best in line with the interests of the eurozone as a whole (Blot et all 2014). In a dollarized nation this is not the case. For example, Ecuador is officially dollarized and therefore it must follow the monetary policy of the Federal Reserve. The Federal Reserve has no mandate to keep Ecuador’s best interests in mind (Zarazaga 2001). Therefore, these

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countries must give up much more of their monetary freedom than a country in the eurozone. The decision whether to dollarize lies in the trilemma just discussed and it is a political-economic debate. When we zoom in on dollarization, I first need to make clear what dollarization is. I will follow the conceptualisation of Mack (2000: 353): Dollarization occurs when residents of a country extensively use foreign currency, usually the U.S. dollar, alongside or instead of the domestic currency. This is a rather broad definition, because using a foreign currency comes in many shapes and sizes. The most important distinguishing factor is, that it can happen officially, when a country’s government and central bank accept dollarization and actively support it, by providing all necessary services. Or unofficially, when there is no official legal consent about the use of a foreign currency within a country’s borders (Mack 2000: 353). In this thesis, three different types of dollarization will be distinguished:

Unofficial dollarization: Unofficial dollarization occurs when people hold a large amount of their wealth in foreign assets, in a currency, which is not the domestic currency (Mack 2000: 353). Unofficial dollarization covers both legal and illegal forms of dollarization. In some countries, it is not a problem to hold bank accounts or savings in foreign currencies, while in other countries this is strictly regulated. Also, some countries allow their currency to be freely traded in the market, while others have strong limitations. These limitations can be implemented in a country’s financial system but can also imply that citizens are not allowed to convert cash freely in their home countries. Some of the largest economies in the world still have these kinds of restrictions. India and South Africa, for example, have very strict currency regulations, and their citizens can only legally obtain cash foreign currencies when they are able to prove that they are traveling abroad (Reserve Bank of India: 2019).

Unofficial dollarization can include holding any of the following (Mack 2000: 354):

• Foreign bonds and other non-monetary assets, generally held abroad; • Foreign-currency deposits abroad; • Foreign-currency deposits in the domestic banking system; • Foreign notes (paper money) in wallets and under mattresses.

Unofficial dollarization typically occurs in stages that correspond to the textbook functions of money as a store of value, means of payment, and unit of account (Mack 2000: 354). Šonje (2002: 3) argues that unofficial dollarization reflects citizens perceptions of the stability of the domestic monetary regime, the credibility of monetary policies and the perceived stability of the domestic banking system.

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Economists describe three stages of this unofficial dollarization, which explains how it is occurring. The first stage is asset substitution. Asset substitution occurs when people convert their assets into something that they trust more. In this case, it means that people convert their domestic currencies into foreign currencies in order to protect themselves from losing wealth. Losing their wealth can be caused by high inflation, or large exchange rate fluctuations (Feige: 2003). Countries that have some form of unofficial dollarization are countries like Argentina, Brazil, Nigeria, but also countries like Russia (Duff, et all 2005: 2). The second stage of unofficial dollarization is currency substitution. This occurs when the public holds large amounts of foreign currencies within their bank accounts (if permitted) or in banknotes and actively uses these foreign currency assets within the domestic economy (Whited 2004, Feige and Dean 2004). This means that people can use foreign currency to pay for their daily expenses, instead of the domestic currency. However, the foreign currency is not legal tender within the country’s borders. In the third and final stage, people think that the foreign currency and prices of goods are determined by the exchange rate between the two currencies (Mack 2000: 354). Countries in this category are countries like Guatemala. Unofficial dollarization is hard to measure, because it is difficult to know how much foreign currency reserves people hold in their bank accounts or in cash. Therefore, it is hard to completely grasp the effect of dollarization in these types of economies. In the latest study, I found that the Federal Reserve estimates that about 60% of all U.S. cash and 75% of all 100 U.S. dollar bills are abroad. This means that there is about 0,9 trillion of U.S. dollars cash circulating in other nations (Judson 2017: 8).

Semi-official dollarization: Semi-official dollarization is characterised by the mix of the use of domestic and foreign currencies (Mack 2000: 355, Meyer 2000). In these types of economies, a foreign currency plays a large role and is accepted in many cases in daily transactions. Semi- official dollarization has much overlap with unofficial dollarization. What differentiates it from unofficial dollarization is, that the foreign currency is legal tender. These countries actively support a bi-monetary system, which is officially implemented. However, they have not fully adopted a foreign currency; the domestic currency still plays an important role and is not completely pushed away by a foreign currency. We see many cases of this in South America and the Caribbean, mostly due to the importance of American tourism to these countries. Unlike officially dollarized countries, semi-officially dollarized countries maintain their own currencies and have a central bank that manages and controls a domestic currency. Countries in this category are, for example, Aruba, Haiti, Barbados, Cambodia, which all use the U.S. dollar. However, also other currencies can ‘dollarize’ nations.

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Examples of this are Bhutan (Indian rupee), Brunei (Singapore dollar) or Lesotho (South African rand) (Mack 2000: 356). These countries still have their own currencies; in many cases they are pegged to a foreign currency. Therefore, there is no fluctuation in exchange rates, which makes it easy for anyone to accept both currencies. In Barbados, for example, the rate between the US dollar and the Barbadian dollar (BBD) is 1 USD : 2 BBD, making transactions in both currencies easy for anyone.

Official dollarized countries: The last category of dollarization is the officially dollarized countries (Mack 2000, Bogetic 2000). These countries have completely adopted the use of a foreign currency within their own economy. This means that a foreign currency is used as the sole legal tender. Not only does the public actively use a foreign currency in their day to day transactions, but the government itself uses foreign currency to pay its people and its debts. Countries have the option to choose for one currency, but some even choose to adopt several currencies, like Zimbabwe (Buigut 2015). Countries that are officially dollarized, are countries like Panama, East-Timor, Nauru and Ecuador. We also find them in Europe: Liechtenstein, Andorra and Montenegro are all officially dollarized countries, even though they use a different currency, in this case, the euro.

Whilst I already briefly explained how dollarization occurs in its different forms, I will shortly explain the main reasons why nations dollarize. Historically, dollarization of a country’s economy has been a response to economic instability and high inflation (Berg and Borensztein 2000: 3). Especially in times of hyperinflation, the public turns to the use of alternative, stronger currencies to the extent of what is possible. Elaborating on this, Honig (2009) argues that dollarization occurs when citizens of a country no longer have faith in policies created by its governing institutions (Honig 2009: 198). Dollarization originates from a strong distrust in domestic currency and the monetary policies that are created in order to keep exchange rates stable and that promote long term currency stability (Honig 2009: 198). When this trust is lacking, the likeliness of people looking for alternatives to keep their savings and their wealth safe is much higher, which can create a strong demand for foreign currencies which are expected to hold their value better over time. As mentioned earlier, dollarization is a political choice; the type of dollarization these countries face is determined by national political actors. Some countries decide to accept dollarization by formally adopting and supporting it, resulting in semi-official dollarization or official dollarization, depending on a country’s choice. Other countries chose not to embrace dollarization, therefore facing unofficial dollarization (Frieden 2001: 2-4). Dollarization predominantly takes place in developing countries, since these countries usually face more political and economic instability. Furthermore, developed nations usually have long- standing records of keeping their currencies somewhat stable (Honig 2009: 199). The performance of 12 | P a g e

semi-official and unofficial dollarized economies has been highly variable but largely unimpressive (Mack 2000: 356). One of the main reasons is, that their domestic currencies still plays an important role in the domestic economy. These local currencies are often unstable and hamper economic growth by causing high inflation amongst other problems (Mack 2000: 356). Officially dollarized nations, however, usually outperform developing nations that still hold their own currency (Schuler 1996). In the end, the most important reason why countries dollarize, is the need to reduce risk and the lack of trust that citizens have in the country’s own currency and monetary policy. Citizens convert their local currencies into ‘hard’ currencies, because they do not trust their domestic currencies enough as they are afraid that their value will decline. Therefore, they seek the solution in other currencies. This can lead to the point in which a foreign currency plays an active role in the day to day payments by the public. When this happens, one can slowly expect an economy to further dollarize. The type of dollarization that will be created, depends on local policymakers. When they actively support dollarization, countries will become semi-officially or officially dollarized nations; when they are unsupportive, this will lead to unofficial dollarization. I am aware that there is an important part missing in the literature review: the part in which I explain the 4 mechanisms which I will discuss. However, I have decided to incorporate their conceptualisation within my analysis in order to have a better flowing argument. Therefore, I will now continue with the necessary background on dollarization in Cambodia and Ecuador, in order to get a better understanding of the causes that lead to dollarization in both nations.

2.2. Understanding policy space Whenever a government tries to make changes in its policies or strategies, in order to stimulate economic development or trade, institutional change is almost always required (UNCTAD 2014: VII). Markets inherently have a certain framework of rules, norms, and restraints in order to function effectively, and because of how deeply markets are embedded in society legally, socially, and culturally, they are sustained and monitored by their respective political forces (UNCTAD 2014: VII). How and to what extent these frameworks are developed and revised, in order to better comply with a society’s needs, depends on the society in which the framework exists. Political forces make decisions on how the implementation of certain rules contribute to things like economic growth or prosperity in welfare, adjusting the framework to their collective liking and desired outcome; however, since nowadays national economies are intertwined into a much larger constellation of international economies, international markets - exactly like domestic markets - require their own framework of rules, norms, and restraints in order to function effectively (UNCTAD 2014: VII). Therefore, this limits how much a national government can adjust their own framework today once operating within an international network of economies. This is especially true since most countries are members of large

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international organisations such as the IMF, WTO, and the World Bank, for example, all of which have their own framework by which their members must adhere to. Rodrik (2004) wrote extensively about how policy space and international organisations work together. Because of these two different frameworks (a domestic and an international framework), there is tension between the two (Rodrik 2004: 35). National governments who wish to implement new policies that are not in line with international policies; countries may want to implement certain tariffs on a product, in order to stimulate the domestic economy. Therefore, countries need to make the decision how much of their independence they are willing to trade for the access to the global economy and the support in economic development and growth that this potentially gives (UNCTAD 2014: VII). This can be prohibited by an institution like the WTO. Because of this, countries only have a limited ‘space’ in which they can make new policies and adjust their framework. This is the policy space governments have. According to Rodrik (2004), this can be problematic. Since these countries are forced to implement certain policies that are not in line with their own best interests. Rodrik (2004) argues that developing nations should be allowed more policy space in order to fulfil their own wishes. In order to define this policy space, I will use two definitions in order to see the overlap between the two. The first one is of the UNCTAD (2014), an institute of the United Nations. The other is from Kentikelenis, Stubbs and King (2016). Kentikelenis, et all (2016) define policy space as follows (I have underlined the most important aspects of their definition): We understand policy space as a government’s ability to select the policy instruments via which they address their economic problems, free from coercive conditionalities (Kentikelenis, et all 2016: 547). The UNCTAD (2014) defines policy space as: this refers to the freedom and ability of governments to identify and pursue the most appropriate mix of economic and social policies to achieve equitable and sustainable development in their own national contexts, but as constituent parts of an interdependent global economy. It can be defined as the combination of de jure policy sovereignty, which is the formal authority of policymakers over their national policy goals and instruments, and de facto national policy control, which involves the ability of national policymakers to set priorities, influence specific targets and weigh possible trade- offs (UNCTAD 2014: VII). When reading these two definitions, there is a clear overlap between the two. They both mention the importance for a country to have the instruments through which it can make policies that are best in line with the domestic needs. Also, they both highlight the importance of the sovereignty of policymakers, and how they should be able to do so without external interference. However, the definition of the UNCTAD (2014) further elaborates on this, by adding the fact that this is restrained by the fact that countries are not independent entities in the world economy; they are bound to an international framework. I believe that this is a point that cannot be ignored in this case, since countries are so interdependent in the global economy. Much of the debate concerning policy

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space, revolves around the tension between economic development and the ability of countries to implement national policies in international cooperation, as describe by Rodrik (2004). In order to successfully cooperate, standards are set by institutions like the IMF, World Bank but also the European Union. The debate is mostly focussed on the relationship between economic integration in the world economy and the implementation of national policies. For countries to be able to cooperate and trade together, they will have to find a way of synchronisation of policies, which will allow them to streamline trading and effectively participate in the world economy. McKinnon and Cooper (1968: 1450) wrote the following about this tension: The central problem of international cooperation - and of this book - is how to keep the manifold benefits of extensive international economic intercourse free of crippling restrictions while at the same time preserving a maximum degree of freedom for each nation to pursue its legitimate economic objectives. This mostly concerns developing nations, which have less of a voice in the international economic order. The UNCTAD argues that this can be a problem: What is needed therefore is a globally coordinated strategy of expansion led by state expenditures, with intervention that guarantees some policy space to allow all countries the opportunity of benefiting from the expansion of their domestic and external markets (UNCTAD 2017: 19). Furthermore, they argue that one of the main reasons the level of policy space is limited to developing nations, is due to dollarization (UNCTAD 2017: 15). Dollarization reduces a country’s ability to control its own policies since it will have to comply with policies that are created in the countries who have the sovereignty over this currency. This makes clear that dollarization leads to a reduction of policy space, in this thesis I will explain how this works. In summary: When looking at policy space and the earlier definitions, I believe the definition of the UNCTAD (2014) makes it clear where the problem lies. As mentioned in the part of dollarization, countries are losing their de jure policy sovereignty. In the end, this means that they will have to give up their de facto national policy control. This is where the problem lies which Rodrik (2014) also discussed. Countries must give up their policy space and they have no other option than to comply with policies, created by and created for, other nations. These countries’ institutions have the mandate to create policies that are best in line with their own interest. Therefore, they are not free to make policies free from coercive conditionalities as mentioned by Kentikelenis, et all 2016. Dollarization plays a crucial part in this, since dollarization creates all kinds of coercive conditionalities which dollarized nations must comply with, since dollarization requires national policymakers to follow various policies set in different nations, which may not be in the best interest of this nation. However due to dollarization, they have no other choice than to follow these policies. This area of tension is crucial in this paper and I will describe how this works on the hand of my four mechanisms.

