Dollarization in Cambodia

Keywords: cambodia dollarization, dollarization effects

Dollarization occurs when a country uses US Dollar or other currency instead of or along with local currency. The picture of dollarization can be as follow: using dollar for bank Deposit, paying debt, buying goods and service, measuring national budget. 1 There are three types of dollarization: official, semi-official, and unofficial. Official dollarization occurs when a country use dollar as the legal currency instead of domestic currency. For example, Panama is the dominant official dollarization adopter. It has no domestic currency published at all. The second type is Semi-official dollarization. Some countries in the world use US dollar and domestic currency at the same time; in other word, they use bimonetary systems. This allows people to make deposit in US dollar, do some transaction, but it only act as second role in paying wage, tax, electricity, and daily expense. Adopting this system, the central bank can place its own monetary policy. Cambodia, Lao, and Haiti are the examples of semi-dollarized countries. Third, in unofficial dollarization, some countries’ majority wealth is hold in foreign currency and people can use US dollar substituting domestic currency either legally or illegally. In short, when a country uses other currency beside it own to substitute the three functions of the monetary, it is theoretically that the country has been dollarized formally, semi-formally or informally.

2. World Dollarization Implication

There are two main aspects of dollarization. Dollarization is the subject of not only the economic or also of Politic. Economists think that money is only just public goods which consist of three functions: means of exchange, store value and unit of account and its purpose is only to ease the economic transaction. Dollarization is the symbol of the US power influence country money. The US aid for the reconstruction of Western Europe after the World War II and many other countries, the role of US in world stage became more important. Then after the abolishment of Gold Standard in 1971, the US dollar also became the main currency in the world. Because of shock of financial crisis, some countries adopt dollar US to reduce the risk and create stability. For, those countries adopting dollarization is only another term for fixed exchange rate compared to US dollar without much effort2. Comparing to developing country currency, it is more reliable, valuable and profitable in doing trade, storing value, and making transaction. However, some countries use other currency with similar quality such as Germany mark, Japanese yen and now Euro in Europe.

Beside economic value, money contains purchasing power which is the heart of politic. The power has distributed to the creator, the exchanger, and especially the controller. Thus, distribution of money does not only create hierarchy of people but it also creates hierarchy in the world.3 However, for some other countries dollarization is the heart of political interest. For instance, using US dollar in Latin America implies its dependence on US and also shows its inferior. East Timor adopt US dollar as its official currency to prevent Indonesian influence. In short, dollarization can be characterize into both economic and politics. Through both means the dollarization is becoming new influence of US in the world.

3. Dollarization in Cambodia Dollarization

According to IMF the proportion of Dollar in economic circulation is 90% which is indifferent for a decade ago. In an article dollarization in Cambodia, and policy options on the way forward, Menon (1998) concluded that “…dollarization is not the problem, but is merely symptom. The problem (or the cause) is a lack of confidence in the riel, whilst the symptom (or the effect) is the use of another currency such as the US dollar.4” Dollarization in Cambodia is the result of both past and present economic and politic status. Dollarization in Cambodia is the direct legacy of the destruction of economic and financial

Institutions after the 1970s, economic mismanagement in the 1980s, and the large inflows of US Dollars during the UNTAC period in the early 1990s5.Today, in Cambodia the US dollar still serves all three functions of money: it is widely used as a medium of exchange, store of wealth, and unit of account. The fact that dollarization is not the real problem but it is the lack confident in riel can be rooted as far as the Khmer Rouge Regime. In 1975 the revolution of Khmer Rouge took over the Cambodia politic and economy. influenced by the Marxism, to make Cambodia a communist country the Pol Pot abolish riel currency as well as stop the national bank operation and thus hope to fill the gap of the rich and the poor. Cambodian people lived in hardship without any personal business activity, any mean of store value or exchange, on private ownership. Fortunately, in 1979 the population was saved; however, this country returned to the state of traditional economy using barter system. Then, not until 1980 did riel currency appear again. Experiencing shock in 1975 when their saving money became scraps in only days, Cambodian people later preferred to use other means such as gold, silver, jewelry for exchange. Most people used riel currency for only small transaction and not over 50$ saving. When the dollar was introduced again in 1990s, it is generally accepted along with previous gold and silver money. As much 1.7 as US million dollars has poured in Cambodia through UN peace keeping activity, the UNTAC6. This situation paved the ways of Cambodian economy depend on the stronger money US dollar and Cambodia was easily the most highly dollarized country in Asia, and one of the highest in the world The share of dollars in currency Circulation is highest in Cambodia, estimated at about 90 percent. Nowadays Dollar still plays major role in business transaction, and the major deposit in bank. The existence of dollarization in Cambodia is also expected to last. Another reason for Cambodia in accepting dollarization is just a pressure of its country as a developing economy. Even though Cambodia has done three decade or reconstructing the economy, reducing political and economic uncertainty, there are more actions to be done to get out of dollarization. While growth and political uncertainty greatly has been reduced, Cambodia remains a low income country with significant inequality and poverty, and some degree of political uncertainty remains. For example, political turmoil in 1997 combined with Asian financial crisis would have been more even more threatening to Cambodia if it had not been dollarized.

