Airlangga Summer Program 2015-Indonesia

Airlangga Summer Program 2015-Indonesia
Airlangga Summer Program 2015-Indonesia

Tuesday, June 10, 2014

Effects of De-dollarization on Cambodia’s Retail Sector under Different Scenarios



*  Introduction
During this last couple of years, Cambodia has shown a rapid growth in retail sector. The evolution of Cambodia’s retail sector is largely due to the increase of middle and high income Cambodian households. The availability of internet and cable television also contributed to the development of Cambodia retail sector as they have tuned Cambodians into abroad lifestyles (Cambodia’s Retail Evolution, 2013). There has been a surge in demand for luxury products or at least mid-tier brands in Phnom Penh lately and as a consequence, many new international brands have arrived to the capital such as Land Rover, Costa Coffee, and AEON Mall. Similarly, many new local investors also start-up their own businesses recently like Brown Coffee Shop and Master Grill BBQ Shop as they see the potential of retail sector in Cambodia. This has created a stiff competition between local and international investors which in turn helps to produce efficiency for Cambodia’s retail sector. Cambodian products need to increase quality and/or lower the price in order to compete with imported products. The retail sector in Cambodia is expected to continue its growth in the future as the GDP of Cambodia and the population in this country keeps growing. Furthermore, Cambodian consumers start to abandon traditional markets and move into supermarkets. As a result, many new international retail stores and shopping centers are also expected to open in Cambodia in coming years. Most of the transactions in retail sector and as well as other sectors in Cambodia are settled in US dollars. This is because Cambodia is a semi-officially dollarization county in which both US dollar and Cambodian Riel are legal tenders. In Cambodia, US dollars are even used more frequently and widely than Cambodian riels. According to The Phnom Penh Post newspaper, about 85% of the currency in circulation within Cambodia is US dollars (Morton, 2014). There were several events in the past that transformed Cambodia into a dollarized country. First of all, there had been an abolishment of Cambodian riels during the Pol Pot regime. Secondly, Cambodians had suffered for several times because of the hyperinflation in 1993 and 2008 which made them lost confidence in their own currency. Lastly, there had been a high influx of US dollars into Cambodia during UNTAC period.  The highly use of US dollars confers Cambodia’s retail sector both pros and cons. Some people suggest that the Cambodian government should give up US dollars and force its citizens to use Cambodian riels in all business transactions as they feel the cons of using US dollars outweigh the benefits, while others think in vice versa. In this report, we would like to analyze how the force of de-dollarization and gradual market-based de-dollarization in three different scenarios will influence retail sector in Cambodia.
*  Impacts of Force De-dollarization
To begin with, the first scenario is concerning with the force de-dollarization and inflation targeting monetary policy by maintaining fixed exchange rate. This scenario will foster several issues for retail sector in Cambodia. If the Cambodian government bans the usage of US dollars within Cambodia, there will be an increase in demand for Cambodian riels. As shown in figure 1, the demand curve will shift to the right. The increase in demand for Cambodian riels will make the riels to become appreciated. Local suppliers will experience a huge suffer if the riels appreciate too much as their products become relatively expensive to import products. Under a fixed exchange rate regime, as the demand curve increases, the supply curve also increases. The increase in supply is occurred by the intervention from government. The central bank of Cambodia can use monetary policy by printing more money in order to cope with the increase in demand for Cambodian riels. However, this action of the central bank can lead to inflation or hyperinflation. In this case, in order to prevent inflation, government implements inflation targeting monetary policy by supplying money to the economy only to a certain level. Therefore, people will have less cash available in their pockets, so they will spend lesser than they want. Whenever there is inflation, the interest rate is likely to rise because nominal exchange rate is equal to real exchange rate plus inflation. When the interest rate increases, it encourages people to save more money and decrease their consumption for goods and services in retail sector since they can earn a high return. The surge in interest rate would also hamper investors from borrowing which in turn would decrease the investment in Cambodia’s retail sector.

The force de-dollarization by maintaining fixed exchange rate and implementing inflation targeting will cause some consequences to the country such as liquidity problem, high interest rate, and transaction cost. Since government implements inflation targeting monetary policy, they will supply less riel to the economy, people will spend less due to the limitation of money supply. Also, government will increase the interest rate because government aims to encourage people to save more than spending in order to prevent the occurrence of inflation in the country. Last, transaction cost will also become a problem for a de-dollarized economy. Businesses have to convert their revenues from riels to foreign currency in order to pay for foreign suppliers. As the result, force de-dollarization in fixed exchange rate regime with inflation targeting policy will increase the demand for Cambodian riels, and cause liquidity issue to the country, high interest rate, and transaction costs in Cambodia’s retail sector.
The second scenario is regarding the force de-dollarization by conducting flexible exchange rate and inflation targeting monetary policy. De-dollarization has its costs and benefits to the retail sector. If Cambodia de-dollarizes the economy, the citizens will demand more riel to buy goods and services in the country since the usage of foreign currency is prohibited. When demand of riel increases, the excessing use of riel makes riel becomes less available for people, therefore lead riel to appreciate. Due to trade-based model, when riel appreciates, it will increase trade deficit in which import will become cheaper, and export will become less profitable. In this case, as import is cheaper, consumers will gain from purchasing foreign goods, they will buy more import goods, and domestic suppliers will suffer by earning fewer profits from selling less domestic products. In the second scenario, government also allows flexible exchange rate and implements inflation targeting monetary policy. Under a flexible exchange rate regime, since the government will not intervene the exchange rate flexibility, market will drive riel to appreciate. In addition, when demand of riel increases, it might cause inflation because government has to supply more riels to meet the demand. The situation will lead the central (National Bank of Cambodia) and policymakers to implement inflation targeting monetary policy in which the government will not having excess supply of riel in order to encourage people to spend less and save more. Therefore, it could help to stabilize the expose of inflation and lead to riel appreciation.
As we can see from figure 2, when Cambodia de-dollarize, people will demand more riel to buy goods and services which makes demand curve shift from D1 to D2. The shift of demand curve will drive the exchange rate to appreciate from 1/4000 to 1/3500.

