INTRODUCTION
Rationale to the study
Recent reports from the International Monetary Fund and World Bank reveal that only a few countries officially use the U.S dollar as their currency However, unofficial dollarization is increasing, with the dollar becoming the primary global currency for trade Many countries are opting to hold their central bank reserves in U.S dollars, while private companies and affluent individuals frequently possess dollars or dollar-denominated assets.
The phenomenon of domestic currency depreciation has garnered significant interest from researchers due to its associated risks Recent international working papers on dollarization have been authored by notable scholars, including Edwards (2001), Stanley Fischer (2006), and Galindo and Leiderman (2005), as well as Benjamin Cohen.
Recent research on dollarization, including studies by Ali M Kutan et al (2010) and Edwards (2001), highlights its fundamental theories and global implications, particularly in developing countries Edwards emphasizes dollarization's role in curbing inflation and promoting trade growth Galindo and Leiderman (2005) analyze the positive impacts and essential anti-dollarizing monetary policies Benjamin Cohen (2000) presents a balanced view of dollarization's pros and cons, noting advantages like reduced administrative costs and lower interest rates, while also addressing drawbacks such as the loss of monetary autonomy and increased foreign influence Kutan et al (2010) focus on dollarization's effects on bank profits in Latin America, while Stanley Fischer (2006) examines its impact within the Israeli banking system.
Since 1975 – Liberation of Saigon, Unity of Vietnam - Vietnam has experienced many challenges and changes, especially in economy and politics
Vietnam's "DOI MOI" reforms, initiated in the 1980s to establish a "socialist-oriented market economy," have significantly transformed the nation's economic landscape Transitioning from a closed economic policy to global integration necessitated the increased use of foreign currencies, particularly the U.S dollar, alongside the local currency This shift has impacted all three classic functions of money: as a medium of exchange, a store of value, and a unit of account, as highlighted in the IMF's Appendixes Report.
As of 2000, 19 countries exhibited a high level of foreign currency deposits exceeding 30%, while 35 countries, including Vietnam, maintained a medium level of 16.4% Notable research on dollarization in Vietnam includes studies by Michặl Goujon (2006) and Andreas Hauskrecht alongside Hai.
Numerous studies, including those by Hong (2010) and Jeffries (2011), have explored the phenomenon of dollarization in Vietnam, utilizing common theoretical frameworks Despite this shared foundation, these researchers employ varying methodologies and objectives, leading to notable discrepancies in their findings and interpretations of monetary policies in Vietnam Overall, existing literature has largely overlooked the specific causes and effects of dollarization on the Vietnamese economy, highlighting a gap in comprehensive analysis.
This article explores the concept of dollarization, focusing on Vietnam's experience from 2000 to 2011 during a tumultuous economic period The research titled "Dollarization – A Case Study of Vietnam: Situation, Effects, and Measures from 2000 to 2011" aims to provide a comprehensive understanding of dollarization both theoretically and practically.
Aim and scope of the thesis
This study aims to explore the underreported effects of dollarization on Vietnam's economy from 2000 to 2011, as well as the effectiveness of local anti-dollarization measures implemented during this period By investigating these aspects, the research seeks to provide a clearer understanding of how dollarization has influenced Vietnam's financial landscape and the success of strategies aimed at mitigating its impact.
Research questions
In order to satisfy the aim of the study, the researcher set up two main questions:
(1) What are the causes and effects of dollarization in Vietnam?
(2) Are the measures by the Vietnamese Government to solve this problem effective?
Research methodology
This thesis employs a combination of descriptive and quantitative methodologies, utilizing secondary data sourced from a diverse range of materials, including books, online newspapers, articles, and annual reports from institutions such as the IMF, ADB, SGO, and SBV.
The paper employs various methods, including scientific abstraction, inductive and deductive reasoning, summarization, comparison, and statistical analysis These techniques are complemented by a visual representation of data through charts and graphs, enhancing the overall understanding through visual observation.
Organization of the thesis
My graduation thesis is divided into four parts:
Chapter 1: Introduction – in which the Rationale to the study, the Aim and
Scope, the Research questions and the Organization of the study are presented.
Chapter 2: Theoretical background – presents the fundamental knowledge of dollarization in definition, types, causes and effects.
Chapter 3: Analysis of Vietnam’s current situation and measures from 2000 to
This chapter focuses on the critical analysis of dollarization in Vietnam from 2000 to 2011, examining its significant impacts—both positive and negative It also explores the government's strategies and solutions in response to the challenges posed by this economic phenomenon.
Chapter 4: Recommendations and conclusion – further comments and suggestions of this graduation thesis are discussed.