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3. Methodology

3.1. Overall approach The main goal of my paper is to understand how the different ‘dollarization policy mechanisms’ affect the policy in dollarized nations. I will do this based on four different variables, or mechanisms, as I will call them. After studying the literature on dollarization and its relationship with policy space, the four most important policy mechanisms that I have found are: the seigniorage mechanism, the monetary policy mechanism, the foreign trade mechanism, and the income distribution mechanism (Mack 2000, Kang 2005, Menon 2008, UNCTAD 2014, Kentikelenis, et all 2016, various IMF article IV reports). In my analysis, I want to make clear how the mechanisms (X) affect the policy space of policymakers in semi- officially dollarized and officially dollarized nations (Y). I will do by conducting a case study, in which I will be analysing two cases (N=2): one of a semi-officially dollarized nation (Cambodia) and one of an officially dollarized nation (Ecuador). I have decided not to incorporate an unofficially dollarized nation in my analysis, since these countries do not support dollarization. Therefore, understanding the impact of dollarization will be much more speculative. The level of dollarization is rather unknown in these countries, since it is hard to understand the level of dollarization. In the semi-officially and officially dollarized nations, policymakers are actively dealing with dollarization, therefore, the effects of dollarization are clearer. For this reason, I will focus on the differences between semi-officially and officially dollarized nations in this thesis. I have decided to focus on two diverse cases, since I will study four different variables (mechanisms) (Gerring 2001). The first is a semi-officially dollarized nation (Cambodia) and the other an officially dollarized nation (Ecuador), according to Gerring (2001) this will give me a clear overview of the differences (Gerring 2001: 88). Gerring (2001) argues that we need to know similarities, which are sometimes even very different, in order to understand what we are talking about. Therefore, in order to get a proper understanding of ‘how things work’ a descriptive comparative research design will suit this research best. I will study both cases separately and describe how the mechanisms affect the policy space of national policymakers. After that, I will describe what the differences in the effects of the mechanisms are, in order to create a better understanding of how these mechanisms affect the policy space of national policymakers in the two types of dollarization and how they differentiate from each other. As discussed earlier, my analysis will consist of the same parts in both case studies. First, I will get to the background of dollarization in both nations. With this background, I aim to give a better understanding of why these countries are dollarized and how it is affecting them. I will discuss the causes of dollarization (history), the current status of dollarization (present) and their current strategy on dollarization (future). After that, I will get to the four mechanisms which I call: the seigniorage

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mechanism, the monetary policy mechanism, the foreign trade mechanism and the income distribution mechanism. I will also incorporate literature, explaining these mechanisms as part of my analysis, in order to create a more fluent story. Finally, I will compare the effects of the mechanisms on the policy space of national policymakers, in order to make clear what the differences in effects of these mechanisms are, therefore explaining why semi-officially dollarized nations still have more policy space than officially dollarized nations. The base of my analysis will be the article IV reports of the IMF since 2010. The Global Financial Crisis ended in 2009, therefore I think the period between 2010-2019 is best suitable for this case study, in order to eliminate the effects that the crisis may had on the relationship between dollarization and policy space. I will study these documents and I will analyse what they say about dollarization and my four mechanisms throughout the years. This way, I hope to see patterns and to create a complete overview of the current status of dollarization and the effect of my four mechanisms, on the policy space of national policymakers. To my regret, Ecuador has decided not to publish all their article IV reports over the past ten years, I was only able to find the reports of 2015, 2016 and 2019. Thankfully, much of the data in these reports also include the data of previous years. While this will give a gap in my total analysis, I still believe this is the best way to do my analysis. The IMF writes their article IV reports systematically in the same way for every country, therefore this gives me a good opportunity to see the differences between the two nations, and forms of dollarization. Furthermore, I will use different documents that are created either by the IMF, national governments (to understand their point of view) or the World Bank (mostly for primary data on economic indicators like GDP growth and inflation) which specifically get into my topic. Therefore, I will create a more in-depth understanding of the effects of my four mechanisms on the policy space of national policymakers. In order to generate a deeper understanding of ‘what is going on’, I aimed to do two in- depth interviews with policymakers in both countries. Arranging these interviews from Amsterdam was extremely challenging and sadly, I have not been able interview somebody in Ecuador. I have tried to arrange these interviews through my current job at Travelex, the world’s largest non-bank banknotes dealer, which, I know, has close ties in both Ecuador and Cambodia. I contacted Michelle Turney, head of the New Markets department. This department is responsible for entering new markets for Travelex, and to spot new business opportunities throughout the world. I know that this department keeps ties in both Ecuador and Cambodia. She brought me in contact with Kelvin Chua, who works for the New Markets department in Asia and Abel Ghacham, who works in North and South America. Both were a great help to me. Abel Ghacham and I e-mailed dozens of times, and soon he had a contact for me. He brought me into contact with someone who works for the Dirección Nacional de Seguridad Financiera in Ecuador and he was personally involved with the

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implementation of dollarization back in 2000. Through him, I hoped to get a better understanding of the effect of my four mechanisms in Ecuador, however, after many e-mails and phone calls from Abel Ghacham I remained unable to get to speak to him. Kelvin Chua put a similar effort into contacting somebody in Cambodia, which at first did not seem to pay off. It was rather difficult getting replies in Cambodia at all. However, thanks to his persistence, I was able to arrange an interview with Long Vibunrith, who currently works for the National Bank of Cambodia as a reserve manager. While he is not directly involved with day to day monetary policymaking, in his current function dollarization still plays an important role. Furthermore, as a member of different work groups throughout his career, he has gained much insight on dollarization over the years. His insights were a great contribution to my analysis, they helped me to understand how these mechanisms are affecting the National Bank of Cambodia’s policy space. Together with the earlier discussed report, this will be the data of my analysis.

3.2. Validity and reliability The biggest problem with the internal validity is, that I only had one interview in Cambodia: the interviewee could have some sort of bias, through which I will not be receiving enough independent data. In order to eliminate this, I will start my analysis with the article IV documents and the other documents and literature that I found. After that, I will see what the overlap is between the interview and the data/literature I had already found. This way I hope to eliminate any bias and to check the information I have gathered by using multiple sources. Another weak point is, that I was not able to interview someone in Ecuador, therefore I was not able to get the insights of somebody who is active on the ground in Ecuador. However, there is enough information in the documents that I found to perform my analysis and generate a clear understanding of how the mechanisms influence the policy space of domestic policymakers. The external validity also has some concerns, since this mostly focusses on how well I can generalise my conclusions. I will focus on two countries and compare the, with each other. It is therefore possible that conclusions based on these two cases are not representable for other cases. In order to eliminate this as much as possible, I will extensively study existing research done on dollarization, in order to get a complete understanding of what could possibly be expected to be found. Therefore, being able to recognise whether my findings are case specific or can be found in other cases of dollarization. Replicability and reliability also play an important role in the external validity. To guarantee the replicability and reliability, I will make it fully transparent; interviews will be transcribed and all used governmental pieces/sources are public, so anyone will be able to fully track my research and replicate it in order to have the same findings.

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3.3. Case selection My total research population are all countries in the world that have experienced some form of dollarization. This scope is rather large, since many countries have experienced some form of dollarization over time. Dollarization occurs on every continent, in various shapes and forms. As mentioned before, I will not include unofficially dollarized nations in my analysis, since the influence of dollarization is less clear to determine. In most unofficially dollarized nations, dollars are used as a store of value, and therefore do not play a large role in the day to day economy (Mack 200: 353). Furthermore, national policymakers actively support dollarization, therefore the effect on the mechanisms on the policy space of national policymakers is much more difficult to analyse. I have decided to focus on the semi-officially dollarized nations and officially dollarized nations. I have decided to select two diverse cases. According to Gerring (2008: 7-8), diverse cases can be used to examine what the effects are of a range of variables. These variables will be my four mechanisms and I will study the differences in effect of these mechanisms between the policy space of national policymakers. The next step is that I must make sure that my cases are comparable, and that no external factor is influencing the mechanisms. I have come up with the following four criteria in order to select my cases:

1. The countries need to be dollarized by the same currency. In order to eliminate the effect of different monetary policies, by the countries which currencies have been adopted, I need to make sure the dollarized economies are dollarized by the same currency, since different currencies could have different effects, therefore excluding this variable. 2. The countries should have similar population and GDP. To have the clearest explanation of how these mechanisms differentiate from each other I aim to eliminate as many variables between these countries as possible. Therefore, I have decided to choose countries which are comparable in population and GDP. 3. There needs to be a ‘before and after situation’. By having a before and after situation, I am better able to see the effects of dollarization. Without this, it becomes less if the variable (dollarization) is the cause of changes. 4. There needs to be enough literature. In order to properly analyse, I need enough data, that enables me to analyse the literature.

With these three criteria, I have picked Cambodia out of the total of semi-officially dollarized nations, and Ecuador out of the total of officially dollarized nations. I wanted that the countries that I picked used the same currency. I have decided to pick the U.S. dollar as the currency I wanted to use in my analysis, since this currency is the most frequently used currency, that countries use in dollarization.

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Therefore, I will argue that, by using the U.S. dollar as my currency of choice, the generalisation of my findings will be the most reliable. By picking the U.S. dollar, semi-officially dollarized countries like Bhutan (Indian rupee), Bosnia (euro), and Tajikistan (Russian ruble) were excluded. Officially dollarized nations that were excluded because of this, were countries like Montenegro (euro), Kiribati (Australian dollar) and Zimbabwe (that uses many different currencies). The officially dollarized nations which remained were Ecuador, El Salvador, Marshall Island, Micronesia, Palau, Panama and East-Timor (Jácome and Lönnberg 2010: 5). I have excluded all the small island states, since there is very little literature about them, and most of them are very dependent on the aid of the United States. Most of them hardly have any functioning government or central bank, therefore studying the policy space in these countries would not make a strong contribution to my research. I have also excluded small (island) nations out of the population of semi- dollarized nations like the Bahamas and Bermuda. This left me with Cambodia, Laos and Liberia in the population of the semi-officially dollarized nation. In the next step, I have excluded Panama and East-Timor since these countries never had their own currency, therefore there is no ‘before and after’. Therefore, the true effects of my mechanisms are more difficult to measure. The transition from a non-dollarized economy to a dollarized economy will be valuable to my analysis. Furthermore, I have excluded Liberia, since its population and GDP is not comparable to the countries which are left. From the semi-dollarized nations, Cambodia is the most interesting for research to me, since dollarization is the current situation. Since I knew Travelex had strong connections there, getting an interview there was most likely, which will be valuable to my research. Furthermore, in Cambodia is in active debate, which I will describe later, whether dollarization is good for them. Therefore, I can contribute to this debate (Sothear 2016, Connor 2017, Kimsay 2018 and Kang 2005). Ecuador is most compatible with Cambodia in terms of population and GDP out of the remaining officially dollarized nations. Both countries are classified as developing nations by the IMF (2018-1) and are therefore in similar stages of development. Besides that, there is also a strong debate on dollarization in Ecuador on which I can contribute. Therefore, I argue that these countries are most interesting and suitable to analyse and base my findings on.

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4. Analysis

4.1. Analysing the effects of dollarization on policy space In the previous chapters, I have conceptualised and described the debate concerning dollarization and policy space and I discussed my methodology. In the following chapter, I will analyse the effects of the four mechanisms to dollarization in Cambodia (semi-officially dollarized) and Ecuador (officially dollarized). The analysis will consist of two case studies, which will be described in the same way. First, I will start by giving the background story on dollarization, describing the causes (history), current situation (present) and current strategy (future) of dollarization in these nations. This will give a better understanding of why these countries dollarized, how it is currently affecting them, and how they are dealing with dollarization. Then I will describe the four mechanisms and how they are affecting the policy space of national policymakers. After that, I will finish with my conclusion in which I will do the comparison and discuss my overall findings.

4.2. Background information on dollarization in Cambodia Cambodia is a country in South-East Asia and has a population of 16 million people and a GDP of an estimated 22 billion USD (World Bank 2018-1). The export of Cambodia mainly exists of clothing and shoes, which accounts for four-fifths of all export. Products like rice and bicycles are also important export products of Cambodia. The most important export partners of Cambodia are mostly Western countries like the countries of the European Union and the United States, but also Asian countries like China and Japan. As for import, Cambodia heavily relies on its Asian neighbours, with China (40%) and Singapore (25%) as its most countries of origin.

Graph 1: GDP development of Cambodia 25

20

15 GDP in USD Billion USD in GDP 10

5

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Year

Source: World Bank (2018-1)

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Cambodia has seen strong economic development over the past two decades, with double- digit growth on a yearly basis (See Graph 1), with GDP per capita nearly doubling in the previous decade alone (IMF 2018-2: 17). Consumer price inflation has fallen from an average of 56% between 1990- 1998 to around 3% in the last 10 years (World Bank 2018-1). Government revenue collections have been exceeding expectations every year, the budget deficit has been brought back to a manageable level and poverty in Cambodia is declining (IMF 2018-2: 9). Overall, the Cambodian economy has seen some strong growth figures recently.

