The Cambodian Case for Dollarization

15 February, 2011
Wall Street Journal

Phnom Penh should use its stock exchange opening later this year as an opportunity to formally adopt the U.S. dollar.

Cambodia doesn't get a lot of attention on the world stage, but it deserves a closer look because of the way its economy has quietly exceeded expectations in recent years. Growth has been running at near double-digit rates over the last decade, and the country is attracting significant foreign investment, particularly in the textile and tourism industries. A big part of this success is due to its use of the U.S. dollar as its primary currency.

The government didn't orchestrate this monetary reform; in fact it resisted most of the way. But Cambodians voted with their wallets, shunning the Cambodian riel and demanding dollars.

This is no doubt due to the country's tragic history, which made its people especially aware of the mischief governments can play with currencies and property rights. The same Khmer Rouge that killed one-quarter of the population in the late 1970s also abolished money and title to land. Though the riel came back into circulation in 1979, people preferred to use the Thai baht initially and then, once international aid poured into the country in the early 1990s, the dollar.

The use of the dollar has soared since then, accounting for 90% of the currency in circulation today and 97% of banking deposits. Most banks don't even lend in riel.

This has brought the country a level of monetary stability it couldn't have achieved on its own. The Asian Development Bank notes that while inflation averaged 56% from 1990-98, it declined to 3.5% for most of last decade—a period the dollar took over.

That in turn created the foundation for greater investor confidence. The financial sector deepened, and foreign direct investment rose to $3.5 billion in 2007 from $38 million in 1990.

Now Cambodia faces an important decision as it prepares to start up a stock market in July. Last month, regulators convened a public workshop to decide whether to denominate stock prices in riel, dollars or both.

Not only would riel listings add costs and confusion in a largely dollarized economy, it would create an additional risk for international investors, driving them away. Instead, Cambodia could use the exchange opening as an opportunity to embark on formal dollarization.

In a neighborhood where governments debase their fiat money—Vietnam devalued the dong by 8.5% last week—Phnom Penh would stand out all the more by making a commitment to stick with the dollar. A stable unit of account for investment as well as trade after all was one key to Hong Kong's transformation from shanty towns to financial center in a single generation. Cambodia also shares Hong Kong's low, flat income tax and few barriers to trade and investment.

The country faces significant problems that Hong Kong never had though, including an autocratic ruler who has undermined civil liberties and the rule of law. But mitigating these shortcomings is part of the reason Cambodians use the dollar in the first place, and the fact that their savings cannot be held captive will gradually strengthen their ability to demand change from their government. Cambodia is providing a fascinating case study in the power of dollarization to promote development in even the most devastated and poverty-stricken of countries.