References – in which the valuable data and sources used in research process are presented.
THEORETICAL BACKGROUND
Definition of Dollarization
Dollarization refers to the widespread use of foreign currencies, particularly the US dollar, in place of or alongside domestic currency within an economy This phenomenon is prevalent in many developing countries, notably in Southeast Asia and South America When foreign currencies are adopted for various functions of the local economy, it signifies a state of dollarization, impacting the overall financial landscape.
Additionally, the International Monetary Fund (IMF) defines dollarization as
In many developing countries and transition economies, it is common for residents to hold a substantial portion of their assets in foreign-currency-denominated forms This trend is particularly prevalent in nations participating in IMF-supported adjustment programs.
According to the IMF, an economy is deemed to have high dollarization when foreign currency deposits constitute 30% or more of the broad money supply (M2), which includes cash in circulation, cash deposits, term deposits, and foreign currency deposits At the Asian Development Bank’s 44th Annual Meeting in Hanoi in 2011, Yuma Knish, the ADB's Vietnam director, noted that dollars represented approximately 20% of the money used in Vietnam, indicating a moderately high dollarization ratio in the country.
Dollarization often brings to mind the U.S Dollar, but it can actually involve any foreign currencies, such as GBP, EUR, or YEN, used alongside a domestic currency This phenomenon highlights the significant role that various currencies play in the dollarization process.
Stability is a key reason many countries have chosen to adopt the U.S Dollar as their official currency, as highlighted in 2010 The U.S Dollar's history of never being devalued and its notes remaining valid further solidify its appeal for nations seeking economic security.
The stability of the U.S dollar provides a sense of security amid bank failures, devaluation, and inflation, facilitating smoother business operations According to Feige et al (2007), an estimated 40-60% of U.S dollars were in circulation outside the United States from 2003 to 2006, highlighting the dollar's global influence.
Causes of Dollarization
The people’s confidence on the domestic currency
“Dollarized” Countries, Dependencies and Territories, as of December 2000
Several independent countries and territories have officially adopted the U.S dollar as their currency These include East Timor, Ecuador, the Marshall Islands, Micronesia, Palau, and Panama Additionally, non-U.S dependencies such as Pitcairn Island (New Zealand), the Turks and Caicos Islands (U.K.), and the British Virgin Islands (U.K.) also use the dollar Furthermore, U.S territories like Guam, the Northern Mariana Islands, Puerto Rico, American Samoa, and the U.S Virgin Islands have also dollarized their economies.
Officially Semi-dollarized – U.S dollar: Bahamas, Cambodia, Haiti, Laos, Liberia
In many regions, including the Caribbean and Latin America, particularly in countries like Bolivia, Uruguay, Peru, and Argentina, the U.S dollar has become an unofficial currency This phenomenon is also observed in several former Soviet Union states and extends to diverse nations such as Mongolia, Mozambique, Romania, Turkey, and Vietnam.
(Source: “Basics of Dollarization” Joint Economic Committee Staff Report, U.S. Congress, Jan 2000, updated by S A Meyer, Federal Reserve of Philadelphia)
As can be seen from the above list of dollarized countries, most are under- developed or developing ones with the low and volatile economic performance presented by:
The real GDP growth rate is lower than the annual inflation rate
Both the national budget and trade budget have a deficit accounting for 5-10% of the GDP
The rate between Foreign debt and GDP is at high level
Corruption is a serious hot trouble of the economy and policy
To mitigate various risks, particularly inflation and domestic currency devaluation, countries struggle to control the USD holdings of their populations As economic weaknesses and ineffective management erode public confidence in domestic currencies, individuals increasingly seek safe assets, including foreign currency-denominated assets like the USD.
According to Leiderman (2005), the US dollar (USD) serves multiple key functions in the economy, acting not only as a store of value but also as a unit of account and a medium of exchange, which are the three primary roles of domestic currency.
In recent years, economies worldwide have adopted open-door policies to attract foreign direct investment (FDI), recognizing the significant impact of trade relations and economic cooperation on domestic currencies, as highlighted by Stephen A Meyer (2000) Consequently, the demand for foreign currencies in trade activities has become essential, leading to the prevalent use of the USD as a standard practice.
Government policies regarding deposits, loans, taxes, tariffs, and international payments indirectly contribute to the serious issue of dollarization This phenomenon is an unavoidable challenge when addressing the interplay between growth, inflation, and dollarization in the pursuit of economic development.
According to Goujon (2006), the government fosters an environment that attracts foreign investment while inadvertently increasing the demand for foreign currency, which can lead to the devaluation of the domestic currency To counteract this effect and stabilize the exchange rate, the government resorts to printing more domestic currency, ultimately resulting in inflation.