4.2.1. History and causes of dollarization in Cambodia While Cambodia has seen strong growth in recent years, this has not always been the case. During the Khmer Rouge regime (1975-1979) of Pol Pot, Cambodia and its economy have been severely damaged, and these scars are still visible (Kang 2005; Prasso 2011; Braiton 2011). During the Khmer Rouge regime, all private commercial activities were illegal. Basic things, like private property, means of exchange and store of value, were prohibited and punishable by death (Prasso 2011). During this period, the national currency (the Cambodian riel), and therefore most savings, were made valueless. There was no monetary system under the Khmer Rouge regime. Therefore, the country was without money (Braiton 2011: 6). Cambodians tried to find a way to save their wealth by investing in substitute form of a store of value and means of exchange. This created a strong demand for foreign currencies, especially the U.S. dollar, but also currencies like the Thai bath or Vietnamese dong were popular. They not only invested in foreign currency commodities, like gold or even rice, were also used (Braiton 2011: 6). The Khmer Rouge regime fell in 1979 and in 1980, the Cambodian riel was re-introduced. However, this was far from a success: Cambodians distrusted their currency, since they had seen how it could be eliminated overnight. The Cambodian riel lost value quickly and inflation skyrocketed (Zamaróczy and Sa 2002: 2). All of this led to Cambodians no longer trusting their own currency. Cambodians decided to keep using foreign currencies, especially the U.S. dollar. This is a typical case of currency substitution, in which distrust in one currency creates a demand for another, foreign currency. In the 1990s, this distrust was further stimulated by an underdeveloped monetary system, political and economic instability and weak legal and institutional structures (Menon 1998). This lack of trust in the Cambodian riel and in the Cambodian institutions where therefore the direct cause for dollarization, however, this is not the only cause of dollarization in Cambodia. Throughout all IMF (2010-2019) article IV reports, it becomes clear that economic and political stability has found their way back to Cambodia. The Cambodian economy is growing at an impressive rate and is one of the fastest growing economies in the world (World Bank 2015). Furthermore, there have been

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strong improvements, due to effective reforms in the fiscal and monetary system (IMF 2010-2018). Finally, trust in the political institutions has been improving over the years (Menon 2008: 230 and Braiton 2011: 1). Political stability and the creating of new, stronger institutions have created the ability for Cambodia to stabilise and generate economic growth over the past decades (Braiton 2011: 11). What is interesting, however, is that dollarization has not declined, but has increased over the same period. Therefore, Cambodia shows a different trend than its neighbouring countries like Laos and Vietnam, which have seen similar political and economic developments. In these countries, dollarization has declined and the use of national currencies has steadily increased (Menon 2008: 232 and Braiton 2011: 3). This means that there are new reasons why Cambodia is dollarizing. Firstly, due to the increase of trust in the Cambodian economy and institutions, Cambodians are retrieving their funds from other countries (Menon 2008: 231). Due to their experiences with the Khmer Rouge Regime, Cambodians used to deposit their savings at foreign banks in places like Hong Kong and Singapore, but in recent years it is widely known that these funds are finding their way back into Cambodia (Menon 2008: 231). When analysing the foreign currency deposits in the IMF article IV (2011-2018) reports it becomes clear that these are still rising (See graph 2).

Graph 2: Foreign currency deposits in Cambodia $90 $80 $70 $60 $50 $40 $30 $20 $10

Value of deposits in USD billion USD in deposits of Value $0 2011 2012 2013 2014 2015 2016 2017 2018 2019 Year

Source IMF 2013: 25 and IMF 2018-2: 33

Since these foreign deposits are already in foreign currencies, this means that they have not been converted into Cambodian riel. This is possible, because the whole banking system is still focused on the U.S. dollar. Therefore, this new inflow of currency contributes to the increase of dollarization in Cambodia. While the ratio of Cambodian riel deposits has slowly increased over time, they still contribute a very small part of all currency deposits (National Bank of Cambodia 2018: 16). The National Bank of Cambodia (2018: 16), argues that this increase of Cambodian riel deposits and the

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increasing demand for the Cambodian riel is a sign of renewed trust in the currency and Cambodia’s institutions, yet it increased the level of dollarization. Secondly, Cambodia joined the WTO in 2004: this created a large inflow of foreign currencies, since this generated a large increase of foreign trade. Historically, Cambodia and its economy have been closed off from the rest of the world, especially during the Khmer Rouge Regime. The article IV IMF reports of (2010: 22) and (2019: 5) show that since joining the WTO Cambodia’s exports have increased from 2,9 USD billion in 2005 to an estimated 14,2 USD billion in 2019. This means exports have almost five folded in 15 years. With an estimated total GDP of 26,3 USD billion in 2019 this means that almost 54% of the Cambodian economy exists of these exports. Global trade is mostly conducted in U.S. dollars. This means that this new foreign trade generated a large inflow of foreign currency in the Cambodian economy, which were not converted into Cambodian riel. The same goes for the increase of foreign aid, which reached Cambodia after it opened its borders. These funds also flowed into the country and were denominated in foreign currencies. Therefore, further increasing the level of dollarization (Braiton 2011: 6). Lastly, another important income stream for Cambodia is the emerging tourism sector. Cambodia is increasingly popular amongst tourists and they also bring along foreign currencies on their trips and pay with them throughout Cambodia. The tourism sector has grown from 1,2 USD billion in 2010 to an estimated 4,7 USD billion in 2019 (IMF 2010: 23; IMF 2019: 30). Since the U.S. dollar is accepted nearly everywhere in Cambodia, tourists tend not to convert their currencies and opt to use U.S. dollars. This generated another income stream of foreign currency in Cambodia. All of this illustrates that the success of the openness of the Cambodian economy and the growth of the tourist sector are therefore direct the cause of the further dollarization of the Cambodian economy.

4.2.2. Current situation and future strategy of dollarization in Cambodia Now that it is clear what the causes of dollarization are in Cambodia, I will discuss the current situation of dollarization in Cambodia and how policymakers are dealing with dollarization. Through this, I want to describe how influential dollarization is in Cambodia and describe the societal debate. With the current situation, I will study the period since 2010 since I will also base the analysis of my four mechanisms on the same timeframe (as mentioned in my methodology).

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Graph 3:

(Source: IMF 2018-2: 24)

What is important to understand is that, according to the latest IMF article IV rapport (2018-X: 24), the level of dollarization is still very high (See graph 3). In this graph, we can see the level of financial dollarization in Cambodia, since it shows us the amount of foreign currency deposits as a percentage of total deposits. The level of financial dollarization is around the 95% mark throughout this period. As mentioned earlier, this increase of dollarization is rather unique, since the Cambodian economy has stabilised in the same period and economic growth has really increased in these years. Usually, this is a recipe for a decrease of dollarization, which can be seen in neighbouring countries like Vietnam and Laos (Braiton 2011: 1). In addition to measuring financial dollarization (as is done in Graph 3), another indicator that illustrates the real impact of dollarization, is the use of U.S. dollar cash in the domestic economy of Cambodia. U.S. dollars are widely available and extensively used throughout the domestic Cambodian economy (National Bank of Cambodia 2016). Cambodians use cash U.S. dollars as a store of value, but also in day to day transactions. Prices are often quoted in U.S. dollars and they are dispensed through ATM machines nationwide. Therefore, the U.S. dollar substitutes some of the functions of the Cambodian riel. It is hard to give an exact number of the amount of cash U.S. dollars in Cambodia, because Cambodia has such a large informal economy, and the National Bank of Cambodia does not control the inflow of U.S. dollars in the Cambodian economy (National Bank of Cambodia 2016). It is extremely

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hard to determine how many cash U.S. dollars are circulating in Cambodia. What is clear, however, is that the amount of cash U.S. dollars in Cambodia is very large, contributing strongly to the level of dollarization (Léon Chef 1997; De Zamaroczy and Sa 2002; Dabadie and Im 2007; National Bank of Cambodia 2016). Overall, dollarization and the use of cash U.S. dollars within the domestic currencies, make clear that the level of dollarization is high (National Bank of Cambodia 2018: 12). However, what are the consequences of this? Up to now, dollarization has not been an obstacle in Cambodia’s economic development, since economic growth rates have been robust and the financial sector has rapidly developed (IMF articles 2011-2018; National Bank of Cambodia 2018: 12). Due to dollarization, the economy of Cambodia has integrated into the world’s economy, resulting in the economic growth that can be seen over that past decade. Together with a liberalisation of Cambodia’s economic policies, this integration into the world’s economy, stimulated by strong direct foreign investment, has led to this sustainable growth (IMF 2018-X: 72). However, Cambodia is openly struggling with how to deal with dollarization. When analysing how Cambodia is currently dealing with dollarization, it is clear how high this topic is on the agenda of Cambodian policymakers. The government of Cambodia has released two extensive documents (Financial Sector Development Strategy 2011–2020, and National Strategic Development Plan 2014- 2018) in which it describes its long-term strategic plans for dollarization. In both documents, the debate on what to do with dollarization is described frequently. I have picked one quote who summarizes the debate the most extensively, in my opinion. In the Financial Sector Development Strategy 2011-2020 the Cambodian government states the following about dollarization: There are benefits to dollarization, such as limited exchange rate movements that promote growth in foreign investment and provide a stable environment for the implementation of prudent fiscal policy. However, the loss of seigniorage and constraints on the wider use of market-based instruments in implementing monetary policy, such as open market operations and foreign currency interventions, raise serious concerns over how well a crisis would be handled, should one occur. This is exacerbated by the limited ability of the NBC to act as the lender of last resort and to provide emergency support to the financial system in the event of a systemic problem. More important than this, the lack of close coordination among ministries (particularly the Ministry of Economy and Finance [MEF]), as well as lack of a clear framework to use in resolving a crisis, are critical gaps that need to be addressed. The fiscal position of the government and adequate “headroom” are crucial for the government to be able to lend support in the event of a crisis (Government of Cambodia 2011: 7-8). The government argues there are clear advantages of dollarization. According to the Cambodian government, dollarization has created stability and a deeper integration in the world’s

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economy. On the other hand, it also states that the loss of seigniorage and the constraints in making effective policies are a big concern (two of the mechanisms I will describe); dollarization has negative effects on the Cambodian economy and the policy space of policymakers (this will be discussed in the analysis). Finally, the government argues that dollarization reduces their ability to mitigate risks due to the high internal exposure to a major foreign currency (National Bank of Cambodia 2018: 12). There has been a debate on whether the benefits of dollarization outweigh the costs (Menon 2008, Braiton 2011; National Bank of Cambodia 2018). Eventually, the government of Cambodia, in cooperation with the IMF, has taken the following position on dollarization: The government of Cambodia has committed itself to focus on de-dollarization, however, it also decided to stimulate de- dollarization slowly. A drastic change in the current policies around the use of U.S. dollars is seen as too big of a risk, since this could lead to distrust and unrest of the Cambodians and foreign investors in the Cambodian economy. It could also lead to rising interest, inflation and higher exchange rates, which would all have a negative impact on the Cambodian economy (IMF 2018: 13). This was also confirmed in my interview (Vibunrith 2019). In the interview he describes the current strategy as follows: We try not to use any administrative measures nor force people to use the Cambodian riel. We just want to make it more attractive for investors to do business in Cambodian riel, instead of the U.S. dollar. That is better than forcing investors to use the Cambodian riel. We want to be market friendly, investor friendly, as we start implementing our de-dollarization strategy. De-dollarization should therefore be pursued, but no at the cost of creating economic instability.

4.3. Background information on dollarization in Ecuador Ecuador is a country in South America and has a population of about 16,6 million people and a GDP of about 105 billion USD (World Bank 2018-2). Its export consists mostly of crude oil, other important export products are bananas and shrimp. Almost one-third of its export go to the United States, while other important export partners are scattered all over the world with Vietnam, Chile, and Russia completing the top four of the most important trading partners.

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Graph 4: GDP development of Ecuador 120

100

80

60 GDP in USD Billion USD in GDP

40

20

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Year

Source: World Bank 2018-2

Ecuador has seen strong economic development over the past two decades. The total GDP increased from 18 USD billion in 2000 to almost 105 USD billion in 2017 (see Graph 4). In the same period inflation decreased from nearly 96% in 2000 to just 0,47% in 2017. Also, the latest IMF article IV report of 2019 describes how fiscal reforms have contributed to the stability of Ecuador; however, they also mention that these have a long way to go and that the large debt and budget deficits are one of the key points of concern in Ecuador (IMF-X 2019).

4.3.1. History and causes of dollarization in Ecuador While Ecuador has seen some strong growth over the years, this has not always been the case. The economy of Ecuador has seen a boom after the discovery of oil in the 1960s. However, despite this large new income stream, the Ecuadorian government has faced large fiscal deficits (World Bank 2004). As a result, the external debt nine folded between 1975 and 1980, increased another 74% between 1980 and 1985, and still another 25% between 1985 and 1988 (World Bank 2004). Two years before dollarization, the external debt of Ecuador had increased to 13 billion, which accounted for almost two-thirds of its total GDP. This was the heaviest burden of any Latin American economy at that time (Beckerman 2002). The 1980s were a decade in which Ecuador suffered many external shocks and slow economic growth (Berríos 2006: 57). This was mostly driven by dropping oil prices, which created a huge drop in foreign trade. This resulted in the fact that the GDP of Ecuador grew slower than the public external debt (Beckerman 2001: 2). This led to an overall economic instability, which reached its peak in 1988 (Berríos 2006: 57). The year before, Ecuador had stopped servicing its foreign debt with commercial banks, since interest rates had gone up so too high for Ecuador to pay. Meanwhile, inflation had

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reached over 75% (World Bank 2004). From then on, Ecuador got into a negative spiral. In the 1990s, the political situation was unstable. The presidency saw a divided congress which made it hard to govern and furthermore, there were labour strikes and public protests that further crippled the economy (Berríos 2006: 57). Between 1996 and 2006, Ecuador had eight different governments, it was a record hard to beat, even for a South American government (Berríos 2006: 56). This illustrates how politically unstable Ecuador was at the time. During this decade, it also encountered some economic shocks that affected the economy. Examples of this are the border war with Peru in 1997, El Niño, which affected agriculture in a negative way in multiple years (and therefore decreasing exports), and the Asian and Russian crisis. In the end, Ecuador was unable to cope with these shocks and the combination of natural disasters and an unstable political situation created this crisis (Castro Escudero 2000; Hey 2004). In 1998, the private financial sector became even more vulnerable. There was a large pressure on the bank due to high interest rates and the rising exchange rates of the Ecuadorian sucre, the national currency. Since banking supervision was inadequate, some major banks became insolvent (Berríos 2006: 57). The government was determined to save the troubled banks, by pumping large amounts of money into the economy. This resulted in severe monetary imbalance as the number of uncollectables rose sharply (Berríos 2006: 57). The Central Bank poured large amounts of money into the economy in order to keep the banks afloat. Moreover, they tried to maintain the value of the sucre, by selling U.S. dollars: the Central Bank saw its international reserves shrink further. At the same time, exchange-rate depreciation led to even more inflation. By the end of 1998, the Ecuadorian sucre had lost one-third of its value. This resulted in an increase in the use of U.S. dollars, since the Ecuadorian sucre had become so unstable (See graph 5), Ecuadorians no longer trusted their national currency and opted to use the U.S. dollar (Beckerman 2001: 24).