4. Conclusion

As many states have problem in both economic and politic stability and weak monetary system people will consider using another currency which is more stable and valuable in most situation. In the serious case some countries do not have own currency at all but US dollar. As the US has strong monetary regime its currency impress those developing states to use US dollar; therefore, US may somewhat influence those state in both economic and politic. Some states may be dollarized in order to create financial stability; however, they are unsure what can US do with dollarization for politics. Cambodia is not the exception. Since 1970s and had been attracted to new currency US dollar in since 1990s. Until now, the degree of dollarization has changed only a little. Dollarization was injected so gradually that people get accustomed to it despite the government effort to de-dollarize in the last decade. Cambodia economic and politic problems still fuel dollarization existence. Next issue is to discuss the advantage and disadvantage in Cambodia.

MC2: Situation of Dollarization in Cambodia Today and Its Cost and Benefit

After the two decade of United Nation Transnational Authority in Cambodia (UNTAC) operated peace keeping activity and introduce dollarization in Cambodia, with high economic performance with average two digits GDP growth and considerable political stability Cambodia should have come out of dollarization already. However, Cambodia’s economy is still highly and increasingly dollarized which urge the government to critically consider whether to de-dollarize by comparing its cost and benefit.

The status of Cambodia dollarization today is not far different from the 1990s1. The dollar still serves three functions in this economy: making transaction, storing value and being used as unit of account. The cash dollar in circulation in Cambodia is 90% of all value of transaction which is similar as a decade ago. Dollar has been widely use for private sector wage payment, medium of international trade and also purchase large value products. Moreover, dollars also dominate the currency deposit as storing value instrument in Cambodia. According to the National Bank, the foreign currency deposit in broad money (M2) is accounted for 75% in 2006 increasing from 54% in 1998. Furthermore, 97% of bank deposit is in term of dollar. The recent increase in dollarization is the result of two main points the higher economic growth and recent political stability has contribute to more dollarization. When the investor think Cambodia is a good place to invest they will inject more dollar investment. In addition, the open trade economy also allows Cambodia to do more trade with other countries using dollar as medium of international trade exchange.

Long before this happen the issue of dollarization has been discussed on cost and benefit but at this time it is even more critical to figure out that the cost of dollarization is more than benefit in Cambodia2. The benefit of dollarization in Cambodia can be encouraging saving, preventing capital flight, providing low risk of currency and exchange rate devaluation. First, the dollarization increasing saving when there is a better currency that is more reliable, therefore, people will tend to save in the bank in dollar to increase their wealth as well as lubricate the economy. Second, this also prevent hot money go out Cambodia in a short time of return from investment because investor still deposit money in local bank and transfer to their homeland at any time when there is high portion of dollar deposit in the bank. Last but not least, dollarization provides security from the risk of currency devaluation and exchange rate depreciation. When the local money face inflation or depreciation the dollar holder will not worry about the value of asset they hold in dollar. On the other hand, those benefits are little comparing to cost of dollarization. First of all, riel is the national symbol of states sovereignty so using dollar is really affect sovereignty and national identity. Second, When Cambodia use dollar as dominate to riel currency, the national symbol has been eroded because the people do not trust their own government. Instead of get easily affected by local inflation, the dollar holder get easily affect by dollar instability especially in recent years. Thus, it means that Cambodia is somewhat dependence on the US federal monetary policy. Finally, dollarization make local monetary policy less effective, in other word, the central bank cannot use its own currency to fully stabilize price and economy. When government want to print more money it will not increase much in the economy because most of transaction done by dollar and the government also cannot control the interest rate since the most deposit is in dollar not riel. Government also cannot get inflation tax (print money to finance short term deficit but let go the inflation) to finance the government budget especially in hard time.3 Being unable to use inflation tax or seignior age to support emergency needs the government of Cambodia is estimate to loss seignior age to be $682 million at the end of 2004, with an additional $61 million lost annually. and especially in the case of paying the military, the Barry Eichengreen (1994): “Money can be printed to pay soldiers, to purchase materiel, and to underwrite the other costs of a war of national defense without having to wait for tax returns to be filed or for a foreign loan to be extended.” As the state sovereignty and being

