Web Page Maker : Make your own web page easy!

Economic Analysis. Issue 1, 2011

Is the Stock Market the Appropriate Tool for De-dollarizing the Economy?

Dr. Kang Chandararot

March 19, 2011

Dollarization is a common currency problem in developing economies and transitional economies, where macroeconomic instability such as long term budget deficits and trade deficits exists. Dollarization occurs because of lack of confidence in domestic currency. It is a market driven phenomenon. Because dollarization creates constraints for macroeconomic management and policy, each dollarized country tries to force de-dollarization of its economy in a way that is not market confirming.

In Cambodia, some people are prescribing to use the stock market as a tool to de-dollarize the economy by requiring securities to be listed in riel. They claim that this restriction would increase the use of the riel. This method is not market confirming.

The primary function of the stock exchange is to mobilize capital for financing the economy. It is too risky for economic stability to use it as an economic tool to de-dollarize because the public is not ready to join the process of de-dollarization.

Let us consider the scenario of denominating stocks in riel and the public buys stocks in riel. In a dollarized economy, when there is macroeconomic problem, for instance, inflation brought on by a price hike in oil or devaluation of the US dollar on international markets, policymakers cannot use monetary policy to restrain the inflation. Policymakers could try to combat the problem by subsidizing oil prices or increasing production, but these tools are mostly not available for policymakers. Thus, the inflation situation is out of Cambodia's control, and depends on oil supply development, world demand and value of the USD on the international market.

In this respect, stockholders would see a loss of capital value and would rush to sell regardless of the profit situation of the company. After cashing out on their riel-denominated stocks, they will rush to exchange for US dollar. These two steps of market reaction would create a negative situation for companies and worsen the value of the riel, even against a weak US dollar. In addition to inflation, Cambodia's economy would be beset with other problems such as growth instability and devaluation of the riel, which is counterproductive to the policy purpose of de-dollarization.

This example clearly predicts that to use the stock market as a de-dollarization tool in a situation where macroeconomic stability is not secured is risky not just for economic growth but also on the confidence and success of the stock market, and could inversely deepen dollarization.

What if stocks are denominated in US dollar? Next issue…