CONTRIBUTORS
Nicholas Hardingham, CFA
Portfolio Manager, Franklin Templeton Fixed Income
Stephanie Ouwendijk, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income
Robert Nelson, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income
Joanna Woods, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income
Carlos Ortiz
Research Analyst, Franklin Templeton Fixed Income
Jamie Altmann
Research Analyst, Franklin Templeton Fixed Income
Preview
Inspired by President Javier Millei’s proposal to dollarise Argentina, this paper explores the phenomenon of dollarisation, where countries adopt a foreign currency, most commonly the US dollar, to address economic challenges and goals.
Various factors fuel the move towards dollarisation, and monetary stability is the primary catalyst among them. As such, nations facing economic turmoil, marked by currency devaluation and hyperinflation (for example, Ecuador and Zimbabwe), see dollarisation as a fast track to restoring economic equilibrium. Meanwhile, countries with open economies and robust private sectors (such as Panama), lean towards dollarisation to enhance trade and economic stability. This strategy is especially beneficial when the adopted currency aligns with a nation's principal capital and trading partners. The relationships between the United States and Panama, the eurozone and countries like Montenegro/Kosovo, and South Africa with Lesotho/Eswatini are examples. Additionally, cases like El Salvador highlight a desire to bolster already-established monetary stability to further attract foreign investment and instil confidence in the national economy.
In this paper, we differentiate between full and soft dollarisation and the reasons driving these different shades of dollarisation. We consider the following:
- Forms of dollarisation
- Dollarisation, a cost-benefit analysis.
- The process of dollarising.
- Case study: Argentina eyeing dollarization
- The double-edged sword of Zimbabwe's multicurrency regime
- Does dollarisation actually work?
The impact of dollarisation on economic growth is seemingly mixed. Given the small subset of countries that have dollarised, it is difficult to draw hard conclusions other than that it has had a seemingly positive effect on these particular countries. The mixed evidence on the impact of dollarisation means that applying what occurred in dollarised economies to others may not be totally applicable given their unique characteristics and the lack of external validity of prior research. Therefore, a country would need to assess their own unique circumstances before taking the leap to dollarisation and ensure it meets certain preconditions before it does so.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically.
Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors.
Sovereign debt securities are subject to various risks in addition to those relating to debt securities and foreign securities generally, including, but not limited to, the risk that a governmental entity may be unwilling or unable to pay interest and repay principal on its sovereign debt. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.