able to use own policy is very important the cost burden by dollarization above have already exceed the benefit. Thus it is time for Cambodian government to get more effort in de-dollarized campaigned despite the problem of lack of both commitment and capacity. In short, even though the economy and politic of Cambodia has improved the dollarization has not been eliminated but it increases because of the more free market mechanism. However, dollarization has impose more cost such as hindering Cambodia from using its own monetary policy, eroding national sovereignty and being not able to finance government budget deficit which is far more significant that the benefit such as creating price stability, encouraging save and discouraging capital flight. This is the high time for Cambodia government to respond to those issues. Cambodia cannot stay aside from dollarization as it shows the higher level. The Cambodia government has to show its commitment and strengthen capacity to combated dollarization either locally or regionally.

MC#3: Policy Option for De-dollarization in Cambodia

The government of Cambodia has realized that the current situation of dollarization in
Cambodia has higher cost than benefit. The cost is that dollarization has weakened domestic
monetary policy capacity to manipulate the financial and monetary system while the benefit has
gone to price stability and trade and investment integration. The Cambodian government has;
therefore, allowed the side effect of US federal policy to influence its economy for a long time
either good or bad. Thus, it is high time for Cambodia to strengthen de-dollarization. There are
two main procedures in de-dollarization which are domestic policy and regional policy.
However, this paper will cover only the possibility of policy option done by the Government of
Cambodia alone. The suggested policies to de-dollarized Cambodia economy are full
dollarization, currency board agreement, and continue Interim policy reform. However, the latest
seems most preferable.

The first choice of Cambodia is to move forward to full dollarization following the
precedential example in Latin American economy especially Panama. Adopting this policy,
Cambodia has a great save in transaction cost, is easy to integrate itself in the regional and global
economy by trade and capital flow and also maintain high price stability. However, full
dollarization seems not the right choice for Cambodia. Since Cambodian economy does not
closely related to US and thus it does not allow Cambodia to keep track with US economy easily.
Moreover, giving up riel currency implies scarifying more seigniorage benefit to US and has no
more ability to use own monetary policy as the lender of last resort of domestic commercial
bank. Moreover, the government of Cambodia hasn’t showed any commitment to turn to keep
dollar as legal tender. The Minister of Ministry of Economic and Finance, Mr. Keat Chhun at the
Launching Cambodian Economic Forum in 2006 said “…However, it should be seen that the
Royal Government is now implementing de-dollarization. …Our economy must be based on
national currency, which should be based on a basket of foreign currencies and consistent with
the integration of our economy into regional and world economy.” It is not likely that Cambodia
take a reverse policy from its commitment.

Second policy is to create currency board agreement in Cambodia. A currency board is a
monetary authority, unlike central bank, issue domestic currency that is always convertible to
foreign currency at a fixed exchange rate on the basis of 100%. This means that if 1$ = 4000 riel,
the currency board needs 10$ reserve to issue 40000 riel. The currency board makes profit by
gaining interest from its foreign reserve by the expense of cost in circulating local currency. The advantage of CBA is the gaining of seigniorage benefit over the dollarization that makes country
loss in that. Although Currency board seems a good choice but it need too much effort from
Cambodia and also has side effects. There is an estimated that riel is 10% of the currency of
circulation and the official reserve is triple of this which is equal to 30%. Thus, it means that
Cambodia need to triple the reserve to collect all dollars in circulation. Therefore, currency board
may lead to a mass government debt. Is there any other ways that Cambodia can get more
official reserve?

