Names:

Dng Thy Dng (Formula, Solution, Current status:

banking operations, trade, reaction, results, Conclusion)
Nguyn Th Hng Tm( Impact, Current status: banking
operations)
o Hi ng ( Causes)
Nguyn Hong Qun ( Forms of Dollarization)
Nguyn Hong Dng ( Introduction + tng hp, lm slide)
Nguyn Th Thy Dung ( Definition, Conclusion)
*****
Dollarization in Vietnam:
Advantage and Disadvantage
I ntroduction
In recent years, Dollarization becomes a familiar word in Vietnam. Nowadays,
Vietnam is amalgamating into the global economy, thus Vietnam has to use U.S
dollar in trade and invest activities. Additionally, the habit of use of U.S dollar in
daily activities and trading activities of Vietnamese people and firms lead to the
dollarization ratio of Vietnam higher than countries in the same area. Therefore,
dollarization is a hard situation in Vietnam now.
Due to the critical role of dollarization in the Vietnamese economy, particularly the
monetary system, studying about dollarization has a very important meaning. Firstly,
it helps understand what is dollarization, when does it happen, and how to recognize
it. To identify an object is the basic step to find out its influence and the ways to adapt
to it. Therefore, with the knownledge gathered and provided in this paper about
dollarization, we also propose some solutions to the problems it causes in Vietnam.
The final and highest purpose of this paper, then, is a reference for the government,
economists, businesses, as well as the whole public to make policies or change their
behavior for the maximum social benefit.
The paper discusses dollarization in Vietnam. It starts with definition and different
forms of dollarization. We identify Vietnam as a partly dollarized economy,
characterized by a dual monetary system that significantly complicates monetary
policy. The third section is the IMFs formula to measure dollarization.The next two
sections are the status and the strong impacts on its economy. The use of dollar as a
substitute for domestic currency produces major ricks, original sin and currency
mismatch. And directly, partly dollarized economies are potentially instable and
extremely prone to financial crises. In the sixth section, we analyze why economies
are dollarized and others are not. The common obstacle for emerging economies is
their inability to borrow internationally in domestic currency due to a perceived
weakness of its currency and structure of the economy. Vietnam is identified as a
directly dollarized economy with a dual monetary standard. The U.S dollar serves as
parallel currency and quasi second legal tender. The final section discusses possible
ways and a gradual approach for Vietnam to reduce and finally abolish dollarization
of its economy.

I. Definition of Dollarization
Dollarization of the economy can be understand as in an economy when the foreign
currencies are widely used to alternative all or some functional of domestic currency,
then the economy were considered as whole or part of dollarization. Additionally,
International Monetary Fund (IMF) define dollarization as the holding by residents
of a significant share of their assets in the form of foreign- currency- denominated
assets, is a common feature of developing countries and transition economies and is
thereby typical- to a greater or lesser extent- of many countries that have IMF-
supported adjustment programs. According to the criteria of the IMF, an economy is
considered to be high dollarization situation when the proportion of foreign currency
deposits (FCD) accounted for 30% or more in the broad money (M2) included cash in
circulation, cash deposits, term deposits and foreign currency deposits. Yuma Knish,
the Asian Development Banks Vietnam director said: Dollars make up about 20%
of money used in Vietnam. This means that the dollarization ratio of Vietnam is
moderately high.
II. Forms of Dollarization
Obviously the degree of dollarization, qualitatively and quantitatively, is varying from
country to country. A number of countries has abandoned their domestic currencies
and replaced them with foreign currency.
Officially dollarized Panama and more recently Ecuador and El Salvador are
prominent examples of officially dollarized economies. Several other smaller
economies have chosen to substitute domestic currency by using dollars or euros. In
all cases the dollarized country announced unilaterally the redemption of domestic
currency and declared the U.S. dollar as sole legal tender. In most but not all cases the
institution central bank is abolished.
However, a more significant number of countries are unofficially dollarized. In these
cases dollars are used as unit of account, means of exchange, store of value, and
medium of deferred payment, while the domestic currency still exists and circulates.
The dollar functions as a quasi-second legal tender of the economy, as a parallel
currency. Among this group of countries the degree of dollarization might be almost
complete (Bolivia, Uruguay, Lebanon) or only partly, as Vietnam with slightly above
20 percent of overall bank deposits.
In addition, some countries are semi-official dollarized, a situation which occurs when
the foreign currency is legal tender alongside the domestic currency, for example
Bahamas, Cambodia, Haiti, Laos (also Thai baht), Liberia.