Graph 5: Exchange rate of the sucre against USD 14000 12000 10000 8000 6000 4000 2000 0

Exchange rate of sucre against USD against sucre of rate Exchange Year

Source: World Bank (2018-3)

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Since then, there was no way back, and things only became worse. In 1999, the economy had severely weakened and the Ecuadorian sucre lost again two-thirds of its value. This meant that the debts of Ecuador became even more unpayable. Consumer prices skyrocketed: at its peak in 2000, they nearly doubled within one year (See Graph 6). The economy had severely weakened and GDP per capita declined with 7,3% in 1999. The depreciation of the Ecuadorian sucre was further complicated by constraints on external financing. The main cause of this was Ecuador’s inability to meet its international financial obligations, resulting in a default on its foreign debt (Berríos 2006: 57). Internally, the government also decided to freeze savings and to check deposits, a decision that damaged depositor confidence. In the end, the monetary authority had completely lost its control over the money supply, the exchange rate, and the price level. Faced with severe inflation and a floundering economy, Ecuador was struggling with one of the worst recessions in its history (ECLAC 2002). One World Bank study noted that poverty and inequality had worsened and estimated that “between 1998 and 2000, about 200,000 Ecuadorians left the country in search of better economic prospects” (Parandekar 2003: 133).

Graph 6: Inflation in Ecuador 120

100

80

60

40

Inflation percentage Inflation 20

0

Year

Source World Bank (2018-4)

In the end, the situation became too overwhelming for the Ecuadorian government and drastic action had to be taken. President Jamil Mahuad decided to replace the Ecuadorian sucre with the U.S. dollar (Berríos 2006: 60). The announcement to formally adopt the U.S. dollar, was made on January 9, 2000. This led to large demonstrations and protests throughout the country and the military removed Mahud from his office. However, the new president, Gustavo Novoa, ratified the bill to dollarize Ecuador, despite mounting unrest by the indigenous population and organised labour. They saw this move as a national humiliation. However, many also believed it would finally bring some economic stability after many years of great instability. Dollarization was a last-ditch effort to avoid an

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economic meltdown (Berríos 2006: 60). To summarize: political instability, declining oil prices, and natural disasters were the main causes for Ecuador’s crisis leading to dollarization (Beckerman 2002; Berríos 2006, Castro Escudero 2000; Hey 2004). Since then, the economic situation of Ecuador has been approving, with the economy growing again (World Bank 2018-2). The political situation, on the other hand, remained volatile. In 2007, Rafael Correa won the election in Ecuador, under his regime a strong populist government evolved (De La Torre and Ortiz Lemos 2015: 221-222). This contributed even more to a hollowing out of the democracy in Ecuador. Because Ecuador had experienced a crisis in its democratic representation before Correa became into power, existing democratic institutions and a divided opposition were not able to make a fist against his rule. Therefore, further shallowing out of the democracy in Ecuador took place (De La Torre and Ortiz Lemos 2015: 222). At the same time, external actors have not been very influential when it comes to checking Correa’s populist government. Due to relatively high oil prices, Correa’s government has developed social policies in favour of the poor and this certainly has contributed to its support. Under his rule, Ecuador saw democratic erosion and according to Mainwaring and Pérez-Liñán (2015), Ecuador has moved from a weak democracy to a semi-democracy place (De La Torre and Ortiz Lemos 2015: 222).

4.3.2. Current situation and future strategy of dollarization in Ecuador Similarly, as in my analyses of Cambodia, I will describe the current status of dollarization in Ecuador by analysing the situation over the past ten years. Therefore, making clear what kind of role dollarization is playing in Ecuador currently. Ecuador has a love-hate relationship with dollarization (Álvarez Vásquez, et all 2018: Cueva and Diaz 2019). It has brought them stability and has further deepened the economic integration within the global economy, but at the costs of losing their currency. A good indicator for this increased stability is the banking deposits to GDP ratio, which indicates the regained trust of Ecuadorians in their banking system. Graph 7 shows that the banking deposits are increasingly steady (side note: banking deposits were below 16% before dollarization, however this is not in the 10-year framework I study in this part). I argue that an increasing % of banking deposits shows regained trust in the Ecuadorian financial system and economy, since its citizens and foreign traders are allowing their wealth to stay in the Ecuadorian financial system. When trust was lacking, wealth is usually subtracted from a nation’s financial system/economy, in order to guarantee its safety.

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Graph 7: Banking deposits to GDP % 35 30 25 20 15 10 5 0

% of banking deposits to GDP to deposits banking of % 2010 2011 2012 2013 2014 2015 2016 Year

Source World Bank (2017: 5)

However, this has come at the cost of not having a national currency or monetary policy (Alvarez Vásquez, et all 2018; Cueva and Diaz 2019: 1). Therefore, Ecuadorian policymakers had to give up some of their sovereignty. Over the past years, Ecuador has frequently pushed the boundaries of dollarization. The Ecuadorian Government and the Central Bank of Ecuador have regularly been implementing policies that conflict with their current dollarization (IMF 2019: 9). By doing so, Ecuadorian policymakers risk losing trust in the Ecuadorian economy from its citizens and foreign investors (Cueva and Diaz 2019: 1). Throughout the latest article IV IMF report (2019-X), this topic is mentioned frequently. At one point, the IMF (2019-X: 4) says the following about dollarization in Ecuador: The foundations of the dollarized system have been undermined by a fiscal policy that is inconsistent with the constraints imposed by dollarization and, in parallel, by an erosion of domestic institutions. The decision to dollarize the economy continues to receive significant public support. However, under the previous administration, policies steadily undermined the viability of the dollarization framework, mainly through central bank financing of fiscal spending. This, in turn, has resulted in an increase in balance of payments vulnerabilities, a high public debt-to-GDP ratio, inadequate reserve coverage, and an overvalued real exchange rate. On the other hand, the IMF also sees the downside of dollarization. It also argues that Ecuador has less policy space due to dollarization. Therefore, Ecuador is under threat from the external environment, since the country does not have many of the tools that countries, which still have their own currency do not have. The IMF (2019: 4) therefore said the following: However, a potentially less favourable external environment, reduced financial buffers, and limited policy flexibility in the context of dollarization could complicate macroeconomic management going forward. Accordingly, Directors called on the authorities to restore policy space, continue to strengthen the financial system, and

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pursue further reforms to boost competitiveness and sustain high growth. Further down in the IMF article IV (2019-X) report, it becomes clear that, even though dollarization leads to an increased amount of policy space of Ecuadorian policymakers, undermining of dollarization is a great deal of concern to the IMF, since it can harm the overall stability of the Ecuadorian economy. In March 2019, the IMF approved a 4.2 USD billion Extended Fund Facility for Ecuador (IMF 2019-X: 3). This was not given without any conditionalities. One of the key points Ecuador and the IMF agreed on is to implement policies to further deepen the relationship between Ecuador and dollarization. The IMF (2019:3) stated the following: The Ecuadorian authorities are implementing a comprehensive reform program aimed at modernizing the economy and paving the way for strong, sustained, and equitable growth. The authorities’ measures are geared towards strengthening the fiscal position and improving competitiveness and by so doing help lessen vulnerabilities, put dollarization on a stronger footing, and, over time, encourage growth and job creation. In the end, the IMF and Ecuador both see that there are advantages and disadvantages to dollarization. Both parties are now committed to further strengthen dollarization in Ecuador. In March 2019, Ecuador and the IMF have agreed on a new policy strategy to further deepen dollarization in Ecuador. The main objectives of the policies are to protect Ecuador from external shocks and to support economic growth; to implement a fiscal plan that will put the debt-to-GDP ratio on a firmly downward path; and to restore the autonomy of the Central Bank. This plan has led to a more robust Ecuadorian economy, with strong institutions and sustainable economic growth (IMF-X 2019: 10)

4.4. Analysing the effects of the four mechanisms After analysing and describing the background story, causes of dollarization (history), the current status of dollarization (present) and the current strategy on dollarization (future) in both Cambodia an Ecuador, I will continue with analysing my four mechanisms. First, I will describe my mechanisms, and their relationship to policy space, then I will describe how these four mechanisms are affecting the policy space of national policymakers per country, therefore answering my main research question and my sub-questions. After this, I will present my overall findings and conclusion.

4.4.1. Seigniorage mechanism

4.4.1.1 Seigniorage mechanism explained Through the ages, governments have appropriated real resources through the monopoly of ‘creating’ money (Buiter 2007: 1). In modern fiat money economies, the monopoly of creating money usually lies within a government institute, usually a Central Bank, which controls the amount of money being created and put into circulation. The Central Banks usually do this as an independent organ within a nation, however, levels of this independence strongly vary throughout the world. It is widely

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recognised that making money is a highly profitable business for any nation (Buiter 2007: 2). While it is much debated what seigniorage exactly is and how it is calculated, I will focus on how the loss of seigniorages is affecting the policy space of national policymakers Cambodia and Ecuador. First I will explain what seigniorage is. For this, I will make a division between three types of seigniorage, which has also been done by Kang (2005). The first form of seigniorage concerns the actual cash in circulation. The loss of this seigniorage can be determined by subtracting the costs of printing a banknote off from the face value of a banknote. For example, if it would cost 1,000 Cambodian riel to print a 100,000 Cambodian riel banknote, the seigniorage revenue of a single banknote will be 99,000 Cambodian riel, since the National Bank of Cambodia will sell these banknotes at face value to the public (Samreth 2010). Therefore, this is a very profitable business. When cash U.S. dollars are used by the Cambodian citizens, this eliminates this revenue stream for the Cambodian government, since the U.S. federal reserve will sell these banknotes at face value to the National Bank of Cambodia. The second type of loss of seigniorage, is that of non-physical money creation. When a country economy is growing, the total amount of money in circulation is also growing (Kang 2005: 203-204). This means that a country can ‘print’ extra money, since there is a higher demand for its currency. This extra supply of money cannot exceed the demand, as this will create inflation, therefore reducing the benefits of this new money creation. However, when countries maintain this balance properly, they can sell more of their own currency in the market, while keeping the value of that currency at a stable level and generating more income. The third and last type of seigniorage involves reserve management. I will explain this by using Cambodia as an example: If, for example, Cambodians were not allowed to use U.S. dollars, all dollars that circulate in Cambodia would be concentrated in the (National) bank(s) of Cambodia. The National Bank of Cambodia could utilise the amount of foreign currency in lending, buying US treasury bills, and holding all kinds of interest-bearing bonds (Kang 2005: 202). Kang (2005) assumes that the National Bank of Cambodia could at least collect 3% interest per year from the total amount of foreign currency, therefore, this creates another loss of seigniorage.

4.4.1.2 Seigniorage mechanism in Cambodia I will now describe how the seigniorage mechanism is affecting (the policy space) in my two cases, starting with Cambodia. The calculation of the total amount of seigniorage lost is rather difficult, since putting exact numbers on the amounts lost is nearly impossible, due to the large number of variables. The IMF article IV reports only mentioned a calculation of seigniorages lost in Cambodia once, in the 2010 article IV report. The IMF (2011) estimates that the total loss of seigniorage is somewhere between 5-19% of total GDP, with an estimated average of 5% of total GDP (IMF 2011: 14). However,

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the IMF is not the only one that estimated the total loss of seigniorage in Cambodia. In the following table, there are three other estimates of the amount of seigniorage lost in Cambodia.

Table 1: Various estimates of U.S. dollars in circulation in Cambodia in their respective years. (in USD billion) IMF (2010) Kang (2003) Im and Dabadie Feige (2006) (2007) U.S. dollar cash in 1.01 3.5 2.0 circulation Seigniorage loss 1.23 0.75 2.7 2.02 (World Bank 2015: 20)

This topic was also discussed in my interview with Mr. Vibunrith (2019). In the interview, he also referred to the last article IV report of the IMF (2010) as a source. His most important critique was about the third form or seigniorage loss, which I have discussed earlier. He said the following: For me as a reserve manager, I consider this loss. People and companies can get in with U.S. dollars, not having to exchange them. I mean, in a normal country, where you cannot use the U.S. dollar, you must come in and exchange your currency for the local currency. In that case, the foreign currency will be in the foreign reserve, which will be gaining interest, with the Central Bank. But in our case, people just bring in U.S. dollars, bypassing the Central Bank by doing so. So that is our loss, and the amount of U.S. dollars in the banking system is around 20 billion, right now. That is 20 billion U.S. dollars that could have been in the Central Bank’s foreign reserve, instead of being in the economy. That is our loss, the interest on the 20+ billion that is not in the central bank reserve. That is my opinion, not the Central Bank’s. However, since money can flow in and out of Cambodia, without the National Bank’s interference, this money does not flow through the National Bank of Cambodia. When we use the estimate of Kang (2005), the average interest on this should lay around 3%, this would cost Cambodia around 600 million U.S. dollars per year. As discussed before, the main consequence is, that they are unable to generate any revenue streams out of this inflow of money. Due to the loss of these three types of seigniorage revenue streams, maintaining this level of dollarization is rather expensive for Cambodia. Kang (2005), Menon (2008) and the IMF (2011) all three believe that the costs of dollarization no longer outweigh the benefits. This leaves the question: what does this mean for Cambodia: How is this affecting Cambodia and the policy space of its policymakers? This main problem is clear: Cambodia loses valuable income, which policymakers could have used as a source of funding to implement new policies. When analysing this data, it becomes clear that there is quite a range between the different estimates of the exact amount of seigniorage lost. The estimates range between 0,75 USD billion and 2,7 USD billion (See

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table 1). Either way with a total GDP of 22 USD billion, even the lowest estimate shows how large the effect is on the total Cambodian economy (World Bank 2018-1). Menon (2008: 6) describes where these revenues go: they stay in the U.S. Federal Reserve, through which they help to stimulate the U.S. economy, instead of staying in Cambodia. Aisen and Veiga (2008) argue that, due to the loss of seigniorage, dollarized countries must have to give up this income stream. This ultimately means that they have less economic freedom and are less able to create policies (Aisen and Veiga 2008: 29). This large amount of money, which national policymakers in Cambodia could have used to fund their newly created policies with, stays out of their reach. Implementing policies usually requires funding, since dollarization leads to a decrease of available it reduces the amount of what Cambodian policymakers can do, and therefore, the policy space for Cambodian policymakers (Aisen and Veiga 2008: 29). Another reason why the loss of seigniorage is limiting the policy space of Cambodian policymakers is their options in funding their debt. When dollarized nations make new debt, they simply do not have the option (the policy space) to use their seigniorage revenues freely in order to reduce these debts, since the amount of seigniorage they are able to generate is limited, due to dollarization. Instead, they must use different types of funding, such as borrowing on the external market, increase taxes or use their own reserves, which can come with all kinds of conditionalities (Rodrik 2004). The lack of having seigniorage revenues cannot be underestimated. As discussed, the IMF currently estimates that the total loss of income is at least 5% of the total GDP. Therefore, giving Cambodia less economic freedom and therefore a decrease in the amount of policy space. Cambodia still holds some seigniorage revenues, since they still issue Cambodian riel, but the amount of riel they can issue is restricted due to dollarization as explained earlier. Therefore, they lose valuable seigniorage revenues, economic freedom, and policy space.

