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Although the law to implement dollarization in El Salvador was initially rejected, a recent book by researcher Claudio De Rosa points out that the dollar helped stabilize inflation in the country.
This past January (2023), El Salvador celebrated 21 years since it officially adopted the US dollar. The process was carried out under the Monetary Integration Law (LIM) that, at the time, was rejected by the Salvadoran population.
The initial adoption of the new currency meant significant social change, above all, because Salvadorans had to educate themselves and learn, little by little, what the conversion values between the Salvadoran colon and the dollar were.
Dollarization in El Salvador took time to gain acceptance
Because the dollar is (still) equivalent to 8.75 colones, for a long time, the population continued thinking in colones and calculating their expenses in income in the Salvadoran currency. However, with the passage of time, and the increasingly substantial income of dollars to the economy (through remittances), dollarization in El Salvador became more accepted.
To analyze the path of this process, more than two decades later, Claudio De Rosa, a researcher at the Public Policy Observatory (OPP) of the Francisco Gavidia University (UFG), Recently introduced a book entitled, Twenty-One Years of Dollarization in El Salvador: Myths and Realities.
In this publication, the researcher addresses the main objectives pursued by dollarization in El Salvador and the results that can now be analyzed.
One of the most important conclusions reached by the analysis is that, ultimately, introducing the US dollar in the country helped the inflation rate stabilize and remain close to the United States. This was precisely one of the objectives of the action.
Suppose the data reflected in the publication are reviewed based on official information from the Salvadoran Central Reserve Bank and the United States government. In that case, it can be noted how, in the years before the entry into force of the LIM, the inflation rate in the country was extremely high. This was especially the case during the decade of the 80s.
Use of the US Dollar stabilized inflation
For example, the oldest data reflected in the book dates from 1984, and at that time, inflation in the United States was around 4.3%, while El Salvador was above 9%. However, the difference did not widen until 1985, when the index soared above 31% in El Salvador, while in the US economy, it stood at 3.6%.
In the following years, although they showed an improvement in inflationary terms and were well above inflation in the North American country. In 2001, the picture changed with dollarization in El Salvador.
The data of these last 21 years reflect how Salvadoran inflation remained stable. This is something that De Rosa acknowledges, and he points out that the issue has been considered in the national arena in the last two years.
This refers to the fact that, after the onset of the Covid-19 pandemic, the actions of governments and the high demand for goods caused a world collapse and triggered inflation rates. This phenomenon was not alien to El Salvador. However, the country’s inflation rate remained, at all times, below the United States. The worst peak of inflation in the United States rose to more than 9%, while in El Salvador, the highest figure reached was 7.76 % in June 2022.
However, De Rosa points out that it is impossible to affirm that inflation in the country could have been worse in recent years if it had continued only with the colon. This is because the so-called exchange regime existed before the LIM was enacted. Had this been run efficiently, it probably would have also helped drive down those rates.
For this reason, the economist and former Minister of Finance in the country between 1994 and 1999, Manuel Hinds, points out that “despite all the financial problems in the world, including inflation and the high-interest rates that the Federal Reserve has recently set in the United States, El Salvador is very stable,” something that he attributes to dollarization in El Salvador. Hinds proposed this law during the period in which he was head of the Salvadoran Treasury.
Likewise, Hinds affirms that the book published by De Rosa “has come out at the right time, since after 20 years it is a sufficient period to determine what the experience with dollarization in El Salvador has been like.” An examination can be made of which objectives have been met.
However, the issue of inflation was one of many objectives that were sought with dollarization in El Salvador. Therefore, the move to the US currency was also made to reduce interest rates and extend credit terms in the country. According to De Rosa’s research, this has been achieved in the 21 years that the dollar has been used as the means of commercial exchange in the country. Currently, interest rates are around 6.35% on credits corresponding to terms between 5 and 20 years.
De-dollarizing is not an option
Another of the points that the book highlights is that if the LIM were reversed and the country de-dollarized, the cost would be very high for the Salvadoran national economy. This is because the cheapening of commercial credits would likely be reversed, significantly affecting the economy’s growth potential.
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