III. IMFs formula to measure dollarization
According to IMF , an economy is considered to be high dollarization situation when
the proportion of foreign currency deposits (FCD) accounted for 30% or more in the
broad money (M2) included cash in circulation, cash deposits, term deposits and
foreign currency deposits. There are several measures of dollarization in an economy
with unofficial dollarization. The common dollarization index (DI), used by the IMF
is measured by the the method below:
We use these variables:
DI: dollarization index
FCD: foreign currency deposits
M2: the broad money included domestic currency in circulation, demand
deposits, time and savings deposits and FCD
FCC: foreign cash in circulation
Measurement of FCC is difficult and is not included in the standard definition of the
money supply. However, in countries with high dollarization foreign currency serves
as a unit of account, store of value and, usually, as a circulating medium of payment.
Due to the lack of data on FCC, research on the currency substitution process has
been forced to accept FCD as a proxy for dollarization. The formula to measure
dollarization is:

IV. Impact of Dollarization in Viet Nam
1. Positive Effects
There are three main positive impact of dollariation.
First, rampant inflation has been dramatically stabilized. Official currency
substitution helps to promote fiscal and monetary discipline and thus greater
macroeconomic stability and lower inflation rates, to lower real exchange rate
volatility, and possibly to deepen the financial system. Firstly, currency substitution
helps developing countries, providing a firm commitment to stable monetary and
exchange rate policies by forcing a passive monetary policy. Adopting a strong
foreign currency as legal tender will help to "eliminate the inflation-bias problem of
discretionary monetary policy". Secondly, official currency substitution imposes
stronger financial constraint on the government by eliminating deficit financing by
issuing money.An empirical finding suggests that inflation has been significantly
lower in economies with full currency substitution than nations with domestic
currencies. The expected benefit of currency substitution is the elimination of the risk
of exchange rate fluctuations and a possible reduction in the country's international
exposure.
Secondly, dollarization is a tool to reduce the foreign exchange trading cost. One of
the main advantages of adopting of a strong foreign currency as sole legal tender is to
reduce the transaction costs of trade among countries using the same currency. There
are at least two ways to infer this impact from data. The first one is a significantly
negative effect of exchange rate volatility on trade in most cases, and the second is an
association between transaction costs and the need to operate with multiple
currencies.Economic integration with the rest of the world becomes easier as a result
of lowered transaction costs and stabler prices.
Third, dollarization can also increase the economys transparency. In an economy
with full currency substitution, monetary authorities cannot act as lender of last resort
to commercial banks by printing money.
2. Negative Effects
Inspire of these above possitive effects, dollariation has negative side. It will be
shown in this part.
First of all, making monetary policy and the macroeconomic policy planning less
effective Currency substitution leads to the loss of seigniorage revenue, the loss of
monetary policy autonomy, and the loss of the exchange rate instruments. Seigniorage
revenues are the profits generated when monetary authorities issue currency. When
adopting a foreign currency as legal tender, a monetary authority needs to withdraw
the domestic currency and give up future seigniorage revenue. The country loses the
rights to its autonomous monetary and exchange rate policies, even in times of
financial emergency;former chairman of the Federal Reserve Alan Greenspan, for
example, has stated that the central bank considers the effects of its decisions only on
the US economy. In a full currency substituted economy, exchange ratesare
indeterminate and monetary authorities cannot devalue the currency. In an economy
with high currency substitution, devaluation policy is less effective in changing
the real exchange ratebecause of significant pass-through effects to domestic
prices.However, the cost of losing an independent monetary policy exists when
domestic monetary authorities can commit an effective counter-cyclical monetary
policy, stabilizing the business cycle. This cost depends adversely on the correlation
between the business cycle of the client country (the economy with currency
substitution) and the business cycle of the anchor country.In addition, monetary
authorities in economies with currency substitution diminish the liquidity assurance to
their banking system.
Secondly, posing the disappearance of the state banks function of the lender and the
last resort. The alternatives to lending to the bank system may include taxation and
issuing government debt. The loss of the lender of last resort is considered a cost of
full currency substitution. This cost depends on the initial level of unofficial currency
substitution before moving to a full currency substituted economy. This relation is
negative because in a heavily currency substituted economy, the central bank already
fears difficulties in providing liquidity assurance to the banking system.However,
literature points out the existence of alternative mechanisms to provide liquidity
insurance to banks, such as a scheme by which the international financial community
charges an insurance fee in exchange for a commitment to lend to a domestic bank.
Commercial banks in countries where saving accounts and loans in foreign currency
are allowed may face two types of risks. First, currency mismatch risk which assets
and liabilities on the balance sheets may be in different denominations. This may arise
if the bank converts foreign currency deposits into local currency and lends in local
currency or vice versa. Secondly, the default risk which arises if the bank uses the
foreign currency deposits to lend in foreign currency.
Finally, dollarization results in the decrease in income from money printing tax. In an
economy with full currency substitution, monetary authorities cannot print money
anymore. Therefore, there are no benefit gain from this activity.