4.4.1.3 Seigniorage mechanism in Ecuador Due to the official dollarization of Ecuador, Ecuador hardly has any seigniorage. Because of this, almost all seigniorage gains stay in the hand of the Federal Reserve of the United States. Since the United States is not redistributing these seigniorage revenues to countries who use the U.S. dollar, there is no way for Ecuador to reclaim any of these revenues. It is rather difficult to estimate the total amount of seigniorage lost in Ecuador. The IMF does not mention seigniorage losses in any of their Article IV reports. The most recent estimation which I could find was made in 2006 by Matthews, et all. They estimate that the total loss of seigniorage in Ecuador is about 6,2% of total GDP (Matthews, all 2006: 98). They also specify that they estimate that the ability to give out cash (seigniorage type 1) generates a loss of about 3,7% of GDP, whilst the inability to print new money (seigniorage type 2) costs Ecuador about 2,5% of total GDP (Matthews, et all 2006: 98). They do not mention the loss of the third type of

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seigniorage, therefore the total loss of seigniorage is expected to be higher. It should be noted that there is a very small way in which Ecuador still generates some form of seigniorage revenues (Jácome and Lönnber 2010: 16). Many dollarized countries still issue their own coins. Banknotes can easily be imported from the United States and are widely available through a wide range of banks and other financial institutions. Importing banknotes is, therefore, a rather straightforward business. However, the public also needs to have coins in various denominations widely available, in order to ensure smooth transactions. Coins are much more difficult to obtain, and transporting these coins comes at a high cost, especially if these coins must travel over a long distance. Therefore, most dollarized countries choose to mint their own coins locally and guarantee that they are always exchangeable for U.S. dollars. Ecuador is no exception in this and issues its own local coins in various denominations, generating some form of seigniorage. However, it is by Ecuadorian law required that the total value of produced coins needs to be fully backed by the holding of foreign reserves. Therefore, the amount of seigniorage generated is very limited (Cueva and Díaz 2019: 29). What is important to understand is, what this lack of seigniorage means to (the policy space of) Ecuador. Again, the argument of Aisen and Veiga (2008) is applicable here: Ecuador loses economic freedom and therefore policy space. This can also be witnessed in two different forms. First, it is costing Ecuador valuable income which it could have used to implement policies. With the latest estimates that the loss of seigniorage is around 6,2% of total GDP, this is a significant amount of money lost, limiting the economic freedom and, therefore, the policy space of Ecuadorian policymakers. Secondly, it reduces the policy options to make foreign debt. Before dollarization, the government of Ecuador strongly relied on its seigniorage revenues (Cueva and Díaz 2019: 1). National policymakers frequently decide to use seigniorage as a source of funding rather than using other tools like lending on the open market or using their national reserves. Ecuador no longer has the choice to use seigniorage as a source of funding, therefore, limiting the policy options that national policymakers have. The only options they still hold are external lending, increase taxation or using their own reserves; this limits the policy options of policymakers in Ecuador in funding their debt. The seigniorage mechanisms, therefore, illustrate how dollarization is limiting Ecuador’s independence and decreasing the policy space of national policymakers. While in semi-officially dollarized nations there are still some seigniorage revenues, in officially dollarized nations this income on almost zero, therefore the seigniorage mechanism explains why semi-officially dollarized nations have more policy space than officially dollarized nations.

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4.4.2. Monetary policy mechanism

4.4.1.1 Monetary policy mechanism explained In most non-dollarized economies, the Central Banks independently set monetary policies. In theory, free-floating exchange rates contribute to monetary independence: because of this, a country can have whatever interest rates or inflation rates it chooses (Bleaney, et all 2013: 876). When a country dollarizes, it loses these free-floating exchange rates and therefore most of its monetary independence. This results in less monetary freedom for the domestic central banks, which are now forced to follow (part of the) monetary policies of their anchor nation. It is therefore clear that there is a strong relationship between dollarization and the ability to have independent monetary policies. Jácome and Lönnber (2010) even argue that central banks in officially dollarized economies become completely powerless. In this part, I will illustrate that this is incorrect and that dollarized economies still hold some ability to create monetary policies. The main questions here are: how much can they still do? How does the monetary policy mechanism determine the amount of policy space? How does the monetary policy mechanism explain the differences in policy space between officially dollarized nations and semi-officially dollarized nations? I will analyse the abilities from both Cambodia and Ecuador to set monetary policies independently, therefore describing how this ‘monetary policy mechanism’ is influencing the policy space of national policymakers in these dollarized nations. By doing this, I will explain how the monetary policy mechanism determines the differences in policy space between semi-officially dollarized nations and officially dollarized nations. I will do this by going over five key monetary policies: the ability to create money; the ability to influence the exchange rate; the ability to set interest rates; the ability to set reserve requirements and the ability to function as a lender of last resort. These five points will be the basis of determining the differences between the policy space of national policymakers in semi-officially dollarized nations and officially dollarized nations. Apart from that, I will also describe some minor points which are more case specific in order to give a more complete overview of the policy space national policymakers still have.

4.4.2.2 Monetary policy mechanism in Cambodia Due to dollarization, the Cambodian Government is unable to implement monetary policies freely (Kang 2005). Throughout the IMF article IV rapports (2011-2018), it becomes clear that the effective implementation of monetary policies is a great concern due to dollarization. In the article IV of 2012, the IMF says the following about this topic: A high degree of dollarization constrains the effectiveness of monetary policy, leaving fiscal policy as the main tool to preserve macroeconomic stability (IMF 2012: 6). The IMF (2011-2018) continuously sees this as a weakness in the Cambodian economy, since it gives the National Bank of Cambodia fewer tools to protect the Cambodian economy from external

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shocks and to maintain stability. In the interview with Mr. Vibunrith, he said the following about this subject: The dollar deposit rate is, of course, set and determined by the FED and the overall market condition. So, we are following the monetary policy of the FED. This makes clear how dependent the National Bank of Cambodia is. In this part, I will analyse how this influences Cambodia, describe what kind of monetary tools they still have and how this relates to the amount of policy space of Cambodian policymakers. One of the most important tasks of any Central Bank is to control the money supply in the Cambodian economy (Kang 2015: 204). With these money supply policies, a Central Bank can affect things like price stability, interest rates, foreign exchange rates, but it can also stimulate economic development. When a country dollarizes, it must give up much of its ability to control the money supply, since much of that money is no longer their own. It is unthinkable that a country can print money in a currency that is not their own, yet Cambodia is still able to control the supply of the Cambodian riel. It is interesting to see how much Cambodia can still do because of this. When analysing broad money in the Cambodian economy, the article IV reports of the IMF (2010-2018) give the following numbers:

Graph 2: Cambodian riel in broad money Year Cambodian riel component of In percentage of broad money broad money in USD Million 2010 3.629 18.6 2011 4.513 19.1 2012 4.826 16.9 2013 5.823 17.8 2014 7.399 17.4 2015 8.291 17.0 2016 9.659 16.8 2017 12.044 16.9 2018 (prognose) 14.385 17.3 2019 (prognose) 16.970 17.8 Average 17.6 Source IMF (2013: 20) and IMF (2018-2: 28)

What is interesting here is, that Cambodia still can do some form of money creation (controlling the money supply). The total amount of Cambodian riels in broad money, increased in value from 3,629 USD billion in 2010 to a prognosed 16,970 USD billion in 2019. However, what stands out is, that the

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total percentage of Cambodian riel component in broad money has stayed almost the same with an average of 17,6% over the past 10 years, with all years very close to this average. This illustrates how much policy space the National Bank of Cambodia has. They can increase the total amount of Cambodian riel over time, however, the total percentage of Cambodian riel in broad money cannot be increased too much. Another reason why this reduces the ability for Cambodian policymakers to control the money supply is that the in- and outflow of foreign currency bypasses the National Bank of Cambodia (Vibunrith 2019). This is happening because the Cambodian economy relies on free trade and capital flows (National Bank of Cambodia 2018: 24). However, this free trade and free movement of capital comes at a price: The National Bank of Cambodia loses the ability to control capital in- and outflows, and therefore much of the control over the total money market (Kang 2005: 205). Mr. Vibunrith (2019) further explained this. He explained that in a non-dollarized nation, when doing trade in a foreign market, the foreign currency will need to be converted into local currency. This usually goes through the Central Bank (therefore controlling capital flows and the money market). In Cambodia this is no longer needed, since U.S. dollars can freely enter and circulate throughout the economy, and conversion in Cambodian riel is unnecessary. Therefore, foreign trade and capital inflows can completely bypass the National Bank of Cambodia. This reduces the abilities of the National Bank of Cambodia to control the money supply in the Cambodian economy (Kang 2015: 204-205). This leaves the question: how can Cambodian policymakers influence the money supply and the percentage of Cambodian riel in broad money? From my interview, I have learned that one of the main policy options Cambodian policymakers still have is setting different interest rates for deposits in U.S. dollars and Cambodian riels (Vibunrith 2019). He said the following about the interest rate policies: We do set different interest rates for riel deposits, than for U.S. deposits. That way banks can deposit U.S. dollars as well as Cambodian riel with us. So, in a way we set interest rates, it is some form of monetary tool. But it cannot diverge too much, due to the impossible trinity like I mentioned earlier. We cannot make the differences in interest rates too high and maintain a stable exchange rate. So that limits us, for setting Cambodian riel deposit rates, which cannot be too different from U.S. dollar deposit rates. We must at least move in sync with current market conditions. So, through having different deposit rates, the National Bank of Cambodia is aiming to make holding Cambodian riel more attractive. Therefore, they still have some policy space to set different interest rates and are therefore trying to influence the market. However, these policies have not been very successful at this, since people just prefer U.S. dollars and the interest rates cannot diverge too much from each other in order to maintain stability (Vibunrith 2019). Another monetary policy tool that the National Bank of Cambodia still has some form of policy

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space in is, that it can set reserve requirements for banks and other financial institutions. Throughout the article IV IMF reports (2011-2018), this is one of the key points Cambodian policymakers still control. By setting the reserve requirements, they can protect the Cambodian economy from external shocks and further promote the use of the Cambodian riel (IMF 2018-X: 13). I will explain how this works. The National Bank of Cambodia uses reserve requirements actively, to further promote the use of the Cambodian riel. They do this by setting different reserve requirements for deposits in Cambodian riel than those in foreign currencies. By setting lower reserve requirements for Cambodian riel deposits, they aim to stimulate the use of the Cambodian riel, since this requires less capital. On June 2008, the National Bank of Cambodia increased the Reserve Requirement Rate in foreign currencies from 8% to 16%, meanwhile the Reserve Requirement Rate for reserves in Cambodian Riel remained at 8%, therefore creating an incentive for banks and financial institutions to keep more reserves in Cambodian riel (National Bank of Cambodia 2018: 26). As mentioned before, the reserve requirement tool also helps to protect the Cambodian economy. The National Bank of Cambodia (2018: 26) argues that this tool also helps to maintain price stability and helps to protect depositors. In the interview (Vibunrith 2019), this reserve requirement tool is also mentioned as one of the most important monetary tools the National Bank of Cambodia still has. Setting these reserve requirements, allow Cambodian policymakers to make sure there is enough liquidity within banks and other financial institutions; it enables them to make sure that these banks and other financial institutions can meet their obligations. Furthermore, these reserve requirements are there to protect the Cambodian Banking systems against external shocks. In times of external shocks, these reserves can act as a buffer, therefore stabilising the Cambodian economy. It is therefore clear that Cambodian policymakers still have a fair amount of policy space in this area. The IMF article IV reports (2011-2018) described another monetary policy tool in which national policymakers in Cambodia still hold some policy space is the foreign exchange rate. They can still intervene in the foreign exchange market and help to set the exchange rate between the Cambodian riel and the U.S. dollar. In 2017, the Cambodian Central bank has purchased dollars on the market 118 times, with a total value of almost 1 billion U.S. dollars (National Bank of Cambodia 2018: 23). In my interview, the following was said, when I asked him if it is difficult to maintain a stable exchange rate: It is fairly easy to control. We just do effect intervention or spot intervention. It has been simple, and we have always been able to succeed in the objectives that we set up. We always maintain high reserves, so we are always able to intervene. It is very much in our control (Vibunrith 2019). It is therefore clear that Cambodians are still very much in control of the exchange rate from the U.S. dollar to the Cambodian riel (see table 4 for specifics). The policy space in their exchange rate policies is dependent of the amount of foreign reserves, since these are needed to perform the market

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interventions. This could potentially limit the amount of policy space the Cambodian policymakers have over their exchange rate policies. However, I have found out in my interview, that this is not a problem the Cambodians currently face. The last important point that stands out in the IMF article IV reports (2011-2018), is the function of the National Bank of Cambodia as a lender of last resort in case of a crisis. This function is one of the key functions of any central bank (Beckerman 2001: 2). In the IMF report of (2017:40), this is one of the greater points of concern of the IMF, since the National Bank of Cambodia has very limited policy options here. This is because the bank has very limited options in order to create money; it would be difficult to support institutions like banks in case of a crisis. The ability to do so, would depend on the amount of reserves kept by the National Bank of Cambodia, unlike other countries, which are able to use the method of money creating, to a certain extent. Cambodians do not have very limited options to do this, as discussed before, therefore they have limited policy options (policy space) to function as a lender of last resort. Because of this, the Cambodian Economy is more vulnerable to external threats or shocks (National Bank of Cambodia: 113).

