Cambodia – Currency Substitution or Dollarisation?

Since my arrival, I have always considered it strange that US Dollars were the de facto currency here in Cambodia. During my years in Central and Eastern Europe I was frequently able to purchase goods and/or services with US Dollars, British Pounds and German Marks, but this was not the norm, it usually only happened if I had no local currency and it always involved a small amount of drama over the exchange rate. In fact, they often only took the currency to ensure the sale, plus I usually ended up losing on the FX rate.

So the all pervasive presence of the US dollar in Cambodia as the real to all intents and purposes currency of Cambodia was slightly intriguing to my curious mind. Off and on the question rolled in and out of my mind during my first year here, now at the end of my second year, I have quizzed many people as to reason and cause of such an event. I have also read several dozen economic papers on the subject and discussed the phenomena with several economist friends of mine. He is a rough overview of mine on it all.

During my research, time and time again the term dollarisation cropped up

Dollarisation is the colloquial term that laymen use for ‘external currency substitution.’ It is the propensity to substitute ones domestic currency for a, more stable, foreign currency.

It is used as a means of holding onto wealth as well as a means of financial transaction. The idea being that residents in these countries attempt to shield the real value of their wealth by increasing their holdings of foreign currency.

Mind you, there are some downsides to currency substitution. The substitution of a foreign currency for a domestic currency is more likely in an economy with a high inflation rate due to the lower purchasing power of the domestic currency. An economy in this situation may experience a significant reduction in the real demand for domestic currency.

Most surprising to my mind was the fact that dollarisation is not unique to Cambodia, it is primarily used in poorer, or developing, nations, often as an attempt to surmount ill managed financial institutions or poor government monitory policy. Other factors which encourage it are corruption and distrust of government or officials.

The extent to which a foreign currency is used, and the ways in which that use is sanctioned can , roughly speaking, be broken into three categories:

Official dollarisation; such as in Panama, Guam, Micronesia, Puerto Rico, et cetera exists when foreign currency has exclusive or predominant status as full legal tender. This means not only is foreign currency legal for use in contracts between private parties, but the government uses it in official payments.

Semi-official Dollarisation; (or bi-monitory systems) such as Cambodia, The Bahamas, Haiti, Liberia, et cetera, exists where foreign currency is legal tender and may even dominate bank deposits, but plays a secondary role to domestic currency in the paying of wages, taxes, and everyday expenses, such as grocery and electric bills. Unlike officially dollarised countries, semiofficially dollarised ones retain a domestic central bank or other monetary authority

Unofficial Dollarisation; such as is found in large areas of Latin America, the Caribbean, some states of the former Soviet Union, it exists where people hold in foreign bonds, bank deposits, or cash. It is usually the currency of the local black market. Measuring the extent of unofficial dollarisation is difficult, due to all the reasons that create the need for dollarisation. However, estimates to the extent to which notes of the U.S. dollar circulate outside their countries of origin give a rough idea of how widespread unofficial dollarisation is. A recent report from the US Federal Reserve estimates that foreigners hold between 55% to 70% of U.S. dollar notes currently in circulation. The amount of dollar currency in circulation is currently about $480 billion, which implies that foreigners hold roughly $300 billion. By way of comparison, a study from the Bundesbank, Germany”s central bank, estimates that foreigners hold 40 percent of German mark notes.

Conversely, there have been some cases, in which the holding of foreign currency has been declared illegal, for example; enforced conversion of foreign currency deposits into domestic currency, such as occurred in Mexico (1982), Bolivia (1992) and Peru (1985).

Which brings us, briefly, to other forms of external currency substitution; dollars maybe the most common example of currency substitution, but it is not the only currency in the game; Brunei extensively uses the Singaporean dollar, Luxemburg the Belgian Franc and of course the Channel Islands and the Isle of Man use the British pound.

However, I digress somewhat.

The case for Cambodian dollarisation can be argued as starting in 1993, although the destructive events of the preceding decades set the stage for 1993?s lack of economic infrastructure, unstable political and social environments and impoverished populous; all of which re major contributory factors in currency substitution.

Then in 1993 the UNTAC sponsored elections were held and Cambodia embarked on significant economic and financial reforms towards a market-oriented-system. Financial sector reform in Cambodia is principally a reform of the domestic banking system. Private banks were allowed to enter the market, to which the extent is Cambodia now has a two-tier-banking system. With the National Bank of Cambodia (Cambodia?s central bank) conducting monetary policy and acting as a regulatory body to oversee domestic banking practice.

This opened up the Country to the outside world and mass inflows of foreign currency.

Coupled with this, UNTAC also brought with them about 20,000 personnel, all of whom were paid in US dollars. This marked a significant increase in US dollar circulation in the Cambodian economy. The United Nations alone spent close to two billion US dollars on organising the election. Due to the poor banking system in Cambodia, the conventional cash-transactions made US dollar?s popularity spread very quickly throughout the country, even into the provincial areas.

Another factor at this time was the economic liberalisation and the opening of the economy to trade and investment with the world. This had the effect of bringing back savings of Cambodians living abroad. A significant quantity of these remittances, brought into the country in US dollars, outside the control of the monetary authority.

Finally, the under-developed financial and banking system is also a major cause of
currency substitution in Cambodia. The non-existence of non-cash monetary instruments such as Shares, bonds, credit cards, has left the US dollar the only available financial asset for domestic residents to hold besides the riel.

Now here we are in 2005, during the twelve years since UNTAC billions more has poured into the country from all around the world, most of that money in US dollars regardless of the origins of the aid. We have a system of self perpetuating dollar usage and in all my research and discussions I have not found a single case study or example of a Country that has reintroduced it own currency.

Where do we go from here?

Lord Playboy

The views in this column are entirely those of Lord Playboy (of Phnom Penh, Sonteipheap and that muddy patch of ground next to the school;) they are in no way are representative of Khmer440, its editors, staff or playthings, of any Ministry of the Royal Government of Cambodia who employs Lord Playboy, of anyone who is left-handed, of fat hairy-arsed lesbians with tennis ball haircuts who drive their 4×4 along St 51 at night without headlights on, or of idiot mechanics employed at certain Khmer bike shops. Damn, things will be different when I am running the Country