V. Causes of dollarization in Vietnam
It is undeniable that the US dollar become the world currency. A wide variety
of commerce use the US dollar to trade. In particular, about 85 percent of all currency
transactions across the world involve the US dollar. According to the IMF, around 45
percent foreign bond was purchased by the US dollar.
Dollarization frequently occurs in the weak economy. For example,
Hyperinflation in Zimbabwe began shortly after destruction of productive capacity
in Zimbabwe's Civil War and confiscation of private farms. During the height of
inflation from 2008 to 2009, it was difficult to measure Zimbabwe's hyperinflation
because the government of Zimbabwe stopped filing official inflation
statistics. However, Zimbabwe's peak month of inflation is estimated at
6.5 sextillion percent in mid-November 2008. In 2009, Zimbabwe abandoned its
currency. As of 2014, Zimbabwe still has no national currency; currencies from other
countries are used.
With regard to Vietnam, the literature identifies four causes for dollarization.
Firstly, loss of credibility of monetary policy due to longer periods of high and
volatile inflation rates and a devaluating exchange rate.

Source: GSO
In the first year of renovation period from 1989 to 1992, inflation rate of
Vietnam was very high such as the inflation rate of Vietnam in 1989 was 34.6%, in
1990 and 1991 was very high 67.5% and 67.6% and this rate was 17.6% in 1992. The
value of Vietnam currency devaluated sharply against the value of USD.
Consequently, gold prices was rising. As a result, many people choose to take direct
US dollars and bank deposit. Domestic commercial banks of Vietnam raised interest
rates for the domestic currency to increase money supply.
34.6
67.5 67.6
17.6
5.2
14.4
12.7
4.5
3.6
9.2
0.1
-0.6
0.8
4
3
-10
0
10
20
30
40
50
60
70
80
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Vietnam's Inflation Rate

Because inflation rate in Vietnam was high and volatile in previous
decades, nominal assets are risk and low liquidity. Therefore, the public shifts
nominal assests into another more stable currencies or into real assets, namely the US
dollar and gold.
Secondly, the limited ability to borrow domestically and abroad in
domestic currency increase foreign currency reserves. Due to the loss of credibility
and the weakness of Vietnam Dong, the government cannot borrow domestically and
abroad in domestic currency. So, the government have to borrow foreign currency.
Thirdly, the interest rate loan of US dollars on average is lower.
According to Vietcombank, the interest rate loan of US dollars on average only 2%
to 3% per year, lower only by 1/3 interest rate loan of Vietnam Dong. So, a vast of
investors choose to borrow US dollars. This will lead to the fact that the absolute
numbers and proportion of US dollars loans outstanding increased.
Finally, the psychology of Vietnamese people also influence their
savings behaviour. Particularly, a great number of Vietnamese people do not believe
in domestic currency. Consequently, they choose to send the US dollar into bank
instead of send by Vietnam Dong. Furthermore, Vietnams currency denomination is
still small compare to US dollar. The highest of Vietnam Dong has value of 500,000
but 100 dollars has value approximate 2.1 million. Therefore, in large transaction,
Vietnam firms and Vietnamese people use US dollar because of convenience.

