Currency Substitution in Cambodia
_____________________________________________________________________
KEM REAT VISETH
Cambodia Institute for Cooperation and Peace, and
Office of the Council of Ministers
Phnom Penh, CAMBODIA
Prepared for the 9th Academic Forum
on East Asian Economy
Nanning, November 24-25, 2005
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OUTLINE




What is currency substitution (CS) and
why is it important for economic
development
Stylized facts of CS in Cambodia
Model of CS and empirical results
Conclusion
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1.a. What is CS?
B
The use of foreign currency (FC) and
FC denominated bonds by domestic
residents.
FC serves the three
roles of domestic
currency in a
domestic economy.
C
The demand for
foreign fiat money
by domestic
residents.
A
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1. b. Dollarization and its types

Official dollarization

Semi-official dollarization

Unofficial dollarization
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1. c. Measurements of CS
i. Stock concept:


measures the volume of FC in an economy.
Normally, measured by a ratio of FCD/M, called
CS or dollarization ratio.
ii. Process or behavioral concept:
measures the propensity of substituting FC for
domestic currency by an economic agent.
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1. d. Importance of CS
i. Benefits of CS:
Promote financial reintermediation and
financial deepening
 Promote confidence in the domestic banks
 Impose discipline on the government to
finance spending though inflation tax

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ii. Costs of CS:
Loss of seigniorage
 Limit the conduct of monetary policy
 Nominal exchange rate cannot be used to
respond to economic shocks
 Exacerbate inequality of income distribution

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2. Stylized facts of CS in Cambodia
 US dollar is widely used as:




Store of value
Means of payment
Unit of account
Thai baht and Vietnamese dong is used as
medium of exchange in main cities and some
areas bordering with Thailand and Vietnam.
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1400000
0.8
1200000
0.7
1000000
0.6
0.5
800000
0.4
600000
0.3
400000
0.2
200000
0.1
0
0
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88
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89
19
90
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91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
in millions of riels
Foreign Currency Deposit: 1988-2001
FCD
FCD/M2
Source: Data provided by the NBC
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Causes of CS in Cambodia

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
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Low confidence in the “riel”, as a result of the
two decades of war
Smuggling activities
UNTAC arrival
Remittances
Under-developed financial market
Inflation, and
Exchange rate depreciation
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Monthly Exchange Rates and Inflation Rates:
January 1993-April 2001
Source: Data provided by the NBC
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3.a. Model of CS
The estimated equation can be written as:
LFM t   0  1 xt  ut
This equation states that the ratio of holdings
of FC to domestic currency and the change in
depreciation rate are positively related.
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3. b. Empirical Results
LFM 2t  0  1 xt 1   xt   LFM 2t 1   2T  3 DUM  ut
xt
t- stat (P-value)
0.61**
3.31 (0.001)
xt-1
t-stat (P-value)
0.85**
4.74 (0.000)
LFMt-1
t- stat (P-value)
0.64**
13.08 (0.000)
T
t- stat (P-value)
0.001**
4.36 (0.000)
DUM
t- stat (P-value)
-0.05**
-3.56 (0.000)
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4. Conclusions & Future Research

There is strong presence of CS in Cambodia,
thus limiting the power of the monetary
authority. In view of this, should Cambodia
officially dollarized or de-dollarized?

Given preliminary studies, the costs of
dollarization in Cambodia seems to outweighs
the benefits.
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Conclusion (cont’d)

Therefore, the National Bank of Cambodia
(Cambodia’s Central Bank) suggests the
gradual de-dollarization process.

However, a thorough study ought to be
conducted to investigate the quantitative costs
and benefits of dollarization. This is a topic for
further research.
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THANK YOU!!!
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