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Peso and Dollarisation UPSC NOTE

 What is Peso ?

  • The peso is the official currency of several countries in the south Americas.

  • It is derived from the Spanish word for "weight"

  • The peso was first introduced in Spain in the 16th century, and it quickly spread to its colonies in the Americas

  • The peso was a major currency in the Americas for centuries, and it is still used in many countries today.

Here are the countries that use the peso as their official currency:

  1. Argentina

  2. Chile

  3. Colombia

  4. Cuba

  5. Dominican Republic

  6. Mexico

  7. Philippines

  8. Uruguay

What is dollarisation?

  • Dollarisation can act as a solution to hyperinflation.

  • It will breaks the feedback link between rising prices and rising money supply

  • If the domestic currency is replaced by dollars.

  • So money supply can no longer be controlled by vested political interests who can increase spending for political ends. 

  • The incessant rise of prices would be forced to moderate since consumers would no longer be able to access currency easily, thus slowing down consumption demand.

  • Dollarisation can also have positive effects on growth. 

  • Since a small economy can only access dollars through foreign trade and/or capital inflows.

  • It would incentivise the economy to focus on export successes and easing conditions for foreign capital.

  • This leads to invest in an economy with a stable currency

  • The stable value of the dollar would ensure that economic agents would be able to make long-term plans regarding economic activity, plans that would otherwise not be possible under a currency that rapidly lost value.

The experience of Ecuador

  • Theory aside, the experiences of some countries hold out promise for the project of dollarisation.

  • Three fully dollarised economies — Ecuador, Panama and El Salvador.

  • They have had successful economic outcomes following dollarisation, 

  • The Ecuadorian economy suffered a series of debilitating crises in the late 1990s, with economic output contracting by almost 7%, inflation at roughly 67%.

  • The domestic currency of Ecuador, the Sucre, depreciating by almost 200% in 1999

  • President Jamil Mahuad announced the adoption of the dollar in January 2000.

  • The economy has shown considerable progress since then, on parameters measuring both economic growth and social welfare. 

  • The World Bank estimates a growth of 4.5% in real GDP between 2001 to 2014

  • The poverty rate fell from 36.7% in 2007 to 22.5% in 2014, with inequality, as measured by the Gini index, falling by 9 percentage points over this period

  • During the 2008 recession, the economy lost only 1.3% of GDP.

Challenges in Dollorisation

  1. When a country adopts dollarization, it forfeits control over its monetary policy, which is now determined by the US Federal Reserve. This can limit the country's ability to address its own economic conditions and respond to crises.

  2. A dollarized economy becomes highly susceptible to fluctuations in the US dollar. Changes in US interest rates and exchange rates can have a significant impact on the domestic economy, potentially leading to economic instability.

  3. Seignorage refers to the profit generated by the government when it prints money

Under dollarization, the government loses this source of revenue, potentially affecting its ability to fund public services.

  • Reversing dollarization can be a complex and challenging process. Once the dollar has become deeply embedded in the economy, transitioning back to a domestic currency may involve significant costs and disruptions.

  • The widespread use of a foreign currency can diminish a country's sense of national identity and cultural pride. It can symbolize a loss of economic sovereignty and dependence on foreign powers.

  • A dollarized economy is more susceptible to the transmission of financial shocks from the US economy. This can lead to increased volatility in domestic financial markets and economic instability.

  • The dominance of the dollar can give the US government significant power over other economies. This can raise concerns about potential misuse of this power for political or economic gain.



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