Template-Type: ReDIF-Paper 1.0
Title: Financial Dollarization in Emerging Markets: An Insurance Arrangement
Author-Name: Husnu C. Dalgic
Author-Email: dalgic@uni-mannheim.de
Classification-JEL: E32, E43, E44, F32, F41, F43
Keywords: Emerging Markets. Financial Dollarization. Corporate Dollar Debt. 

Abstract: Households in emerging markets hold significant amounts of dollar deposits
while firms have significant amounts of dollar debt. Motivated by the perceived
dangers, policymakers often develop regulations to limit dollarization. In this
paper, I draw attention to an important benefit of dollarization, which should be
taken into account when crafting regulations. I argue that dollarization repre-
sents an insurance arrangement in which the entrepreneurs that own firms pro-
vide income insurance to households. Emerging market exchange rates tend to
depreciate in a recession so that dollar deposits in effect provide households with
income insurance. With their preference for holding deposits denominated in dol-
lars, households effectively starve local financial markets of local currency, which
raises local interest rates. By raising local currency interest rates, they cause
entrepreneurs to borrow in dollars. Consistent with my argument, countries in
which the exchange depreciates in a recession have a higher level of deposit and
credit dollarization. In those countries, I verify that the premium of the local
interest rate over the dollar interest rate is higher. This premium is the price
paid by households for insurance.

Note: 
Length: 58
Creation-Date: 2018-11
Revision-Date: 
File-URL: https://www.crctr224.de/research/discussion-papers/archive/dp051
File-Format: application/pdf
Handle: RePEc:bon:boncrc:CRCTR224_2018_051