Impact of Remittances on Natural Rate of Dollarization—Trends in Caucasus and Central Asia

WP/20/185Impact of Remittances on Natural Rate of Dollarization—Trends in Caucasus and Central Asia Rocio Gondo, Altynai Aidarova, and Manmohan Singh IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 2© 2020 International Monetary Fund WP/20/185IMF Working Paper Monetary and Capital Markets Department Impact of Remittances on Natural Rate of Dollarization—Trends in Caucasus and Central Asia Prepared by Rocio Gondo, Altynai Aidarova, and Manmohan Singh Authorized for distribution by Jihad Alwazir September 2020 Abstract This paper discusses migration and remittances trends, and calculates the natural (or benchmark) level of dollarization in Caucasus, Central Asia and others in the region. This natural level of dollarization is conceptually linked to the currency allocation in a portfolio of deposits to maximize welfare, in line with Ize and Levy Yeyati (2003). The fall in remittances due to the economic slowdown since the spread of COVID-19 affects the macroeconomic fundamentals that determine demand for foreign currency deposits. We calculate the natural dollarization level by integrating structural macroeconomic characteristics. We show that despite the reduction in deposit dollarization, there is still a gap with respect to the natural level of dollarization, especially in a scenario of (persistent) lower remittance inflows. JEL Classification Numbers: F24; F22; F30 Keywords: natural rate of dollarization, Russia, COVID, remittances, Central Asia, Caucasus Author’s E-Mail Address: msingh@imf.org; rocio.gondo@bcrp.gob.pe; aaidarova@nbkr.kg; IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 3 Contents Page Abstract ......................................................................................................................................2 I. Introduction ............................................................................................................................4 II. Stylized Facts about Remittances and Dollarization .............................................................5 III. Determinants of Remittance Inflows and Estimation for Remittance Drop in 2020 ...........9 IV. Estimation of Natural Level of Dollarization and Impact of Drop in Remittances ...........13 References ................................................................................................................................18 Tables 1. Bilateral Remittances, 2017 ...................................................................................................6 2. Loan and Deposit Dollarization .............................................................................................7 3. Real GDP Growth Forecast .................................................................................................10 4. Exchange Rate per U.S. dollar .............................................................................................11 5. Natural Rate of Dollarization, 2020 .....................................................................................17 Figures 1. Remittances as a Share of GDP in 2019 (in percent).............................................................6 2. Dollarization and Remittances ...............................................................................................7 3. Predicted Percentage Change in Remittances, 2020 ............................................................12 4. Predicted Percentage Change in Remittances, 2020 ............................................................13 5. Natural Rate of Dollarization, 2019 .....................................................................................16 Box 1. Trends in Migration and Remittances in Post-Soviet Republics ...........................................8 Appendices I. Natural Rate of Dollarization Regressions ...........................................................................19 II. Regression Results from the Gravitational Model for Remittances ....................................20 III. Predicted Change in Remittances in the Current Scenario: Interval between Different Regression Specifications ........................................................................................................21 IV. Predicted Change in Remittances in the Counterfactual Scenario: Interval between Different Regression Specifications ...........