How Dollarization Could Impact on Cambodia & Vietnam Reviewed by Momizat on . By Marc Djandji, CFA The global economy is still fragile as the European debt saga continues and there are battles ahead between the Congress and President in t By Marc Djandji, CFA The global economy is still fragile as the European debt saga continues and there are battles ahead between the Congress and President in t Rating:
You Are Here: Home » Views » How Dollarization Could Impact on Cambodia & Vietnam

How Dollarization Could Impact on Cambodia & Vietnam

By Marc Djandji, CFA

The global economy is still fragile as the European debt saga continues and there are battles ahead between the Congress and President in the US. No one is quite sure when the bond buying binge by the Federal Reserve will stop. As it seems for a medium term, that is the only game in town. With Europe still trying to figure out its mess, the US myriad in its fiscal mess; the Arab world in turmoil with unknown impact on the oil prices; Africa is still learning the robes of managing the economic engine and Latin America is pondering its future without Castor and Chavez, Asia has a story- a promising one but with risks on the horizon.

The ASEAN economic outlook is of a continued but modest growth on the back of recent policy easing which has enhanced the consumption and investment in the region. The main challenge for the policy makers will be to balance the external risks and at the same time to manage this growth in the short and medium turn. The main external risks are the continuation of the European debt crisis and upcoming debt deal in the US. If these risks were to materialize, ASEAN’s open, trade-oriented economies would be faced with lower external demand and other spillovers (for example, on confidence), and growth could be substantially lower.

ASEAN region, like many emerging regions in the world, has become more integrated with global financial markets. This makes this region, like many other, vulnerable to external financial shocks which can hamper the growth and create financial bubbles in these regions. With increased exposure to global markets, volatility in global capital markets also can have larger effects, including through effects on exchange rates. A related risk: what happens if there is a reversal on the Chinese investment which is an important factor in the ASEAN economic growth equation. This could result in a sharper-than-expected investment slowdown in the future. Such a shock would strongly affect economies in the highly interlinked Asian supply chain—for example, Malaysia, and Thailand.

In the ASEAN region, the impact of the US$ is most extensive in Cambodia and Vietnam. The experiences of Cambodia and Vietnam in conducting monetary policy illustrate the complications posed by dollarization. That is true of any nation which has a dollarization dilemma. Holding around 90% and 20% of M2 in foreign currency deposits in Cambodia, and Vietnam, respectively, allows businesses and individuals to cushion the effect of high inflation and macroeconomic instabilities and imposes a certain degree of dollarization in these economies. However, it also entails substantial costs. The continued QE operation by the Federal Reserve has far reaching implication outside the US borders to say the least.

This dilemma of dollarization creates its own challenges for the policy makers. The use of multiple currencies can result in economic authorities losing control over monetary and exchange rate policies. The ability of the private sector to switch between the local currency and the dollar or other foreign currencies makes it more difficult for central banks to control the money supply through their determination of base money, reserve requirements, and/or policy interest rates. The demand for local money is also likely to become less stable, making the effect of changes in the domestic money supply on the economy less predictable. Largely for these reasons, the adjustment to major external shocks can be more prolonged and painful when dollarization is extensive. The potential fall in the exchange rate and the resulting contraction in economic activity from a loss in confidence in the domestic currency could be especially great for Cambodia and Vietnam, given their extensive dollarization. Rest assured, any financial shocks to either Cambodia or Vietnam will have an adverse impact on other ASEAN members. In the event of global or local liquidity shortages, central banks in the ASEAN region should stand ready to backstop liquidity.

And there is one more risk to the region. In fact, this risk is the largest threat to the global economy and that is the potential of a conflict in the Middle East. Tension between Iran and Israel are very high and any potential attack on Iran will leave no choice for Washington but to join the conflict. This is a nightmare scenario for the whole world and for the global economy. As of now, no solution or road map has been found to contain this potential disaster at the political level. If this scenario were to materialize, all bets are off. Let’s just hope that cooler heads continue the journey of dialogue and diplomacy and not the path of disaster and destruction.

3,367 total views, 1 views today

Clip to Evernote

Leave a Comment

You must be logged in to post a comment.

© 2013 Asean Investment | Marc Djandji Blog. All Rights Reserved. Phone: +8490-318-9687

Scroll to top