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Mahesh

28/11/23 13:43 PM IST

Can dollarisation save an economy?

In News
  • Javier Milei, the recent winner of Argentina’s presidential election, has drawn attention for his unconventional and worrying views, such as his opposition to abortion and his ambivalent attitude towards the torture and undemocratic excesses of Argentina’s military government.
Dollarisation
  • Dollarisation can act as a solution to hyperinflation by breaking the feedback link between rising prices and rising money supply.
  • If the domestic currency is replaced by dollars, so the theory goes, money supply can no longer be controlled by vested political interests who can increase spending for political ends.
  • The incessant rise of prices would be forced to moderate since consumers would no longer be able to access currency easily, thus slowing down consumption demand.
  • Dollarisation can also have positive effects on growth.
  • Since a small economy can only access dollars through foreign trade and/or capital inflows, it would incentivise the economy to focus on export successes and easing conditions for foreign capital, who would be more willing to invest in an economy with a stable currency.
  • The stable value of the dollar would ensure that economic agents —both foreign and domestic — would be able to make long-term plans regarding economic activity, plans that would otherwise not be possible under a currency that rapidly lost value.
Concerns
  • The adoption of dollars as a currency implies that economies lose an important source of policy leverage, with monetary policy now unable to control money supply.
  • On the foreign trade front, countries would no longer be able to take recourse to depreciation to boost exports, focusing only on export promotion to stave off downturns.
  • Some proponents of dollarisation see this as a positive outcome, since it would ensure the government resorts to productivity boosting methods to combat recessions, instead of changing exchange rates.
  • Three fully dollarised economies — Ecuador, Panama and El Salvador — have had successful economic outcomes following dollarisation.
Ecuador Example
  • The Ecuadorian economy suffered a series of debilitating crises in the late 1990s, with economic output contracting by almost 7%, inflation at roughly 67%, and the domestic currency, the Sucre, depreciating by almost 200% in 1999.
  • President Jamil Mahuad announced the adoption of the dollar in January 2000; widespread protests following the move forced him to resign two weeks after the announcement. Despite this political upheaval, Ecuador persisted with dollarisation.
  • Ecuador is helped by significant reserves of oil and gas.
  • The commodity price boom of the 2000s greatly aided the growth of the economy and allowed for a greater inflow of dollars.
  • Subsequently, the reduction in oil prices after 2014 saw a reduction in economic growth and rising debt and deficit levels, bringing new challenges to the economy.
Way Forward
  • Dollarisation, therefore, is not a silver bullet, but if used well in conjunction with nimble domestic policy, can offer a route to success.
  • But with a president-elect that brandishes a chainsaw to indicate his desire to slash government spending, and who has asserted that he will abolish the Central Bank, policy in Argentina might find its sphere reduced under the Milei administration.
  • The world awaits the results of yet another macroeconomic gamble played out on the backs of a suffering populace.
Source- The Hindu

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