Other causes might be the limited usage of soft domestic currency, inexperienced banking system, low economic benefit, so on According to the IMF annual published working papers about dollarization.
International trade necessitates a common global currency to minimize transaction costs, reduce uncertainty, and enhance price transparency According to Investopedia, individuals and businesses in countries experiencing high inflation may opt to use a stable currency, such as the U.S dollar, for everyday transactions and international trade agreements, as inflation diminishes their domestic currency's purchasing power quickly It's important to note that dollarization can involve currencies other than the U.S dollar.
Other major currencies such as GBP, EUR, and YEN are also widely used globally; however, none have achieved the U.S dollar's dominance, which accounts for 70% of international trade turnover, as reported by Baliủo, Thomỏs, J.T et al (IMF).
1997) Therefore, it is also called dollarization.
In their 2005 book, Galindo and Leiderman propose that countries with lower economic development, intellectual standards, banking system efficiency, effective monetary policy, and foreign currency management tend to have higher dollarization ratios Economists argue that dollarization should not be viewed as a crisis; rather, it is a temporary response to a loss of confidence in the national currency and government.
Types of Dollarization
2.3.1 Based on the function of foreign currency in economy
Partial dollarization involves the use of multiple currencies to fulfill the three primary functions of money: unit of account, medium of exchange, and store of value, as noted by Adriano Armas et al (2006) This phenomenon often arises from previous economic instability, particularly during periods of high inflation It is important to differentiate between three types of dollarization: asset-and-liability dollarization, medium-of-exchange dollarization, and unit-of-account dollarization, the latter sometimes referred to as "real" dollarization.
This type is demonstrated by the Dollarization ratio (FCD/ M2) According to IMF criteria, if the ratio of a country is greater than 30%, its economy is considered as a highly dollarized one
During the financial crises of the 1990s, many banks believed they had effectively hedged their foreign currency liabilities by lending in dollars However, they often found themselves unprotected as their non-exporting borrowers struggled to repay these dollar-denominated loans Even banks with a perceived net long position in foreign-exchange assets faced significant balance sheet damage due to severe devaluations This highlights the critical need for lenders to carefully assess their borrowers, as such dollarization can heighten the vulnerability of banking and financial systems to exchange rate fluctuations While these fluctuations can stem from external factors, they are frequently triggered by domestic fiscal issues As noted by Stanley Fischer (2006), asset and liability dollarization increases the financial system's susceptibility to exchange rate shocks, ultimately impacting the broader economy.
Dollarization refers to the use of foreign currency, particularly the U.S Dollar, in daily transactions and international payments Ian Katz (2000) highlights that in developing or under-developed economies, defining legal foreign-currency transactions is challenging due to government policies aimed at attracting local capital Moreover, it is nearly impossible for governments to fully control the use of the U.S Dollar among the population, as employees in joint ventures may receive their salaries in U.S Dollars, leaving uncertainty about whether they will retain or exchange it for the local currency This phenomenon is known as unit-of-account dollarization, or real dollarization.
Even after a country achieves price stability and eliminates most forms of dollarization in assets and liabilities, it may still encounter situations where certain domestic commodities are priced in dollars.
In countries where tourism significantly contributes to GDP, such as Israel, Turkey, and Ecuador, housing and apartment rentals, along with various service fees, are often quoted in dollars This phenomenon, known as unit-of-account dollarization, highlights the prevalence of non-traded goods priced in a foreign currency.
2.3.2 Based on the scope of U.S Dollar usage
Dollarization in an economy can be categorized into three types: Unofficial, Semi-official, and Official dollarization, as outlined in the Joint Economic Committee Staff Report by the U.S Congress (January 2000) Unofficial dollarization occurs when foreign currencies, particularly the U.S Dollar, are used alongside or instead of the local currency without formal endorsement from the government This phenomenon reflects the popularity of the U.S Dollar and the varying responses of authorities towards de-dollarization efforts.
Unofficial dollarization, as defined by Schuler (1996), occurs when a country's economy extensively utilizes the U.S dollar without official recognition This phenomenon arises when residents opt to hold a substantial portion of their financial assets in foreign currency due to the poor performance of their domestic currency or as a safeguard against local inflation, despite the absence of legal tender status for the U.S dollar.