Finally, the last alternative for de-dollarization is to use interim policy. Interim policy is
to set objective of de-dollarization in longer term and accelerate reform. In this approach, the
government of Cambodia should left the monetary system as they are on the one hand; and
increase macroeconomic stability which increase riel confident and demand as well as restore
riel-friendly environment on the other hand. First of all, National Bank of Cambodia plays an
important role in this policy. NBC is the last resort of loan of commercial bank, so NBC provide
riel as a mean to refinance. Then Cambodia government should promote the use of riel currency
as a mean of exchange with security and low cost. Last, the NBC can use Treasury bill to attract
the riel financial market by providing higher interest than dollars saving. Beside the role of the
bank, the tax policy reform is also taken into account. Demand of riel can be raised when there
is obligation to pay all kind of tax in riel. Thus, when there is more tax collection in riel implies
more demand in riel. Besides, the adaptations of existing institution that allow ease the
dollarization is important. For example, the minimum wage law in Cambodia is indentify is
dollar not riel and the most international organization operated in Cambodia preferred to pay
salary in dollar only while in other country the government required the international
organization to pay 30%-40% in local currency. Moreover, there are also surplus demands of riel
in microfinance that cannot be fulfilled. it is estimated that microfinance industry demand Riel
120 billion in 2008, but the supply is not enough. Thus, it is important to resolve the
dollarization-friendly-condition above by remove any status serve for dollarization although
there is a certain portion in dollar paying in wage and salary and increase supply of riel in
microfinance industry.

One can criticized that Cambodian government has done a lot in reform for macroeconomic
stability but the result is still high dollarization in today economy. Cambodia has
enjoyed high growth, average two digit growth in last five year, despite the distraction from the
global financial crisis in 2008, yet the there still the same dollarization. In addition, to restore
attract demand in riel as a secure and low transaction cost currency is not good because the
commercial bank has promote it by giving higher interest rate than dollar deposit already. The
problem is not focus on what have Cambodian has done, instead it is important to know what
else needed to achieve long-term goal of de-dollarization. Moreover, gradually de-dollarization
process can ease the economy adaption. As result, when the Cambodia reach the macroeconomic
stability the authority can take advantage of strong financial system to increase confident in riel
and thus to de-dollarized.

In conclusion, Dollarization in Cambodia is not the matter that easily to settle because
there a high link between citizen who prefer dollarization as the result of being not confident in
riel and weak financial institution and a high loss in the government who is the coordinator
between those two. Among the suggested policy in de-dollarization which are full dollarization,
currency board agreement and interim policy, the last choice is likely the best option for
Cambodia because it respresent the appropriate capacity ot the states as well as allowed people to
increase confident and demand in riel considerable. However, the previouse effort in this policy
is not enough so Cambodia need a higher commitment and capacity in this policy. On the other
hand, domestic policy alone may not enough to deal with the dollarization which is the result
from capital and trade integration. Therefore, regional cooperation combating dollarization can
be the future choice for cambodia.

MC4: Subregional Cooperation in Dedollarization.

Cambodia, Laos and Viet Nam have shared common characteristic as the newly
emergence economy. Firstly, the three countries or so called CLV countries have transform
from central planned economy to free and open market economy during 1980s and 1990s.
Because of the experience of price instability, fragile monetary and exchange rate policy and
the underdeveloped or non existence of financial market make all countries similarly tend to
use Dollar alongside the local currency despite the different level of dollarization. Although
dollarization has contribute to price exchange rate stability, it is not the good choice for them in
long‐term because the government has lost much seigniorage, benefit and also the role of last
resort of lender of central bank. CLV has tried their own method to de‐dollarize to cope with
short‐coming problems by their own reform so as to gain currency confident and also improving
financial institution. Those policies seem to need much effort and time and CLV to achieve
alone, therefore there is also another choice of sub‐regional cooperation among CLV countries
such as exchange rate regime and single currency area.

