Measuring Persistent Currency Substitution:

The Case of Cambodia

Vichetrath Meas

Motivation

Controversy over defining Currency Substitution :

McKinnon(1982):
CS :Foreign Currency + Foreign Currency denominated Bonds

Calvo and Vegh(1992)

CS: when foreign currencies play three roles of money

Mizen and Pentescost(1996) and Ramirez-Rojas(1985)

CS : substitution between two currencies

Giovannie and Turtelboon(1992)

CS: complete replacement of domestic currency by other, e.g. Panama

Measurement: 2 main concepts

Stock: TFC = FCC + FCD + CBD Behavioral: measures propensity to switch to FC holdings in response to macro indicators (Exchange rate, Inflation, and Interest rate) Imrohoroglu(1994) used elasticity of substitution between U.S and Canada

Motivation
Feige (2003) proposes CSI = (FCC+FCD) /(M2+ FCC) as opposed to the common method: (DI) = (FCD)/(M2)
Despite the fact that currency substation have been studied a lot, only a few studies have been conducted.
Viseth(2001): CDI = FCD/M2, leaves out FCC and CBD Samreth(2010) uses FCD as a proxy for Foreign nominal balance in attempt to build the Money-in-service model, estimating elasticity of substitution

Girardin (2011) favors using cumulating net transfers from abroad as a proxy for stock of foreign currencies circulating in an economy.

Contribution

Use alternative model of Money Demand to estimate degree of currency substitution

Effectively determine its extent and draw some policy implications Utilize longer span of period data.

This period would capture the effects due to macroeconomic, political changes and especially those due to banking reform since 2001.

Evidences

US dollar has been the most preferred currency held in form of cash and
bank deposits.

Experience of the abolishment of money during period of 1975-79 Remaining weak confidence in domestic banks Huge foreign aids flow after the arrival of UNTAC in 1993
$1.7billion over 1991-93 came from UN peacekeeping force expenditure

Economic liberalization and opening to trade and investment

In1995, the ratio of FCD/M2 was 56.4%, the highest among countries in the region, escalated to almost 75% in 2006(Viseth 2003).

Evidences

Evolution of the Detailed Composition of the Money Suply(M2)

Methodology

Foreign Currency Substitution(FCS) =

for t = 1992q1, , 2010q4

Currency Substitution Ratio

= 2

Methodology

Divide the data into two subsamples:

Data from period of 1980 1991: close economy, slow growth, low inflation Data from period of 1992- 2010: flows of foreign currency(foreign aids, transfers), exchange rate volatiles: 700 Riels/USD to 2700Riels/USD from 1992 1993(IMF) Triple digit inflation of 112.5 percent in 1992 (Viseth, 2001)

First-stage: estimate coefficients

= 0 + 1 , + 2 + 3
where t = 1980q1, , 1991q4

Second Stage: Use the parameter estimates to estimate the real money balance from 1994 to 2010

= 0 + 1 , + 2 + 3
Where t = 1992q1, , 2010q4

Expected Results
Variable , RGDP Inflation Expected sign of + -

Given the low remaining confidence in banking system and increasing inflow of foreign funds, high share of foreign real balances in providing liquidity services in Cambodia We, therefore, expected increasing CSR

References

Mizen Paul and Pentecost Eric J., Evaluating the Empirical Evidence for Currency Substitution: A Case Study of the Demand for Sterling in Europe
Samreth Sovannaroeun (2010), Currency Substitution and Seignioragemaximizing inflation: The Case of Cambodia Viseth Kemreat (2001), Currency Substitution and Financial Sector development in Cambodia. Girardin Eric (2011), Chapter 6: Measuring Dollarization, Dealing with Multiple Currencies in Developing Countries, IMF 2011. Feige, Edgar L. (2003), The Dynamics of Currency Substitution, Asset Substitution and De Facto Dollarization and Euronization in Transition Countries

Question?