Unofficial dollarization may include the following:
The foreign currency bonds and other non-monetary assets in foreign countries
Oversea deposits in foreign currency
Foreign currency deposits in domestic banks
Bonds or other valuable papers in foreign currency b) Semi-official dollarization
This type of Dollarization happens in a country where the foreign currency is legal tender alongside the domestic currency (official bi-monetary system)
Under semi-official dollarization, foreign currency serves as a unit of account, medium of exchange, and store of value alongside the domestic currency, often dominating bank deposits Despite this, it remains secondary to the domestic currency for paying wages, taxes, and everyday expenses like groceries and utility bills.
Official dollarization is an economic situation in a country where the payments and the everyday expenses are released in the foreign currency, usually the U.S
Dollar For example, Lebanon and Cambodia are two countries considered to suffer from as semi-official dollarization.
Official dollarization, also known as full dollarization, refers to the complete adoption of a foreign currency, specifically the U.S dollar, as the sole legal tender in a country, eliminating the use of local currency This transition from informal or limited dollarization to official status allows the foreign currency to be used in all transactions, including government payments and private contracts In cases of official dollarization, any domestic currency present typically plays a minimal role, often limited to small denominations Countries like Panama and Ecuador exemplify this practice, with Panama using the U.S dollar since its independence in 1903 and Ecuador officially adopting it on January 9, 2000, often as a response to economic stabilization challenges.
Impacts of Dollarization
Although dollarization is considered as a bad signal of a volatile economy, according to economists, it still brings about some advantages
Dollarization acts as a protective measure against inflation by allowing foreign currency deposits in the banking system, which helps individuals safeguard their purchasing power and access goods from unofficial markets In countries with high levels of dollarization, the central bank is restricted from printing domestic currency, a key factor contributing to inflation This limitation also prevents the government from relying on note issuance profits to cover budget deficits, leading to more effective financial project implementation.
Dollarization promotes the development of a banking system by enhancing its roles and effectiveness, evidenced by the rising percentage of banking deposits in a dollarized environment According to Michặl (2006), dollarization mitigates the risk of currency crises that can adversely affect the banking system through the balance sheet channel, while also reducing the likelihood of systemic liquidity shortages and optimizing banks' reserves due to increased citizen deposits Additionally, the influx of foreign currency facilitates banks in expanding their operations and supporting both domestic and international transactions.
Dollarization reduces transaction costs in trade between countries using the same currency by eliminating the discrepancies between bid and ask prices during currency exchanges This minimizes the need for provisions against exchange rate risk, thereby freeing up more capital for banking investments, increasing turnover, and reducing overall expenses.
Dollarization enhances trade and investment by lowering transaction costs associated with using a strong foreign currency as legal tender This reduction leads to a significant decrease in exchange rate volatility's negative impact on trade and diminishes the complexities of operating with multiple currencies As transaction costs decrease and price stability in dollars improves, economic integration with the global market becomes more accessible Additionally, full dollarization eliminates currency crisis risks, reducing the country risk premium and leading to lower interest rates, ultimately fostering a higher level of investment.
Dollarization positively impacts monetary policies and exchange rates by fostering greater fiscal and monetary discipline, leading to enhanced macroeconomic stability and lower inflation rates It reduces real exchange rate volatility and may contribute to a more robust financial system By adopting a strong foreign currency as legal tender, countries can eliminate the inflation-bias associated with discretionary monetary policy Official dollarization also enforces stricter financial constraints on governments by preventing deficit financing through money issuance Empirical evidence indicates that inflation rates are significantly lower in dollarized countries compared to non-dollarized ones Additionally, dollarization mitigates the risks of exchange rate fluctuations and potentially decreases a country's international exposure, aligning with Michal Goujon’s theory.
(2006) Though dollarization cannot eliminate the risk of an external crisis, it provides steadier markets as a result of elimination of fluctuations in exchange rates.
Economic and political policymakers often view dollarization as an indicator of a vulnerable economy and a threat to national sovereignty To understand the drawbacks of dollarization, it is essential to highlight its negative economic and political impacts.
Dollarization comes with significant economic implications, primarily the loss of monetary autonomy, as countries can no longer control their money supply or exchange rates According to Stephen A Meyer (2000), this relationship is hierarchical, as countries typically consider dollarization due to existing economic pressures In their collaborative work, Berg and Borensztein (2000) argue that a higher degree of currency substitution reflects market preferences, which can limit a government's capacity to manage macroeconomic conditions Consequently, if a local currency is formally eliminated, the actual loss of monetary autonomy may be less severe than anticipated, given the constraints already imposed by market dynamics.
Dollarization leads to the loss of a significant financial tool for governments—the ability to create money, known as seigniorage According to Benjamin Cohen (2000), seigniorage represents the difference between the nominal value of currency and its production cost, serving as an alternative revenue source for states beyond taxation or borrowing However, when a country adopts dollarization, it eliminates this revenue stream unless a specific seigniorage-sharing agreement is established with the United States.
