De facto dollarisation

LAHORE: Partial or de facto dollarisation is a practice in which local currency remains the exclusive legal tender of a country, but financial transactions and payments are allowed to be denominated in dollars, has been around in Pakistan for a long time.

We have seen many schools and institutes charging fees in rupees based on the value of dollar. In other words, the school fees increase or decreases in line with the value of rupee against the greenback.

Many executives these days negotiate their salaries in dollar terms. A decade earlier only businessmen used to accumulate dollars to shield themselves from the regular weakening of rupee. However, given its growth, now even housewives are buying dollars using their savings as apposed to gold in some cases.

This is going on despite central banks restrictions on dollar trading in the open market. We see that informal market catering to small savers of Rs18,000 with a $100 note. One can safely say that bi-currency system is effectively operating in our country. Having lost faith in local currency Pakistani entrepreneurs have started using dollar as a benchmark in business dealings, which economists fear could move the country towards de facto dollarisation of economy.

This new trend is in line with what entrepreneurs in other troubled economies have been doing for decades. For instance, during strict US trade restrictions, the informal economy in Cuba primarily relied on the US dollar. The high and unstable inflation rates have gone out of hand in Pakistan because the state has increased the money supply to finance higher levels of government spending. High and unstable inflation rates result in a more unstable investment climate and a lower rate of economic growth evident in Pakistan.

Individuals who bring their goods and services to the international marketplace are unfairly punished and rightfully discouraged when currency movements turn legitimate profits into foreign exchange losses.

They then look for ways to protect their interests by converting to a stable and reliable international currency.

Unofficial dollarisation at a lower level has been in the country since the 1990s. Apart from many elite schools that charged their monthly tuition fee in dollars, salaries of several employees in the big corporate sector were pegged to dollars. The state itself promoted dollarisation when it signed agreements signed with the independent power producers during 1993-1996 in which guaranteed rate of return on investment was in US cents per unit instead of rupee. The same practice is being followed by all foreign investors that come to Pakistan on sovereign guarantee of the government of Pakistan. This practice has protected them from all types of economic problems in Pakistan.

According to International Monetary Fund (IMF), dollarisation can take multiple forms. Official (de jure) dollarisation occurs when the US dollar is adopted as the predominant or exclusive legal tender. In countries where legal tender is the local currency, but transactions are pegged to the value of dollar, de facto dollarisation has sped up in Pakistan in recent years.

It is useful, in turn, to distinguish between payments’ dollarisation (the use of foreign currency for transaction purposes), financial dollarisation (residents’ holding of financial assets or liabilities in foreign currency), and real dollarisation (the indexing, formally or de facto, of local prices and wages to the dollar).

There is a serious debate going on in the domestic manufacturing sector to fix the rates of products in US dollars to bring stability in prices and cushion themselves from ever-increasing inflation and volatility of local currency. In fact, we have already seen rates of many locally-produced products (even from local inputs) increasing in line with the increase in value of dollar against rupee.

De-facto dollarisation shields the businesses from inflation and decline in rupee value but burdens the consumers with higher rates. Despite dollar being used as a benchmark for business transactions, the government of Pakistan is unlikely to go for de jure dollarisation of economy because of some substantial drawbacks in adopting a foreign currency.

This would deny the government the option to print its own money, thereby depriving the state of its ability to directly influence its economy, including its right to administer monetary policy and any form of foreign exchange regime. Moreover, the central bank would lose its ability to collect ‘seigniorage’ that is the profit gained from issuing coins and printing notes (the minting and printing of monies costs less than the actual value of the notes or coin).