For CLV cooperation in monetary and exchange rate policy to combat both
depolarization and monetary system sustainability which includes price stability, financial
stability and exchange rate stability, CLV have to create cooperation environment as a
precondition. First, they have to create a network of policy makers, economist elites, officials,
and researcher from all level of government and financial institution to take close surveillance
on CLV economic performance and discuss the possibility of new policy. Moreover, the
networks should make a regular meeting information exchange, checking progress and also
make consultant the possible area in economic integration in the region. Secondly, CLV
countries should create strong connection of capital market among them. There are two
possible alternatives for this. The Viet Nam should allow the Cambodian and Laos company to
list it stock market or the CLV can create common bond market of CLV sub‐region. To develop
capital market in CLV countries they also need to make a joint regulation and supervisory to
ensure transparency to investors and they need to reduce foreign exchange restriction among
the three countries to reduce exchange rate risk among investor too.

After achieving the above precondition in monetary and exchange cooperation above,
CLV have two choices which are exchange rate cooperation and monetary cooperation to
multilaterally combat dollarization.

First of all, consider the possible of future exchange regime in ASEAN+3 in the East Asian
economic community, the CLV exchange rate cooperation can be pilot project of the bigger
picture of cooperation. CLV countries should consider the joint peg of currency to Dollar or
currency basket of currency famously Dollar, Euro and yen while the weight of currency
depends on the trilateral discussion. This common peg to Dollar is a good choice for CLV
countries because of several reasons despite some difficulties. First, the stable exchange rate to
Dollar has showed the strength of currency against outside fluctuation thus gain credibility of
currency. Second, CLV already adopt restricted fluctuation of currency against Dollar and those
main trading partner, China also already peg to Dollar. By doing this the three countries will
have less transaction cost in changing their currency to Dollar when they are doing trade and at
the same time their currency will get confident from people since it is stable with Dollar. On the
other hand, when CLV peg to the basket of currency including Dollar, Euro and Yen, the CLV
country can reduce risk when there is currency shocked in US. Instead of rely solely on
exchange rate stability with Dollar, CLV reduce the risk by depend on two more major
economies, Europe and Japan. There is no correct proportion of the three currencies in the
currency basket, yet it depends on the economic relation of CLV to the G‐3 (US, Europe and
Japan) and also their own negotiation. Besides, CLV can move further to sub‐regional currency
board which ensures the stronger peg to foreign currency thus they get more seigniorage
benefit. However, they need much more effort to achieve this. First, they have to create a
stronger cooperation in coordinating currency policy. Second, they need more foreign reserve
to run currency board and it needs high legal endorsement to get people use local currency.

In addition to cooperation in Exchange rate regime, it is also important that CLV cooped
to create monetary regime. The CLV common currency is a long term goal they require many
effort from CLV to improve the credibility among public of currency as well as effective
institution to handle the transitional change of currency and strong political will of CLV leaders.
Besides, the CLV currency area can be established only after the Asian Currency Unit (ACI)‐
which is similar to European Currency Unite, has been created in ASEAN+3. When there is
common peg to ACI in ASEAN+3 economy, the CLV will change to peg ACI and they can create
their own sub‐regional common currency in lower level to increase their voice in ASEAN
cooperation, in addition to the benefit for Exchange rate regime. However, some scholar
suggests this option is difficult to achieve at least in short and medium term because there are
many political sensitive issue to overcome, weak institution, and flexibility of people.

In summary, in order to cooperate with each other so as to de‐dollarize their economy
CLV countries has to two choices of Exchange rate regime and single currency. Those policies
are only achievable when CLV countries have strong foundation of cooperation in critical are
such economic consolation and information sharing, joint assessment and so on. They can more
benefit from this cooperation rather than taking action individually however it is only long‐term
goal for them. In prospect there is still possibility to get out dollarization when CLV are
determined enough in cooperation.

MC#5: Dollarization and Implication of Financial Architecture Reform

Cambodia among CLV is solely dollarized countries in the world which face the
problems. Dollarization is the common problem in developing countries such as Latin America
also. Thus the case of dollarization in Cambodia can also reflect the situation of the change of
financial architecture that affect the financial and monetary system in the world. Dollarization is
the symptom of weak ability of domestic financial structure, historical price in stability and
political problems urges people to use foreign currency. While the government the seigniorage
benefit and role of last resort of lender the people enjoy the stability of money in deposit as
well as trade and investment. Rooted from the globalization there are three main debates in
global financial system:

1. Does dollarization good for developing country?
2. Should states liberalize people choice in using currency they like or impose people to
   choose national fiat money?
3. Should IMF play important role in the world exchange rate stability?