VI. Solution to Dollarization
Dollarization is an unavoidable situation for countries with low starting point which is
in transition economies and promotes international integration such as Vietnam.
The fear of inflation, the devaluation of its currency, the habit of using cash in
transactions, etc cannot be an early, one-way elimination or reduction thoroughly. To
reduce the impacts of dollarization, some methods can be applied.
Firstly, Vietnams government can increase the legal effect of the management
regulation of foreign exchange. Every year, a lot of Vietnamese people, who live
abroad, send the foreign currency to Vietnam for their family. On the other hand,
there are plenty of domestical households and organizations want to borrow USD for
many reasons. In order to control the USD in Vietnam, Vietnams government should
narrow the organizations that are permitted to sell or buy USD. Besides, the dollars
lending by banks should be limited to borrowers with dollar revenues to limit a
currency mismatch. Vietnamese people are encouraged to use Vietnam Dong, not U.S
dollar. Vietnam needs a consistent policy of managing foreign currency
circulation in the direction of "The country of Vietnam only paid in Vietnam
dong." For this, there should be regulations on the use of foreign currency by
individuals such as individuals do not pay by U.S dollar in Vietnam, only the
State Bank of Vietnam has function of buy and sell foreign currencies. Since 2006,
the law of foreign exchange was revealed, it strictly prohibited transactions,
payments, advertising USD among organizations and individuals.
Secondly, interest ceilings for dollar deposits should be introduced in order to
discourage dollar holdings; the envisaged effect is to motivate a further shift out of
U.S. dollar denominated into VND deposits and a repatriation of U.S. dollars outside
banks in circulation.The State Bank of Vietnam has to reduce saving interest rate of
U.S dollar. For example, in the first quarter of 2011, the State Bank of Vietnam
decided to reduce the saving interest of U.S dollar. Instead of 6% to 7% per year, the
State Bank of Vietnam decided to reduce saving interest of USD to 2% per year.
Therefore, Vietnamese people will not saving by U.S dollar and change to saving
by Vietnam Dong.
Thirdly, Vietnamese people have to trust in VND. To achieve this purpose, the
government has to maintain currency values and exchange rate stability in the future.
The value of VND is reduced for a long time because of high inflation rate. Therefore,
people dont trust in VND anymore. In order to improve this stituation, Vietnam
should not devaluate our currency. The government should control the inflation and
keep the exchange rate less fluctuate. However, this solution doesnt encouraged
export and employment. So, the government and the state bank of Vietnam have to
think carefully in order to balance the benefit and the cost.
In addition, the central bank can pursue a more independent monetary policy.
Independent monetary policy means policy makers can make decisions about a
nation's money supply without interference from other elements of the government,
such as the country's legislature or head of state. This independence allows monetary
policy to be based on economic, rather than political, considerations. In contrast, this
method can cause other problems because the monetary policies can affect not only
the value of money but also the unemployment rate.
Moreover, the government can attract foreign capital into the banking system.
Reserve requirements for dollar deposits should be raised to reduce the profit margin
for banks doing dollar denominated business. It is crucial to reduce banks incentive
to attract further U.S. dollar deposits. This measure, taken by the State Bank since
2001, has been proven to be very effective.