4.4.2.3 Monetary policy mechanism in Ecuador When studying the monetary policy space of Ecuador in the IMF article IV reports (2015, 2016, 2019), one statement really stood out: The fact that monetary policy is constrained in a dollarized economy does not imply that there is no role for the central bank. The Ecuadorian authorities are committed to rebuild and modernize the institutional basis and structure of the BCE. They wish to consolidate the new institutional framework in legislation, ensuring that the BCE has clear objectives and functions, designed to support the dollarization. This will include strengthening the bank’s operational autonomy by, among other measures, establishing an independent Board that has fiduciary responsibilities and creating strong internal and external audit functions. As a first step in this process, and consistent with the authorities’ commitment to transparency and good governance, they have recently published BCE’s past externally audited financial statements (IMF 2019: 113). The IMF and the Central Bank of Ecuador, therefore, make clear that the Central Bank of Ecuador still has some control over its monetary policies, however, it is very clear that their policy space is very limited. The most crucial is, that the Central Bank of Ecuador lost three elements of monetary policy completely: exchange rate management, interest rates management and money supply (Álvarez Vásquez, et all 2018: 15). The first thing that limits Ecuador’s policy space is, that there is no longer an exchange rate they can control. The exchange rate of the U.S. dollar is out of their reach, so national policymakers lose this policy space. Secondly, interest rates on U.S. dollar deposits are also set by the Federal Reserve, therefore Ecuador has no other policy option than to follow these. Thirdly, the fact that they are unable to control the money supply, since they no longer have their own

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currency, which they can issue (Álvarez Vásquez, et all 2018: 15). Money supply can only be increased by a net inflow of foreign currency, which can arise from a current account surplus, foreign direct investment or bond issues (Drouot 2018). Furthermore, Beckerman (2002: 32) argues that there are small amounts of money creations whenever the Treasury withdraws from its deposit account, or when dollars move from the Central Bank’s vaults into circulation within the economy. Money creation is the key tool for any central bank to control the economy, therefore it is undeniable that the amount of policy space for national policymakers in Ecuador is reduced due to their inability to issue money. Together with the lack of policy space in exchange rate management and interest rate management, the overall policy space of policymakers in Ecuador is very limited (Álvarez Vásquez, et all 2018; Beckerman 2002). Yet there is some space in the monetary policies that Ecuadorian policymakers can use, which I will discuss now. One of the areas in which the Central Bank and the Government of Ecuador still have some degree of policy space, is their financing of foreign debt. Countries that still hold their domestic currency can finance these with new money supply. This is no longer a possibility for Ecuador, as discussed before in the part about seigniorage. Yet, national policymakers do hold some policy space here, since they still hold the following policy options in order to finance their foreign debt: (i) run down the Treasury’s deposit account at the Central Bank, reducing foreign-exchange balances; (ii) contract additional external debt; (iii) sell public debt in domestic financial markets, which would pressure interest rates up (and perhaps attract foreign finance); and (iv) incur arrears (Beckerman 2001: 32). Therefore, they still hold some options (or policy space) in what way they would like to finance their debt, even though creating money is no longer one of them. This leaves the question: what else can national policymakers in Ecuador still control; where else do they still have policy space? There are a few other things the Central Bank of Ecuador can still do. These are: (i) issue small-denomination coins, (ii) hold commercial banks’ reserve deposit accounts, (iii) maintain the Treasury’s deposit account, and (iv) carry on limited liquidity management and lender- of-last-resort functions (Beckerman 2001: 2). Point (i), (ii), and (iv) are mostly concerning reserves management. Ecuador is still able to set reserve requirements for local banks and other financial institutions. This way, they can control the stability of the overall Ecuadorian economy, since this determines how well protected these institutions are against shocks. Keeping adequate reserves for the Central Bank itself is one of the key monetary tasks they still must perform. In a non-dollarized economy, these reserves are usually needed to meet foreign obligations, when conducting trade, for example. Since most international trade is done in U.S. dollars, there is no longer a necessity for Ecuador to keep large foreign reserves. Furthermore, they do not need large buffers to stabilise exchange rates, since these are no longer under their control. However,

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reserve management is still one of the key tasks of Ecuadorian policymakers. The IMF article IV report of (2016-2: 13) discusses the need for reserves for dollarized nations like Ecuador. The clearest reason for Ecuador that it needs these reserves, is to be able to support itself in a crisis and to fulfil the demand of the internal and external markets. Generating these reserves can, under normal circumstances, come from money creating, however, as discussed earlier, this is no longer possible. The only way to obtain these reserves is with a clear fiscal system, in which taxes are transparent and efficiently implemented. Whilst other countries have the policy space to choose between multiple options, this is the only way Ecuador can gather adequate reserves, therefore limiting the policy space. The final point of my analysis that came forward in studying the IMF article IV reports is that, even though Ecuador is dollarized, the Central Bank of Ecuador still functions as a lender of last resort (IMF 2016-2: 9). This is a key task for any central bank and Ecuador is no different (Beckerman 2001: 2). As lenders of last resort, central banks provide loans to banks facing liquidity problems by assuring the availability of deposits in a bank run situation. In non-dollarized nations one of the main ways to guarantee this ability is to print money. However, since Ecuador uses the U.S. dollar, policymakers are unable to do this, therefore limiting their policy space (Quispe-Agnoli 2002: 8). In financial emergencies, the central bank will have to use alternative measures, in order to function as a lender of last resort. Policy options Ecuadorian policymakers still have, are external lending, using national reserves (if they are enough) or increase tax income. This means a further limitation of policy space of national policymakers (Quispe-Agnoli 2002: 8).

4.4.3. Foreign trade policy mechanism

4.4.1.1 Foreign trade policy mechanism explained Whenever a country decides to dollarize, one of the key arguments to do so, is to further stabilise the economy, which should spur foreign investment, trade, and economic growth (Hinds, 1999; Hinds, 2002). By dollarizing, countries eliminate exchange rate risks for foreign trade partners, which can make them more attractive for foreign investment (Álvarez Vásquez, et all 2018: 12). It is also a key task of central banks to set foreign trade policies that are best in line with the interests of their nations. There are two main objectives, which I will study, that national policymakers are able to influence through their trade policies. First, they are able to influence their country’s competitiveness within the global economy, and second, they are able to protect their economies against external shocks. In the following part, I will analyse how much policy space domestic policymakers still have concerning these two points.

4.4.3.2 Foreign trade policy mechanism in Cambodia As mentioned in the monetary policy mechanism part on Cambodia, the National Bank of Cambodia is still able to control their internal exchange rate. However, it needs no explanation that the National

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Bank of Cambodia is unable to influence the exchange rate of the U.S. dollar. This means that national policymakers in Cambodia have limited policy space to influence the competitiveness of the Cambodian economy within the global economy. Under normal circumstances, countries can influence their exchange rates within the global economy. For example, if a country wants its exports to be more competitive and attractive, it can increase money supply, therefore increasing its exchange rates (Kang 2005: 206). For example, by supplying more Cambodian riels in the economy, the exchange rate of the Cambodian riel can increase from 3,000 Cambodian riel per U.S. dollar to 4,000 Cambodian riel per U.S. dollar. This means that Cambodian products will become cheaper in the global economy, therefore buying these will be more attractive to foreign trade partners. Because of this, the Cambodian economy will see an increase of exports, but a decrease of imports, since products from outside of Cambodia will become more expensive. By doing so, the National Bank of Cambodia can stimulate economic growth. However, the question is: How free are Cambodian policymakers in determining the exchange rate within the global economy? In the latest IMF (2018: 52) article IV report, it becomes clear that the flexibility of the exchange rate between the U.S. dollar and the Cambodian riel can only fluctuate 1% per day. This is recorded in Cambodian law, in order to maintain economic stability. This reduces much of the policy space that national policymakers have in this area. This means that there is a managed float between the U.S. dollar and the Cambodian riel. Therefore, the National Bank of Cambodia is limited to use this tool in order to keep the Cambodian Economy competitive. Currently, the IMF (2018: 43) estimates that the Real Effective Exchange Rate (REER) has an overvaluation of 7.8%. This is reducing the competitiveness of the Cambodian economy, and policymakers only have very limited control to adjust this, as mentioned before. This is especially relevant since the Cambodians have their neighbours as direct competitors, of which most are increasingly able to use this policy tool. Countries like Vietnam and Laos are rapidly de-dollarizing; therefore, they have more control over their own currencies and therefore over their foreign trade policies. From my interview, I have learned that dollarization also has positive effects on the Cambodian economy. According to Vibunrith (2019), investors find the Cambodian economy extra attractive, due to dollarization. Since there is no need to convert to local currencies in order to trade in Cambodia. This reduces trading costs and eliminates exchange rate risks. On the other hand, dollarization reduces the abilities of national policymakers to use exchange rate mechanisms to reduce the risks of external shocks. The effect of dollarization has two sides: it can be a source of stability but also a source of instability. I will explain the source of stability first: Due to the high level of dollarization, Cambodia is less vulnerable since its own currency is less of a target of speculators in times of crisis. The dollar has stabilising effects on the Cambodian economy. This was

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witnessed in the Asian financial crisis in 1997, when speculators caused exchange rates of Asian currencies to increase rapidly. Cambodia stayed mostly unharmed, since there was no real exchange rate market in Cambodia (Kang 2005: 206). On the other side, not having this monetary tool can be a great risk within the global economy. According to Kang (2005: 206) and the Article IV reports (2011-2018), this is a great deal of concern. Cambodian policymakers lack this important policy tool, in order to protect their national economies. Normally, exchange rates form a buffer between domestic economies and external shocks. By not having the policy space to control the exchange rate tool in their foreign trade policy, the Cambodians can be vulnerable to external shocks. Dollarization is the direct cause of this limitation in this policy area in Cambodia, therefore reducing the policy space of Cambodian policymakers.

4.4.3.3 Foreign trade mechanism in Ecuador Since the implementation of dollarization in Ecuador, foreign trade has increased in Ecuador (World Bank 2018-2). Dollarization has had two major effects on the Ecuadorian economy competitiveness. The positive side is, that having an officially dollarized economy also brings some benefits to the Ecuadorian economy. Foreign investors no longer must deal with any exchange rates. Since most foreign trade is already completed in U.S. dollars, this reduces trading costs and exchange rate risks. On the negative side, in the latest Article IV report (2018-X: 9) of Ecuador, I have found that REER overvaluation in Ecuador is currently at 31%. This means that the competitiveness of the Ecuadorian economy is severely under pressure. The Central Bank of Ecuador, however, has no policy space to reduce this overvaluation. It simply has no control over the exchange of the U.S. dollar; therefore, it has no policy space in this area. The other point of my foreign trade policy mechanism is the ability of local policymakers to protect the Ecuadorian economy from external shocks. Ecuador is a country that is always vulnerable to external shocks. Banks, as well as the private sector in Ecuador, remain vulnerable to changing oil prices, but also things like seismic or weather hazards and evolving international finance conditions (IMF reports 2015-2018). This year, for example, Ecuador’s current account became negative due to declining oil prices (IMF 2018-X: 33). In order to overcome these threats, Ecuador is no longer able to use exchange rate policies in order to overcome some of these risks (Beckerman 2001: 63). Ecuador can only protect its market by setting higher reserve requirements or by external lending; this illustrates how the policy space of Ecuadorian policymakers is reduced.

4.4.4. Income distribution mechanism

4.4.1.1 Income distribution mechanism explained Income redistribution policies are one of the key tasks of policymakers within central banks and local governments. Income redistribution involves moving a fixed quantity of resources between people

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(Piachaud 2013: 24). Through income redistribution, policymakers can create a net of social protection for all members of society (Piachaud 2013: 24). Income redistribution policies are normally implemented to benefit the people in society who are the least well off, supporting their economic position in society. Therefore, these policies are a key driver in supporting sustainable economic growth. When such redistribution affects economic growth, it influences the availability of the total amount of resources and income levels in the future. Therefore, income redistribution policies are important to all members of society (Piachaud 2013: 24). In this fourth, and last mechanism, I will argue that there is a difference in the policy space national policymakers have between semi-officially dollarized nations and officially dollarized nations. I will explain by analysing my two cases.

4.4.1.2 Income distribution mechanism in Cambodia I will start this analysis by introducing graph (8). This graph was created by the National Bank of Cambodia (2016: 21) and shows the currency composition of income by income level. Graph 8 illustrates that the people with the lowest income in Cambodia, receive their income much more frequently in Cambodian riel (almost 80%) than people with the highest income levels (just over 50%). I will argue that this creates an unequal level playing field in Cambodian society and further reduces the policy space national policymakers have in order to control the redistribution of income.

Graph 8:

Source: National Bank of Cambodia (2016: 21)

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I have discussed this argument in my interview. Mr. Vibunrith (2019) argued that he did not see this in the same way. According to him, convertibility of the Cambodian riel into U.S. dollars is so accessible to all Cambodian citizens, that anybody can access both Cambodian riels and U.S. dollars equally. While this is true, this is only the case when exchange rates maintain stable over time and transaction costs remain low. If the exchange rate of the Cambodian riel against the U.S. dollar will increase from 4.000 Cambodian riel to 5.000 Cambodian riel per U.S. dollar, the income distribution of all the people who receive their salaries in Cambodian riel will not change. However, compared to the people who receive their income in U.S. dollar their purchasing power will decline by 20%. This will create an unequal level of playing field within the domestic economy of Cambodia. So far, this situation has not yet accrued, since, according to the IMF article IV reports (2010- 2018) and Vibunrith (2019), the National Bank of Cambodia has been very successful in maintaining a stable exchange rate over time (see table 4). However, if this would be no longer the case, in times of crisis and external shocks this could have some serious consequences. As discussed earlier, the ability of the National Bank of Cambodia to influence the exchange rate, is mostly dependent on their foreign reserves. When these would run out in times of a longer crisis, they might not be able to control the exchange rate effectively. This leaves the question: what could this mean to their policy space in income distribution policies? The National Bank of Cambodia currently controls the exchange rate and is therefore able to maintain an equal level of playing field. Therefore, they can control the redistribution of income accordingly. In times of shock they only have limited policy space to maintain this equal level of playing field and therefore limiting their ability to influence the income distribution. The only redistribution policies they would be able to make, in order to protect the people who receive their pay in Cambodian riel, is the elimination of the use of the U.S. dollar in the Cambodian economy (which they are not willing to do, as discussed earlier) or a severe increase on taxes for people who receive their salaries in foreign currencies, and redistribute their wealth. These policies would most likely create serious harm to the Cambodian economy, and a wave of panic throughout its citizens (sending their wealth to other countries like they did in the Khmer Rouge regime, for example). The abilities to implement such policies are therefore very limited, they are likely to do more harm than good. Dollarization is the direct cause of this vulnerability, and therefore limiting policy space for Cambodian policymakers have over the distribution policies (in times of crisis).

