Can Dollarisation Cope with External and Fiscal Vulnerability?

Abstract

In order to make emerging markets less vulnerable to external shocks, exchange-rate corner solutions such as dollarisation have been proposed. One of the main arguments put forth by the dollarisation supporters is the expected decrease in sovereign spreads, as currency risk will no longer hold. According to this optimistic view, which also relies on a credibility spillover effect, such a decrease could start to improve solvency weaknesses while boosting economic growth. Pessimists, on the other hand, have emphasised alternative policies focused on improving competitiveness and bolstering structural reforms. In this article, we aim to shed some light on these crucial issues through an examination of the Argentine case. First, we will show that the benefits of reducing dollar interest rates would be limited and un certain : only peso debt-a minor part of total liabilities-would yield safe lower spreads. Second, we will provide empirical evidence on how A rgen tina's external and fiscal vulnerability sharply worsened from 1994 to 1999, as reflected by sovereign ratings and bond spreads. Third, we will argue that dollarisation does not seem to be the best policy to improve fiscal dis cipline and push forward structural reforms. The results of this analysis suggest that, irrespective of dollarisation, there might be room for other policies to strengthen solvency, e.g., bolstering incomplete structural reform, export promotion, or better fiscal management.