Up until the first quarter of this year, Cambodia’s riel made up just 10 percent of the Kingdom’s gross domestic product (GDP).
The ongoing promotion to encourage its widespread use began some years ago when retailers were asked to increase transactions in riel and tag their products in the local currency. The most recent push by the National Bank of Cambodia (NBC) was the compulsory implementation of a 10 percent loan portfolio in riel by banks.
The government recognised the need to increase the circulation of the riel not only to ensure a sustainable economy but also to create a sense of national pride and sovereignty.
In March this year, NBC Director-General Chea Serey said whatever the status of the use of the riel was, the move to populate the economy with the local currency is timely because the world order is changing and developing quickly. “We don’t know what would happen [but] the global market has been changing. So is global politics. This is something that the banks should be aware of and take pre-emptive action about so that it is not too late, causing them to panic,” Serey said.
So far the good economic performance of the country has demonstrated that “dollarisation” is not an obstacle to the growth and development of the financial sector, said Japan International Cooperation Agency (JICA) in a 2017 study on the policy implications of dollarisation. But it warns that dollarisation could expose the country to risks, making the economy vulnerable to external and internal shocks alike. Back in 2011, a study “Dollarisation in Cambodia: Causes and Policy Implications” by the International Monetary Fund (IMF) said that although the riel has risen in volume over the years, dollar inflows have been larger. “Banking system riel deposits have grown four-fold since the mid-2000s, indicating that the rise in dollarisation over the past decade has not necessarily come about through a substitution of riel for dollars but through dollar inflows,” said its author, Nombulelo Duma.
JICA said dollarisation is heavily prevalent in developing countries in which financial systems are still immature. Titled “Financial Dollari-sation: Evidence from a Survey on Branches of Cambodian Financial Institutions”, the 2017 study found that while dollarisation is sometimes a consequence of a weak financial system and lack of trust in local currency and governments, it undermines the monetary policy of a central bank in a country. In any case – although dollarisation has pros and cons for the Cambodian economy – de-dollarisation might also have some disadvantages.
Journey of the currency
The riel was first issued during Cambodia’s independence in 1954 but its use stopped briefly in 1975 when Pol Pot’s Khmer Rouge regime reigned until 1979. The central bank was then re-established and the riel was reintroduced on March 20, 1979.
A re-print of the currency was made on March 20, 1979, surviving for nearly two decades before it was devalued in the late 1990s as US dollars started to flood the market.
The slow insurgence of the US dollar began in the mid-1980s as the United Nations dispatched humanitarian and emergency aid. It was a time when international nongovernmental organisations were allowed to operate in Cambodia.
JICA said from 1989 Cambodia started to seek a two-tier banking system, which was a gradual reform to separate commercial banking functions from the NBC.
However, the lack of confidence in the local currency, hyperinflation and massive exchange rate devaluation of the riel against the dollar from 1988 to 1991 occurred and discouraged the public from holding their riel-denominated assets.
Two parallel worlds
The IMF study found that Cambodia has two parallel worlds. One is the urban economy which is mostly
dollar-based, benefiting from the garment, tourism, foreign direct investment and foreign aid. The other is the rural economy that is largely agricultural and riel-based.
This is stressed in a policy implications study published by JICA in 2017 that states the degree of dollarisation in the activities of an enterprise is not necessarily dependent on its size: Other factors such as geographic spread and sources of incomes and borrowings are also important.
“In other words, there is no clear trend in the use of foreign currency with regard to enterprise size. Most enterprises and, in particular the foreign ones, declare the use of US dollars as an essential part of their activities,” the study states. Enterprises say they receive revenues in dollars and pay in dollars, except for tax payments, and largely borrow in US dollars. For some enterprises, mostly in the retail trade sector, the riel is the main currency used in their financial operations. JICA observed that some large enterprises in the agro-industrial and utilities sectors, use multiple currencies including large rice millers that pay farmers or middlemen in riel or to a lesser extent Thailand’s baht to retailers, but pay workers in riel.
State-owned enterprises that provide utilities, such as water and electricity, receive their income totally in riel but convert the local currency to dollars to pay their suppliers.
“These currency mismatches potentially expose them to exchange rate losses and risk,” JICA said.
Firms can be exposed to currency mismatch risks between revenues and borrowings and between revenues and expenditures. This can be a result of borrowings in US dollars although enterprises use local currencies in their operations. In a joint study titled “Dollarisation and enterprise’s behaviours: The case of Cambodia” in 2017, JICA and the NBC examined the perception of managers of enterprises regarding expectations of exchange rate changes, behaviours and government policy relating to currency. It found that not only loans but revenues, expenditures and price quotations are highly dollarised in Cambodian firms.
“A lot of firms had either a surplus or shortage of foreign currency, meaning that they have to convert currency to meet different currency compositions between revenues and expenditures,” the study said. The study warns that enterprises that do not prepare for de-dollarisation might face damage to their operations. Thus, some policy measures, including the introduction of hedging instruments should be in place before the implementation of de-dollarisation.
The NBC should preserve the purchasing power of the riel by keeping inflation at a manageable level and the riel should not be largely depreciated, JICA said.
“So far, the stability of the exchange rate between the riel and US dollar has been serving as an anchor of price stability. It has promoted public confidence in the riel,” it added.
However, in the medium-to-long term, a more flexible exchange rate in accordance with economic fundamentals and, in particular, a bias towards riel appreciation, seems appropriate. JICA suggested that inflation targeting would be a good option in the development of a future monetary regime that can maintain price stability. “Notwithstanding the need for flexibility, the stability of the exchange rate should be maintained until confidence in the riel is strong enough. Then the exchange rate could be allowed to float in a gradual and careful manner,” JICA added.
Reserve requirement rate
There should be increased price quotations, payment of goods and services and salaries in riel, with the latter reducing the risk of households suffering losses in exchange operations.
Payment systems, which promote the greater use of riel, should be increased while also reducing cash-based transactions. Banks should enable a variety of riel notes, denomination-wise, in automated teller machines (ATMs).
The NBC contends that in the context of a highly dollarised economy, the effective conduct of monetary policy is constrained and the central bank loses its ability to act as the lender of last resort. Given that, NBC developed monetary policy instruments to achieve price stability by setting a reserve requirement rate and conducting foreign exchange intervention. In this middle of this, JICA advised that a foreign exchange market should be further developed towards a wholesome and formal market in which banks play a central role in responding to the demand for riel and to efficiently absorb foreign currency inflows to the economy.
In 2016, the NBC introduced the liquidity-providing collateralised operation (LPCO) aimed at establishing a benchmark rate for riel borrowings for the market. It followed the implementation of the negotiable certificates of deposit, a short-term interest bearing debt issued by the NBC to promote interbank lending that can also be used as collateral in interbank transactions. In short, the LPCO is seen as a tool to increase riel liquidity in the market. When the government requires sustainable financing in the future, it should seek options for long-term debt financing from domestic sources, such as issuing government bonds in riel to finance investment plans.
Foreign debt dependence
The domestic debt-financing plan would contribute to reducing dependence on foreign debt and currencies and lessen the risks associated with exchange rate fluctuations.
“If all revenue collection and payments for consumption and investments are in riel, the government would raise the currency’s demand and supply in the economy,” it says.
“Perhaps, the government can look into imposing taxes on revenues, profit and any other form of tax on operations in riel at a lower rate than the operations carried out in foreign currencies to provide incentives for economic agents to conduct their operations in riel,” says JICA.