A country that adopts a foreign currency effectively relinquishes its central bank and the safety net of a formal lender of last resort This transition can leave domestic banks more vulnerable to liquidity risks during financial crises, as they lose the ability to access discounted funds from a central authority.
Dollarization decreases the demand for international reserves by allowing certain external transactions to be treated like domestic ones This enables central banks to allocate a portion of their dollar assets to a public stabilization fund, providing support to domestic financial institutions in distress As noted by Benjamin Cohen (2000), an alternative approach could involve gradually building a contingency fund from tax revenues or negotiating flexible credit lines with foreign banks, using future tax revenues or seigniorage-sharing as collateral.
It is more difficult to exaggerate the political costs of dollarization, which are highly visible and could be quite dramatic At the symbolic level, Benjamin Cohen
The preservation of a national currency plays a crucial role for governments concerned about internal division or dissent, as it fosters a sense of unity among citizens This centralization of state authority is strengthened when individuals perceive themselves as part of a cohesive social unit and a shared political and historical community Money, as one of the most powerful national symbols, enhances national identity by reinforcing this collective belonging and promoting a unique sense of cultural identity.
First, because it is issued by the government or its central bank, a currency acts as a daily reminder to citizens of their connection to the state and oneness with it.
The currency serves as a daily reminder of our shared social identity, similar to the role of a national language, which governments often promote for nationalistic purposes.
Adopting a foreign state's currency diminishes the effects of loyalty to a unique political community, as the symbolic value associated with a distinct national currency is lost.
Preserving a national currency acts as a crucial insurance policy for governments, as highlighted by Stephen A Meyer (2000) Beyond being a marginal revenue source, seigniorage serves as an emergency financial resource, enabling quick access to purchasing power during unexpected situations, including wartime This immediate mobilization of resources eliminates the delays associated with tax collection or loan negotiations, a significant advantage that is forfeited when adopting another state's currency.
Maintaining a national currency is crucial for governments concerned about external dependence and threats, as it allows for monetary autonomy and reduces reliance on foreign economic resources According to Stephen A Meyer (2000), this autonomy helps policymakers establish a clear economic boundary between the state and the global economy, thereby strengthening political authority However, adopting a foreign currency, such as the U.S dollar, compromises this insulation and exposes the country to potential manipulation and coercion, as dollarization gives the United States significant influence over the dependent economy.
Through the literature review, it is probably to conclude:
Dollarization has both positive and negative effects on the dollarized countries
Dollarization is an unavoidable phenomenon in the recent global economy, but it is necessary for economies to take precaution and control in policies due to the different goals.
CHAPTER 3: ANALYSIS OF VIETNAM’S CURRENT SITUATION AND
Situation of dollarization in VN from 2000 to 2011
The financial crisis in Thailand during 1997-1998 had significant regional and international repercussions On August 17, 1998, the Prime Minister issued decree 63/1998 to reform international currency management, which included updated definitions and distinctions between residents and non-residents A key measure was the prohibition of illegal foreign currency circulation, allowing only legal transactions between banks and customers However, the IMF's 2000 report highlighted that 19 countries had over 30% of their deposits in foreign currencies, indicating a broader issue in currency management.
35 countries with the medium level of 16,4% including Vietnam (table 2).
List of Dollarized countries (based on FCD/M2 - 1988)
High (>30%) Argentina, Azerbaijian, Belarus, Bolivia, Cambodia, Costa
Rica, Croatia, Georgia, Guinea - Bissau, Laos, Latvia, Mozambique, Nicaragua, Peru, Sao Tome, Principe, Tajikistan, Turkey and Uruguay.
Medium (≈16.4%) Albania, Armenia, Bulgaria, Czech Republic, Dominica,
Honduras, Hungary, Jamaica, Jordan, Lithuania, Macedonia, Malawi, Mexico, Moldova, Mongolia, Pakistan, Philippines, Poland, Romania, Russia, Sierra Leone, Slovak Republic, Trinidad, Tobago, Uganda, Ukraine, Uzbekistan, Vietnam,
According to the IMF's 2000 report, Vietnam is classified as a moderately unofficial dollarized country, as the USD is not legally recognized but remains a preferred asset for many Vietnamese Despite government efforts since 2000 to combat dollarization, the trend has persisted, exacerbated by the global economic crisis and the rising exchange rate of the VND against the USD.
Unofficial dollarization in selected countries (2004)
Middle (>20%,