• Does dollarization good for developing country?

Dollarization can give price and exchange rate stability in low cost in most emergence
market economy. Hanke recommend developing countries to use dollarization in case that the
states do not have strong monetary and fiscal policy to tighten currency value in long term
should use dollarization as monetary institution. The above idea is not raised by him alone
some scholar also propose choice of dollarization because of several reasons. First, considering
the financial and dept crisis during 1980s and 1990s in much part of the world and thus leads to
increase of high inflation, currency devaluation and mass capital outflow by foreign investors.
When developing country dollarization they can stabilize the currency, exchange rate. When
those countries use a high confident and good quality currency like dollar in economy is no
possibility of a sharp depreciation, and sudden capital outflows because of investor unconfident
is also omitted. Second, dollarization can highly reduce transaction cost and integrate
developing economy closer to US. Thirdly, the stability of dollar in the economy as currency in
developing countries will encourage people to save more and foreigner to invest more.
However, dollarization is costly. Government of developing countries need to scarify
seigniorage benefit in dollarized economy and the Central bank losses its role of lender of last
resort to the commercial bank in case there is liquidity problems. Moreover, the states will lose
its sovereignty in term of monetary policy and exchange rate policy. Thus, it is a critical decision
to whether or not to dollarize in developing countries because they have to compare the
benefit of dollarization the cost to bear it as well as balancing the internal risk with external
risk.

• Should states liberalize people choice in using currency they like or impose people to
  choose national fiat money?

According to Laurence H. Meyer, a member of the Board of Governors of the Federal
Reserve System when there is more global financial integration the government should increase
role in market discipline, regulation and also supervision in money and also exchange rebate.
The states should improve the international capital standard, market discipline. The state has
monopolized the authorization on Money discipline by introduces national currency to show
the self‐help system in term of currency and also gains seigniorage benefit. However, Randal
Krozner, an economist at the University of Chicago’s Graduate, rejects the role of government
in currency circulating. He claim that private regulation found in private actors such as clearing
house, credit rating agency, trader, capitalist investor, and others has provided stability and
innovation because they work closely to financial and currency market. He advises that the
government should reduce the intervention in the financial and monetary system and let the
dynamic private sector to regulate the system. In short, while some scholar support
government role in regulation the currency market, some other reject it and promote the
private regulation instead. It is a difficult decisions of a state, however, to loss its sovereignty in
term of currency. Yet that does not mean the stability in the market force by private sector is
not important. Eventually, the second debate becomes a difficult decision.

• Should IMF play important role in the world exchange rate stability?

The third debate is about the role of IMF as the financial stabilizer. IMF is theoretically
very important to stabilize the exchange between states. When the government is unable to
pay the debt or has large budget deficit the IMF will provide short time fund to finance the debt
or budget deficit. The countries that have short term balance of payment problem will get
financial assistant to help them maintain the stability of exchange rate. For, example during
Asian financial crisis IMF provide fund to Thailand, Indonesia, Philippine to help them come out
of the crisis. Nowadays, the fund is larger and term is longer. However, an Economist historian
form Rutger University, claimed that the because of its moral hazard problem IMF should
reduce its current role. When the state economies are always backed by help IMF they may
reduce to effort to strengthen own monetary and budget policy and they tend to borrow and
spend more because whenever they get problem IMF will help them. Moreover, when borrow
are expected to get money pay the debt even when they cannot pay the debt they will likely to
borrow more and dare to bear more risky investment. For example, in 1990s there was a
widespread debt crisis in Latin America countries receive much help from IMF and after that
they still borrow much money for other countries. Then, when they borrow too much they still
thought IMF will help them again. This, problems create distrust in local currency in those
country that make local people turned to dollar currency instead. Thus, IMF can play an
important role in financial crisis by providing short‐term debt financing but it also open door to
crisis by creating moral hazard.

Cambodia only faces the problem of two former debates about the dollarization and role of government in currency choice. However, Cambodia haven’t experience high debt crisis as Latin America although Cambodia used to receive temporarily fund from IMF twice in 1994 and 1999 to fill the government budget deficit.