The implementations of second scenario will cause some impacts to the country. First is liquidity problem, in order to flight inflation, government will limit the supply of riel within the country. People will have less money available to use, therefore it will cause liquidity problem. Second is high exchange rate risk, for example, if Cambodian want to buy a U.S bond, they will have to pay principal and interest in dollars, so they will face exchange rate risk due to de-dollarization. Last is transaction cost, as in first scenario stated, when Cambodia de-dollarize, the businesses in Cambodia will face transaction cost while trading with other countries, this could create a few difficulty to the retail sector.

As we can see from table 1, the growth rate of Cambodia trading with the world along the year of 2000s is rapidly increasing. The import in 2012 has increased by 31.4% and export has increased by 29.3%. If Cambodia is de-dollarized, businesses will have difficulty in converting riel into foreign currency, therefore it will reduce the amount of international trade, import and export will decline respectively, retailers will not increase import and will reduce export. Last, growth will decline and economy might become worse off.
*Impacts of Gradual market-based de-dollarization
Gradual market-based de-dollarization in Cambodia can achieve through providing higher interest rates for Riel denominated assets, implementing government fiscal policy to lower the interest on loans denominated in Cambodian riels for specific industries, and using only riels in public sector, including national companies. By giving high interest rates for Riel denominated assets, people will increase their demand for Riel denominated assets and save more. The increase in saving will decrease the consumption of goods and services in retail sector. The implementation of government fiscal policy to lower the interest on loans denominated in Cambodian riels for specific industries will not affect much on retail sector, but may benefits local producers. In this regards, domestic producers will try to find ways in order to get access to low-cost loans supported by the Cambodian government. As a result, this government fiscal stimulus will helps local producers to reduce their cost of production. Some local producers will use the funds they save from paying high interest loans to increase their productions or invest in research and development. The use of only Riels in public sector in order to increase the utility of Cambodian riels will increase the transaction costs for businesses in retail sector. Businesses in Cambodia receive most of their revenues in dollars and if the government entities and state-owned enterprises in Cambodia accept only Cambodian riels, those businesses need to exchange some of their US dollar revenues into Cambodian riels in order to make payments for taxes, electricity charge, water charge, etc. As a result, those private retail businesses will lose some of their profits from exchanging their revenues. The pursuance of crawling bands exchange rate arrangement will increase the confidence of people in Cambodian riels as there is less fluctuation in Cambodian riels. More investors are likely to come to invest in Cambodia as the exchange rate risk is low. As a consequence, Cambodia’s retail sector will see more new start-up businesses sprawling around town if the Cambodian government can maintain a minimum exchange rate fluctuation.
*  Conclusion
In conclusion, Cambodia’s retail sector is one of the potential sectors in Cambodia and it keeps growing swiftly. Nowadays, most of the business transactions in Cambodia are done using US dollars. There have been some criticisms about the usage of dollars within Cambodia and some suggest the Cambodian government should de-dollarize its economy. In this writing, we have chosen to analyze how de-dollarization in three different scenarios will affect Cambodia’s retail sector. Based on our analysis, the third scenario which is regarding the implementation of gradual market-based de-dollarization in conjunction with the usage of crawling exchange rate arrangement scenario might work better for retail sector than the first and second scenarios if the Cambodian government wishes to de-dollarize her economy. The government inflation targeting policy in the first and second scenarios can cause liquidity problem within the economy. There is no such liquidity problem in the third scenario. Through the government fiscal policy to lower interest on loans, it will indirectly benefit local producers as the cost of capital decreases. Some local producers will use the fund they save from paying high interest loans to increase their production capacity or increase the quality of their products. The use of crawling band exchange rate system can reduce the exchange rate risk which in turn can attract more investors into Cambodia and build people’s trust in Cambodian riels. Even though there will be an increase in interest rate for riel denominated assets which causes people to save more, it will not much affect the consumption in retail sector as Cambodians will not increase their savings very much. Cambodians do not have much faith in riel denominated assets yet, so the increase in interest rate for riel denominated assets can entice people to increase their saving only for a small portion.  Overall, the gradual market-based de-dollarization and pursuance of crawling band exchange rate arrangement will not affect Cambodia’s retail sector very much as forced de-dollarization.  



Bibliography

Asia: Cambodia's retail revolution? (2013). HSBC Global Connections. The Economist Intelligence Unit Ltd. Retrieved 04 28, 2014, from https://globalconnections.hsbc.com/global/en/articles/asia-cambodias-retail-revolution
Morton, E. (2014, 04 25). Riel trust needed for stability. The Phnom Penh Post. Retrieved from http://www.phnompenhpost.com/business/riel-trust-needed-stability

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