Finally, with tight capital account restrictions in place it should be possible to reverse
dollarization as the public has no legal way to earn legally interest on dollar savings
outside the domestic banking system. The successful de-dollarization is a necessary
precondition for a more flexible exchange rate regime. With the opening of the
financial sector in the coming years and the liberalization of capital account
transaction it will be much harder to achieve this objective.
VII. Current Status of Dollarization in Vietnam
1. The expressions of dollarization in Vietnam until 2010.
Dollarization in Vietnam clearly manifested in two important areas of the
economy: trade-investment and banking operations

a. The dollarization in banking operations

Vietnams economy widely used U.S. dollar in trade ... starting to get noticed in 1988
when banks were allowed to receive foreign deposits . By 1992, the state of
dollarization has increased sharply over 41 % of the bank deposits in USD. To solve
this problem, The State Bank of Vietnam has been trying to reverse dollarization
process and economyquite successful at significantly reduced levels in dollar deposits
in banks to 20 % in 1996 . But followed the Asian financial crisis causedVietnam
currency devalued , and Vietnam continued pressure of thedollarization .
If we apply the formula above in the case of Vietnam, we can estimate the DI of
Vietnam.
Using the IMF statistic data, we determine the dollarization status through the graph:

DI of Vietnam from the first quarter, 1995 to the first quarter 2010

Source: IMF
The graph above shows the rate of dollarization in Vietnam peaked with
approximately 35% in 2001. Therefore, Vietnam is considered one of the top
countries in countries with high dollarization ratio. However, the current period (2008
- 2010) was significantly reduced from an average of 28% -30% -18% down to
16.5%. Thus, Vietnam today is not a country with a high rate of dollarization.
However, in comparison with China, Vietnams dollarization index is still much
higher.

Source: IMF

Vietnam is a partly dollarized economy with a dual monetary system. The precise
degree of dollarization, however, is hard to determine. Typically, the degree of
dollarization is measured by the ratio of foreign deposits to total bank deposits. This
measure has two pitfalls. First, it excludes foreign currency outside the banking
system. Following McKinnon, foreign currency covers all money functions, unit of
account, medium of exchange, and medium of deferred payment. For an emerging
economy with undeveloped financial markets, dollar currency holdings may represent
a very large share of foreign currency money holdings. Unfortunately, estimates of its
size and evolution are usually of poor quality. Hence, for the perspective of a central
bank dollarization complicates the business of liquidity management. Seconly, it
Excludes foreign currency borrowings abroad. A more comprehensive measure of
dollarization, however, must also include these borrowings.
Two factors contributed mainly to the dollarization process. The failed monetary
reform in fall 1985 with the consequences of dramatic increases in inflation and
depreciation of the Vietnamese Dong (VND) against the dollar until end of 1991. The
low quality of VND as store of value forced savers into alternative assets, gold and
with the opening of the economy also U.S. dollars. The low quality of VND but also
the perceived instability of the bank system is reflected in the short duration of
deposits of less than one year in average. The stabilization of the Vietnamese price
level and the nominal exchange rate of the U.S. dollar caused a reversion of the
currency substitution process. Inflation rates are single digit and very modest since
FCD/M
2
_ VN
FCD/M
2
_ China
1996. Strict capital controls helped to stabilize the nominal exchange rate against the
U.S. dollar.
b. The dollarization in trade
A field of dollarization is trade such as online sales , tradingimported products like
electronics, business restaurant and hotel. We can recognize that the prices listed in
both VND and USD in almost 100 % of the pageweb sell electronics such as
computers, household appliances , etc. Although two prices are set parallel, the actual
payment is always carried out by USD. If customer pays by VND the price of goods
will be based on exchange rates between VND and USD currency at the day trading.
These goods are usually goods that Vietnam has to import, so the price would depend
entirely on the dollar. Therefore , the joint, to avoid exchange rate risk to themselves,
forced to list prices in U.S. dollars . In addition,business listing price in USD was to
increase the "modern" , " commerce element . " It can make the dollarizations status
worse because online business will become type of major business in the future .