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Table 4: Exchange rate of Cambodian riel (KHR) to U.S. dollar (USD) Year Average exchange rate Standard deviation Percentage of standard KHR : USD deviation 2010 4185 128 0.031% 2011 4046 9 0.002% 2012 4017 40 0.009% 2013 4027 30 0.007% 2014 4038 19 0.004% 2015 4060 3 >0.001% 2016 4053 4 >0,001% 2017 4030 27 0.006% Average 4057 32.5 +/- 0.007% Source IMF (2013: 20) and (2018: 28)

4.4.1.3 Income distribution mechanism in Ecuador When studying the policy space of national policymakers in Ecuador, it becomes clear that in Ecuador there is no unequal level of playing field. All citizens receive their income in the same currency. Because of this, dollarization is not affecting the amount of policy space of Ecuadorian policymakers over their income distribution policies. It does not mean that Ecuador has no problems regarding income distribution. Paredes (2017: 144) argues income distribution is one of the key problems in Ecuador, creating a large gap between the rich and the poor. This again leads to less sustainable economic growth. However, dollarization is not the direct cause of this. Policymakers in Ecuador do not see any limitations in their policy space when making income distribution policies, not in normal circumstances, nor in crisis.

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5. Discussion and concluding remarks

The main goal of this master’s thesis was to answer the following research question: How does the implementation of dollarization affect policy space of policymakers in dollarized nations? I wanted to make clear how the difference in the amount of policy space between semi-officially dollarized nations and officially dollarized nations is created. The main question is not if there is a difference (it is already clearly described in the literature that semi-officially dollarized nations still have more policy space than officially dollarized nations), but how this difference is created. I decided to do this on the hand of four mechanisms: the seigniorage mechanism, the monetary policy mechanism, the foreign trade policy mechanism, and the income distribution policy mechanism, after studying the literature. In order to give the answer to this question, I have first conceptualised dollarization. I decided to follow Mack (2000: 353) conceptualisation of dollarization: Dollarization occurs when residents of a country extensively use foreign currency, usually the U.S. dollar, alongside or instead of the domestic currency. After that, I conceptualised the concept as policy space. For the conceptualisation of policy space, I have chosen to follow two different definitions of Kentikelis, et all (2016) and the UNCTAD (2014). This led to the conceptualisation of policy space as the de jure policy sovereignty a country’s policymakers hold to effectively control their national policies free from coercive conditionalities. I also mentioned the debate around policy space with the argument of (Rodrik 2014), since a lack of policy space of national policymakers can create a situation in which national policymakers have no other choice than to adopt policies that are not in line with the best interests of their countries or their citizens. Furthermore, I argued that dollarization plays an important role in this, since the implementation of dollarization leads to a decline of policy space of policymakers in dollarized nation. After this, I have argued that Cambodia and Ecuador are two diverse cases and that I have selected them based on the following tour criteria: (1.) The countries need to be dollarized by the same currency; (2.) The countries should have similar populations and GDP’s; (3.) There needs to be a ‘before and after situation’; and (4.) There needs to be enough literature. I have argued that out of the total population of dollarized countries, Cambodia and Ecuador were best suited for answering my research question based on these four criteria. I also introduced my four mechanisms (or variables). I came to these four mechanisms after extensive literature research. I argued that these four mechanisms were most important in determining the policy space of national policymakers. Finally, I started my analysis. I began my analysis by describing the background of dollarization (history), the current status of dollarization (present) and the current strategy (future) on dollarization. By doing this it became clear how important the role of dollarization in Cambodia and Ecuador still is. The causes of dollarization between the two nations were nearly the same: political instability, which

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created a distrust of citizens in the national currencies, institutions and policymakers. In Cambodia the Khmer Rouge regime was mostly responsible for instability and lack of trust, while in Ecuador a combination of national disasters, declining oil prices, and political instability were the direct causes of dollarization. Ecuador became officially dollarized, while Cambodia currently is semi-officially dollarized, yet the level of dollarization is high in Cambodia. When analysing the current strategy on dollarization in these countries, it became clear that Cambodia’s current strategy is to slowly de- dollarize, while Ecuador has committed itself to further deepen dollarization within its economy. Then I started describing my four mechanisms and their effect on the policy space of national policymakers. The first kind of mechanism that I described, were the seigniorage mechanisms. I explained that seigniorage is the income generated with money creation, and that there are three different types according to Kang (2005). In Cambodia, the IMF estimated that the loss of seigniorage was an average of 5% of GDP, while in Ecuador the latest estimate (by Matthews, et all 2006) was a loss of 6,2% of GDP. Aisen and Veiga (2008: 29) argue that the loss of seigniorage reduces the amount of economic freedom within a nation. I then argued that this loss of economic freedom, created by the loss of seigniorage, reduces the amount of policy space in dollarized nations. The argument consists of two parts. Firstly, due to the lack of seigniorage policymakers have less money (and therefore less space) to implement new policies. Secondly, they have fewer policy options to fund their foreign debt, due to the inability to use seigniorage. In the case studies of Cambodia and Ecuador, it became clear that Ecuador completely lost its abilities to generate seigniorage, with minor exceptions like the issue of small denomination coins. Cambodia, however, is still able to print money, since the Cambodian riel is still actively used throughout the country. Therefore, the economic freedom, and because of that, the policy space, in semi-officially dollarized nations remain higher than in officially dollarized nations. I also showed that before dollarization, Ecuadorian policymakers frequently used seigniorage to do this, but that they no longer have this option. In Cambodia, the amount of seigniorage that can be generated needs to stay in balance with the level of dollarization. I have shown that the total amount of Cambodian riels may have increased over the years, yet the percentage of Cambodian riel of broad money has stayed roughly the same. This illustrates the amount of policy space that Cambodian policymakers still have. Meanwhile, Ecuador generates almost zero seigniorage, due to official dollarization. Therefore, the type of dollarization explains the difference in the ability to generate seigniorage, and therefore the differences in policy space. Officially dollarized nations have less seigniorage than semi-officially dollarized nations. Because of that, officially dollarized nations have less economic freedom and due to that less policy space, than semi-officially dollarized nations. The second mechanism was the monetary policy mechanism. This is one of the most important

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factors that explain the different amount of policy space between officially dollarized nations and semi- officially dollarized nations. I have done this by analysing five key monetary policies: monetary policies; the ability to create money; the ability to influence the exchange rate; the ability to set interest rates; the ability to set reserve requirements and the ability to function as a lender of last resort (see table 5). This gave me the following results, I will classify the influence on the policy space as high, medium or low (with high meaning this has a strong effect on the amount of policy space):

Table 5: Comparison of policy mechanism Cambodia Ecuador Money supply High: Can semi-control the supply of riel High: Not able to control money (limited due to inflation and having to supply, since they cannot print any keep a stable exchange rate of the new money. Cambodian riel to the U.S. dollar). Cannot control the supply of U.S. dollars Exchange rates Medium: still controllable, if reserves High: no control, policies are created allow. by the FED. Interest rates Medium: Able to set different interest High: no control, policies are created for U.S. dollars and Cambodian riel, but by the FED. these cannot diverge too much. Reserve Low: Mostly under the control of the Medium: Mostly under control of requirements National Bank of Cambodia. Limited, the Central Bank (especially when since they have not full control over setting for banks and other money supply. institutions), limited due lack of money supply option Lender of last Medium: money creation is a limited High: money creation is no longer a resort policy option, therefore limiting the policy option, therefore limiting the policy options. policy options.

These five components illustrate how the differences of policy space between policymakers in semi- officially and officially dollarized nations is created. Officially dollarized countries lose complete control over their money supply policies, exchange rate policies and interest rate policies, while semi- dollarized nations still have limited control over this. It stands out that the ability to create money is felt throughout most of these five areas and plays a central role in the different amounts of policy space. The third mechanism I have analysed, is the foreign trade policy mechanism. One of the

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reasons countries do dollarize is to be more attractive to foreign investment due to more stability. I have studied two aspects within this foreign trade mechanism: the ability to control competitiveness within the global economy and the ability to protect the domestic market against external shocks. In Ecuador, the ability to influence the competitiveness of the Ecuadorian economy by national policymakers is extremely limited, since they are not able to control the exchange rates of their currency. While this is also mostly true for Cambodia, they cannot control the exchange rate of the U.S. dollar, but they have some control over the exchange rate of the Cambodian riel. However, almost all international trade is completed in U.S. dollars, therefore the effect of local policymakers is limited. This is also the case for the ability to protecting the domestic market from external shocks. Exchange rate usually form a protecting buffer for domestic economies for external shocks, policymakers in both countries do not hold any real policy space here, therefore further reducing their ability to act. Overall, these two objectives show the difference in the amount of policy space policymakers have between officially dollarized nations and semi-officially dollarized nations concerning their foreign trade policies. The ability to influence the exchange rates in the global economy lies on the base of this difference. Semi-officially dollarized nations still hold some control, through their exchange rate policies, over the competitiveness of their economies and the ability to protect their economies from external shocks. Officially dollarized nations have almost zero control over these policies, therefore, they have less policy space than semi-officially dollarized nations. Finally, I have analysed the income distribution mechanism. Income distribution is one of the key tasks of central bank in order to support sustainable economic growth and to protect the ones that are the least well off within society. The most important difference here is that officially dollarized nations have more policy space due to this mechanism than semi-officially dollarized nations. I have argued that semi-official dollarization creates the base for an unequal level playing field within a domestic, since people can receive their salaries in different currencies. This is not a problem in times of economic stability and stable exchange rates, but in times of crisis or external shock I have argued that the policy space of policymakers in semi-dollarized nations is limited due to dollarization, since this would mean implementing policies which are expected to do more harm than good. In officially dollarized nations, this unequal level playfield cannot occur, since everyone receives their income in the same currency. Therefore, national policymakers have a better ability to control these policies even in times of crisis or external shocks. Overall, I have described how these four mechanisms create the difference in policy space between policymakers in semi-officially dollarized nations and officially dollarized nations. While it was clear that policymakers in officially dollarized nations have less policy space than in semi-officially dollarized nations, this was not the case for all four mechanisms. The income distribution mechanism

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showed that policymakers in officially dollarized nations hold more space due to this mechanism than policymakers in semi-officially dollarized nations, since the income distribution mechanism created an unequal level playing field in semi-officially dollarized nations. However, the seigniorage mechanism, the monetary policy mechanism, and the foreign trade policy mechanism all explained how policymakers in semi-dollarized nations have more policy space than in officially dollarized nations. The key explanation of why policymakers in officially dollarized nations have less policy space than in semi-officially dollarized nations, is the ability of policymakers to control the money supply. In officially dollarized nations this ability is almost zero, while in semi-officially dollarized nations policymakers still hold some control over the money supply. Therefore, the ability to control the money supply is playing the most important role in explaining how the difference in policy space between semi-officially dollarized and officially dollarized nations is created. This effect could be seen throughout all three of the mechanisms, they are playing an important role in explaining the different amounts of policy space. Finally, I would like to add one more explanation which explains the difference in the amount of policy space for national policymakers between semi-officially dollarized nations and officially dollarized nations. Policymakers in semi-officially dollarized nations have the options to slowly reduce the level of dollarization, within their economies, over time. Cambodia is currently doing this and is aiming to slowly de-dollarize. By de-dollarizing countries can slowly reclaim some of their policy space. I have described that they only want to de-dollarize slowly, since drastic measures could create economic instability, therefore doing more harm than good. Officially dollarized nations, however, do not hold this option. When they want to reduce dollarization, they would have to create a new currency, and obligate their citizens to use this new currency. This would likely create a large wave of economic instability and unrest, therefore making this decision much riskier. This also illustrates how the difference in the amount of policy space is created between officially dollarized nations and semi- officially dollarized nations, since this shows the difference in freedom (policy space) on how to deal with the level of dollarization of national policymakers. I would like to conclude this thesis by arguing how important it is for nations to have a proper amount of policy space, since not having policy space reduces the ability for nations to develop themselves. Rodrik (2014) already argued that we should re-evaluate the importance of policy space in developing nations. Due to a lack of policy space, countries are unable to make policy choices which are best in line with their needs, therefore reducing the ability to further stimulate economic growth and development. Having sufficient policy space is therefore crucial to a country’s sovereignty and success and should not be underestimated. Dollarization clearly influences the amount of policy space national policymakers hold, and since dollarization affects many countries throughout the world, its impact is very significant. I hope that my research can contribute to this discussion, by highlighting the

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causes of the differences in policy space for national policymakers in officially dollarized nations and semi-officially dollarized nations. Further studies can elaborate on my study by studying more cases, holding more interviews and study the effects of dollarization over a longer period. Therefore, creating a better understanding of the effects of dollarization on the policy space of national policymakers, and showing what the consequences of the lack of policy space for national policymakers are around the world.

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6. Reference list

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Aizenman, J. (2010). The Impossible Trinity (aka The Policy Trilemma). Retrieved from: http://www.escholarship.org/uc/item/9k29n6qn

Alesina, A., & Barro, R. (2001). Dollarization. American Economic Review, 91(2), 381-385.

Álvarez Vásquez, C., Guaranda Sornoza, V., Aguilar Ponce, L., Pinargote Vásquez, A., Zambrano, D., & Morán Chilán, J. (2018). Cost-benefit analysis of dollarization, Ecuador case. Dominio de las Ciencias, 4(4), 3–24. Retrieved from https://dialnet.unirioja.es/servlet/oaiart?codigo=6560207

Berríos, R. (2006). Cost and Benefit of Ecuador's Dollarization Experience. Perspectives on Global Development and Technology, 5(1-2), 55-68.

Beckerman, P (2001). Dollarization and Semi-dollarization in Ecuador. Retrieved from: http://documents.worldbank.org/curated/en/940971468746637984/pdf/multi0page.pdf

Beckerman, P. (2002). “Long-term Origins of Ecuador’s ‘Predollarization’ Crisis,” in Paul Beckerman and Andres Solimano (ed.). Crisis and Dollarization in Ecuador, Washington, DC: The World Bank.

