Foundations
Dollarization
It is important to note that the distribution of humanitarian assistance in foreign currency (such as USD) does NOT necessary lead to the dollarization of the economy. Often times, participants will have to exchange the USD into local currency to be able to effectively use their entitlements.
What are we talking about?
There is often some confusion around the use of the term dollarization. First, dollarization actually refers to the process of a foreign currency replacing a local currency in terms of use in the economy. It can be any currency, not just the USD! (But the term 'euro-ization' is a lot less easy to pronounce...)
Technically, dollarization means the use of USD for direct payments & exchanges in the economy. In the humanitarian sector, the term dollarization is also used to talk about the distribution of assistance in USD rather than in local currency.In the humanitarian sector, the term dollarization is also used to talk about the distribution of assistance in USD rather than in local currency.
The dollarization of an economy is usually a progressive process over time. Typically, we observe dollarization when prices start to be displayed in USD in marketplaces and shops start accepting payments in USD. It is important to note that the dollarization of an economy is often a semi-permanent solution to high depreciation. When the local currency starts being replaced by a foreign currency, it is difficult to go back.
In an economy that is partially dollarized, providing assistance in a currency which is a store of value offers additional options to beneficiaries who can decide whether to exchange it or to keep it.
Why do we care?
Do we.....?
Dollarization of the economy mostly presents longer term risk for the country that uses it as it basically turns its capacity to leverage monetary policy and fiscal policy tools.
It mainly impacts humanitarian organizations with regard to liquidity constraints. If there are constraints to the use of the local currency, the dollarization of the economy opens eventually the possibility to provide assistance directly in a foreign currency without transferring the risk of exchange on participants.
In the humanitarian community, a different conversation about when it becomes appropriate to consider 'dollarizing' assistance usually takes place over time.
One impact that dollarization has on the population is that it creates new sources of power and new sources of vulnerabilities depending on which specific groups in the population have access foreign exchange or not and which groups control foreign exchange. It is thus important to understand who has access to liquidities in foreign currency.
For humanitarians, dollarization of an economy mostly presents opportunities, as it simplifies the decision to switch operational payments, and possible programmatic payments as well, into USD.
How do we monitor it?
To monitor the dollarization of the economy, we look at the currency that is used by the population in daily exchanges (in marketplaces, in shops, to pay for specific commodities like rent, electricity, water, etc).
But dollarization can be progressive and usually starts with more 'invisible' payments. To anticipate dollarization, we can monitor what proportion of their wealth the population is holding in USD on average. This gives a good indication of how 'liquid' the USD is in the economy.