2. The reaction of Vietnams government against the dollarization
Since 2003, Vietnam government has also begun to attract foreigncapital by
issuing foreign currency bondsto focus on developing national key projects.
This may be one of the most effective method of attracting foreign currency
floating outside the banking systems. In addition, this solution can help reduce
the foreign debt burden of government.
Implement a flexible exchange rate regime is determined on the basis of supply
and demand currency markets regulated by the State, in order to narrowing the
distance between the market rate and the unofficial market rate.
From 2005, the law that prohibit the listing price in foreign currency, was
issued.This law which is fixed and offically applied in 2011, help to improve
the dollarization in trade effectively.
The State Bank kicked off the program on fighting against the dollarization in
2011, striving to stop the dollarization by 2020. The first thing the State Bank
did was raising the required compulsory reserve ratio for foreign currency
deposits, which aimed to enlarge the gap between the local currency and
foreign currency deposit and lending interest rates. This has forced commercial
banks to lower deposit interest rates and raise the lending interest rates in the
dollar. As a result, the dollar has become no longer attractive in the eyes of
people. Having realized that it is not profitable to keep dollars, people and
businesses tend to convert their dollar into dong. Meanwhile, commercial banks
have also found it more profitable to lend in dong than in the dollar.
The State Bank has also released the decisions aiming to reduce the foreign
currency positions of commercial banks, lowered the ceiling foreign currency
deposit interest rates. Especially, it has requested state owned enterprises to sell
100 percent of the foreign currencies they earn from exports to commercial
banks.
3. The results of avoiding dollarization in Vietnam
The comprehensive measures taken by the State Bank have brought satisfactory
achievements. The foreign currency deposits had decreased from 19.5 percent
in 2011 to 14.6 percent of the total mobilized capital, while the foreign
currency deposits ratio on the total money supply had decreased from 15.84
percent to 12.36 percent. The ratio of outstanding loans in foreign currencies
had dropped from 20 percent to 17.5 percent of the total outstanding loans. By
the end of August 2013, the ratio of foreign currency deposits on the total
money supply had reduced further to 11.82 percent. Commercial banks and
businesses, which were the foreign currency lenders and borrowers, have
become the sellers and buyers. This has helped reduce the foreign currency
outstanding loans to 11.5 percent, while the dong outstanding loans had
increased by 10.4 percent over 2012.The dollarization reduction has helped put
the foreign currency market under the State Banks control.The State Bank
once had to devaluate the dong sharply by 9.3 percent on February 2011.
However, over the last two years, the dong/dollar exchange rate has been
stabilized at VND20,828 per dollar, while the trading band has been staying
firmly at one percent (the buy and sale prices quoted by commercial banks
could be 1 percent higher or lower than the interbank exchange rate announced
by the State Bank).

Conclusion
Dollarization is an important and complex issue for Vietnams economies that
make the authorities find difficult to solve . The first challenge that policy
makers confront is the difficulty in measuring dollarization because of its
several dimensions, the shortage of reliable data and the lack of perfect
formula. To understand the status of dollarization in Vietnam, we has to use the
approxiate data, so the decision can be not relevant.

Secondly, dollarization brings not only the disadvantage but also the
advantages to the economy. Therefore, when the government enforces the laws
to improve the stituation, they can not stop the dollarization immediately to
prevent the economy from the shock. In order to solve the dollarization, the
government has to apply the comprehensive methods in the long terms.

Third, there are many reasons that lead Vietnams economy to dollarization.
Some of them can be affected to stop the dollarization in Vietnam, but the
others can not be changed by Vietnams government. Thus, we have to accept
that dollarization always exist in Vietnams economy. The government can
decrease the dollarization; however, they can not completely remove it.

Furthermores, the authorities can used a lot of methods against dollarization.
On the other hand, dollarization is a complex enough issue to not think that
simple rules are going to be the solution for every problem. Every measure to
prevent dollarization can cause the problem in other field.

After considering all of these challenge, the laws and policies to de-
dollarization taken by Vietnams government are quite successful. Among the
ASEAN countries, Vietnam is probably the one which has gone furthest in
terms of de-dollarization and we can recognize the decrease in the rate
FCD/M2 of Vietnam in earlier four year. A successful de-dollarization is
necessary given the foreseeable opening of the Vietnamese economy in the
context of WTO.