Beckerman, P., & Solimano, A. (2002). Crisis and Dollarization in Ecuador : Stability, Growth, and Social Equity (Directions in development). Washington, DC: World Bank.

Berg, A. and Borensztein, E. (2000). The Choice of Exchange Rate Regime and Monetary Target in Highly Dollarized Economies. Washington: International Monetary Fund

Bleaney, M., Lee, H., & Lloyd, T. (2013). Testing the trilemma: exchange rate regimes, capital mobility, and monetary independence. Oxford Economic Papers, 65(4), 876–897. Retrieved from: https://doi.org/10.1093/oep/gps038

Blot, C., Creel, J., Hubert, P., & Labondance, F. (2014). Dealing with the ECB’s triple mandate? Revue de l’OFCE - Debates and Policies, (134), 163–173.

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7. Appendix

7.1. Appendix 1: Transcription of interview with Long Vibunrith

There is a short introduction before this interview, which I was not able to record. It was about 30 seconds to a minute in which we great each other.

V is Long Vibunrith talking T is Tim Beckers talking

V: I am not in charge of this method, but my local economist is in charge. But I know some part of it, I am not comprehensive, but hopefully it is enough.

T: Yes of course. I just have some questions. Let me first ask you if it is okay if I record this interview, so I able to transcribe it later?

V: No problem, no problem.

T: Okay, thanks, because that is very important. My thesis is about how dollarization is affecting the policy space of Cambodian policymakers. So as well as the national bank as the local government. So I just wanted to hear your view about this, and that’s what I wanted to talk to you about today. I am sure you are much more knowledgeable than I will ever be, so it will be very interesting to hear your view about this. So that is what I wanted to talk to you about. Is it okay if I start with my first question?

V: Yes, Yes.

T: Okay, my first question would be, could you introduce yourself. Of course I have looked you up, and talked with Kelvin about what you do and who you are, but could you maybe introduce yourself and also explain what dollarization plays for kind of role in your daily work life?

V: Okay. Well I am the reserve development manager at the National Bank of Cambodia, so that is my day to day job, really focussing on the international economy. But in my other capacity I get to join a working group, which gets to focus on the local economy. I was previously part of the financial stability working team, so we talk about dollarization and the strategy to de-dollarize. So I am not involved in the day to day talk about the day to day monetary policies or the de-dollarization strategy.

T: Okay, thank you. That is very clear to me. So my thesis is about how dollarization is affecting the policy space in Cambodia, so how it is limiting, or not limiting at all. Do you understand what I mean with policy space, or do I need to elaborate on that? Or what is your personal vision on policy space?

V: I can comment on monetary space, fiscal space, that is something else, which I can comment on.

T: Both are very interesting to me, can you elaborate on how you think dollarization is affecting the policy space in Cambodia?

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V: Sure. As a dollarized economy…. We call it manage flow, almost like a soft pack. So in theory, the impossible trinity, you can only have independent monetary policy, while at the same time have a fairly fixed exchange rate. And that is the situation for us, we do not have interest rates as a monetary tool. We do set interest rates, local interest rates, trying to influence local economy. What we use is reserve requirements for banks. We set them up and down, concerning the local condition. For our exchange rate, we maintain a stable exchange rate against the U.S. dollar, and for interest rate policy. We issue a local currency central bank bill, in riel deposit. We do set different interest rates for riel deposit, than U.S. deposits. That way banks can deposit U.S. dollar as well as Riel with us. So in a way we set interest rate, it is some form of monetary tool. But it cannot diverge too much, due to the impossible trinity like I mentioned earlier. We cannot make the differences in interest rates to much, and maintain a stable exchange rate. So that limits us, for setting riel deposit rates, which cannot be too different form U.S. dollar deposit rates. We have to at least move in sync with current market conditions. The dollar deposit rate is of course set and determined by the FED and the overall market condition. So we are actually following the monetary policy of the FED.

T: That is very interesting, that there is a slight differences in the riel deposit rate and the U.S. dollar deposit rate. What is the main incentive to implement this difference? What are you trying to accomplish with that?

V: We try to influence the riel liquidity as well. In theory you try to maintain a stable exchange rate, you cannot have divergent interest rates, but in practice there is some space but there is obvious friction, in things like regulation and you can actually achieve something. Which in theory is not supposed to be possible. Normally when you set a riel deposit rate higher than that of the U.S. dollar, and the exchange rate will still be stable, people will swap their dollar for riel. Since they get a higher interest rate and are not facing a currency risk. In Cambodia even our commercial deposit rate between riel and dollar is different. We pay people a little bit more for riel, but again you do not see people swap their dollar for riel, to get the higher interest rate. Because I think people still prefer to safe in dollar and are they don’t have complete confidence in stability of the exchange rate between the dollar and the riel. They still think there might be some exchange rate risk going forward. So we are still able to have two different interest rates for riel and dollar.

T: That is very interesting to me, of course I have looked into this before, and found this one of the most interesting facts as well.

V: Yes

T: You mentioned that you are still trying to maintain a stable exchange rate, how are you able to do that? What kind of tools do you still have? Do you still have much effect on the exchange rate? Or is hard to control for the National Bank?

V: No it is actually fairly easy to control. We just do effect intervention or spot intervention. It has been really simple, and we have always been able to succeed in the objectives that we set up. We always maintain high reserves so we are always able to intervene. It is very much in our control.

T: Okay. When you look at your position in the global economy. Are you able to make policies that are best in line with Cambodia’s interest on the global market, or are you very much bound to international rules and regulations, or are you still very much in control?

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V: This is about foreign trade policy right?

T: Yes, foreign trade policy.

V: Okay. I am not really in the best position the comment on this, but I will try, since I have been in a workgroup before, in which we talked about liberalising the Cambodian market, that could be something I could talk about as well.

T: Yes please.

V: Cambodia, as a developing economy, has to make quite a lot of concession, because of things like ASEAN to establish a common market. When it comes to things like custom taxes, Cambodia has a concession. We are very dependent on the income of these taxes, so it is not possible for Cambodia to just get rid of it, as would happen in one common market when there is a free movement of goods, without tax. They understand the importance of this tax, so they allowed us more time to slowly peel away our taxes. So they give us concession as a developing country.

T: Do you think it is in the best interest of Cambodia, to reduce these taxes? Or do you think it is more in the beneficial for other actors?

V: Well I mean the leader definitely think it is more beneficial for them to take away these taxes. In the short run it is more challenging. Free market is always good, but you need to compete well. For the long run I think it is beneficial. On the short term it is more problematic. however they give us a lot of concessions, in the time line, so they are not rushing it, only when we are ready to do so. I think it is okay for us, manageable for us.

T: Are you able to tell me if the exchange rate of the riel to the U.S. dollar plays any function in international trade?

V: Most settlements are done in U.S. dollar. Even the trade with China is usually done in U.S. dollar instead of the Chinese RMB or the riel, 80%-90% of the trade is done in U.S. dollar. The thing is having a dollarized economy, having a fairly fixed exchange rate, when the dollar appreciates the for example, it makes us less competitive import destination and it affects tourism as well, this has been quite an area of concern. When our real effective exchange rates among our trading partners appreciates, making us less competitive. It is a trade-of because we do gain from having a fairly stable exchange rate, because a lot of investors are a lot more comfortable in Cambodia, since they are aware they do not face any exchange rate risks. They can bring in dollar and take out dollar, they do not have to use the Cambodian Riel, and even when they do, the exchange rates are fairly stable. So you are not facing any risks. I hear a lot from investors, this is a very attractive thing to them, not having to face exchange rate risks. If you invest in a country like Vietnam, Myanmar or Laos, maybe you get a good return, but due to exchange rate devaluations you will evaporate these returns. So to them Cambodia is very attractive.

T: I found the trade-off myself in this, since this comes back in many dollarized nations. The trade-off between stability and handing over some of your freedom. One of the most clear issues in dollarized nations is the loss of seigniorage, can you maybe elaborate a bit on that? How this is affecting Cambodia? How much do you think seigniorages is getting lost?

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V: You can get an estimate on the loss of seigniorage in Cambodia by the IMF article 4. They estimate that the loss is about 0,5-1% of GDP.

T: Yes I found that one.

V: For me as a reserve manager, the way I see this loss. People and companies are able to get in with U.S. dollar, not having to exchange. I mean, in a normal country, where you cannot use the dollar, you have to come in and exchange your currency for the local currency. In that case the foreign currency will be in the foreign reserve, which will be gaining interest, with the central bank. But in our case people just bring U.S. dollars in, without having to bypass the central bank. So that is our loss, and the amount of dollar in the banking system is around 20 billion, right now. That is 20 billion dollar that could have been on the central banks foreign reserve, instead of being in the economy. That is our loss, the interest on the 20+ billion that is not in the central bank reserve. That is my personal opinion, not really the central bank.

T: No of course. That must be a very interesting situation when money can come in, without the central bank interfering at all, or controlling it at all. Another thing that I found interesting is how dollarization is influencing the income redistribution, if found some information in the literature, that dollarization is worsening this gap. Do you see this as well, and how does this affect in Cambodia?

V: In my opinion, I never thought that dollarization influences income distribution. I do not know how that happens. Can you explain?

T: Sure, I have found an article, also by the IMF I believe, that part of the population is paid in U.S. dollar, while the other part is paid in Cambodian riel. Therefore creating an uneven level playing field, with the people receiving they money in U.S. dollar having an advantage over people who are payed in Cambodian riel. Therefore further in increasing the gap in income.

V: I do not see any advantage in getting U.S. dollar over getting riel. Since the exchange rate is stable, and Cambodians can easily convert their riels into dollar, or the other way around. I do not see this affect in Cambodia. If the riel was depreciating, then I could see this, however the exchange rate is stable.

T: Sure, that was something I found in the literature, and I was interested to hear your opinion about that. These were the four main things that I found in the literature, monetary policies, global trade policies, seigniorage and income redistribution, do you think I have missed anything? Did I miss any effects of dollarization of Cambodia on policy space of Cambodian policymakers?

V: I think we have covered the most important ones, like that we don’t really have an interest rate tool, because of dollarization. That is a limit to us. But we are able to attract a lot of investment because of the stable exchange rate. I think we have to separate two issues. One is dollarization and the other one is the fixed exchange rate. We can still have a non-dollarized economy, while having a stable exchange rate. For us, the long term goal is still to de-dollarize. There are some benefits to be dollarized, as mentioned before. So we do it slowly, make sure that investors and market are comfortable to de-dollarize, and not doing it on a to high speed and by using force.

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T: I also wondered is there a internal debate now going on in Cambodia? And what are the arguments of both sides? I believe you already made clear that the debate is strongly leading to one side. Could you maybe elaborate on the whole debate as well, what is going on?

V: As the country develops, you need to have more effective monetary policy tools to control the overall inflation. Right now our inflation is fairly stable, even though we do not have effective monetary policy. Everything is kept under control, so there is no urgency to de-dollarize at the moment. Since we are still getting the benefits of foreign investors, who see this as a big plus to them.

T: If I may ask you one thing in between? How do you accomplish this stable exchange rate, is that just through the reserve management, or do you still have any other monetary tools?

V: We just have reserve requirements, the other things is maintaining a stable exchange rate. Which is currently in our favour. A stable exchange rate with the U.S. dollar does not always give you low inflation. You would not have super high inflation, but there are times in which a stable exchange rate to the U.S. will still give you high inflation. The current situation is kind of working in our favour. Just by having a stable exchange rate, does not give you price stability on the long run.

T: How does this work in your favour, having this stable exchange rate?

V: Just by maintaining a stable exchange rate we are able to keep the inflation under single digits. The stability is not always achievable by maintaining an exchange rate. There are countries that hold a peg to the U.S. dollar like Hong-Kong, Oman and Saudi-Arabia, and all these central bank do not have price stability as they are aware that they can only have two out of the trinity. They can have free capital flow, fixed exchange rate, and you cannot really influence monetary policy or price stability.

T: Thank you very much, can you please elaborate more on the debate you were sketching before?

V: Okay to de-dollarize is a medium to long term objection. Since, as a mentioned earlier, we have stable inflation now, a stable exchange rate does not give you control over it. So having effective monetary policy, only that can guarantee you consists levels of inflation. So we need to de-dollarize and introduce more interest rates tool in local currency. Only then can we try to dollarization. So right now if all the banks hold dollar, even if you set a higher interest rate in riel. It does not really affect them, since all their savings are in U.S. dollar. Everyone is still saving and borrowing in U.S. dollar, so there is no point in setting different interest rates. People do not really care about it, since they want to have U.S. dollars.

T: So the long term goal is still clear. You are aiming to de-dollarize in order to have more control over your monetary policy tools. Thank you very much, I think I have most of the points, which are important to my thesis, touched upon already. Do you have any other things you would like to add?

V: No just to sum up: dollarization has its pro’s and con’s for Cambodia in the current situation. If our approach is to de-dollarize we need to make sure it goes smooth. We try not to use any administrative measures, and force people to use riel. We just want to make it more attractive for investors to do business in riel, than the dollar. That is better than forcing investors to use the riel. We want to be market friendly, investor friendly, as we go implement our de-dollarization strategy.

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T: So just to sum up: what are the most important things that you currently cannot do, that you would like to do in the future?

V: The main thing we would like to do is to set interest rates on riel which will have impact on the whole economy, we do not right now, since everyone is using dollar. That is what we want, and have a more effective monetary tool.

T: That is the main objective for the foreseeable future?

V: Yes

T: For the rest; you are able to maintain the exchange rate at a stable level fairly easy, you are able to set reserve requirements. However when looking at inflation, it is currently stable, but to maintain this stability you will need more monetary tools in the future.

V: Correct

T: I think that were the most important things. Oh, and international trade. That there is a lot of inflow of U.S. dollar without having to go through the National Bank of Cambodia and then we talked about ASEAN, how they are influencing the tax level.

V: And also having the riel tied to the U.S. dollar could make us less competitive if the dollar appreciates

T: Yes, that hard to control for the National Bank of Cambodia. I am actually through all my questions, I would like to thank you for your time.

V: You are welcome, it was good speaking to you.

After this the recording was ended and we had a little small talk after this.

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