Foreign Currency Deposits and the Demand for Money in Developing Countries

IMF Working Papers, January 1, 1992

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Foreign Currency Deposits and the Demand for Money in Developing Countries

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Bibliographic details

• Authors: Mohsin S. Khan, Pierre-Richard Agénor
• Published: January 1, 1992
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451931303.001

Overview

• Paper examines the relative demands for domestic and foreign currency deposits by residents of developing countries.
• Formulates and estimates a dynamic currency substitution model that incorporates forward-looking rational expectations.
• Empirical work is conducted for a group of ten developing countries.
• From an empirical standpoint, the forward-looking framework adopted here is superior to the conventional currency-substitution model.

Methodology

• Develops a dynamic currency substitution model with forward-looking rational expectations.
• Estimates the model for a sample of ten developing countries to evaluate determinants of deposit choice between domestic money and foreign currency deposits held abroad.

Key findings

• The foreign rate of interest is an important factor in the choice between holding domestic money or switching to foreign currency deposits held abroad.
• The expected rate of depreciation of the parallel market exchange rate is an important factor in the choice between holding domestic money or switching to foreign currency deposits held abroad.
• The forward-looking framework adopted here is empirically superior to the conventional currency-substitution model.

Implications for policy and practice

• Policy analysis of currency substitution should account for forward-looking expectations, particularly expectations about parallel market exchange rate depreciation.
• Interest rate differentials between domestic and foreign currencies are key determinants of residents' deposit allocation decisions and thus relevant for monetary management in developing countries.

Subjects and keywords

• Subjects: Bank deposits, Currencies, Currency markets, Dollarization, Financial markets, Financial services, Foreign exchange, Monetary policy, Money, Multiple currency practices
• Keywords: Bank deposits, Currencies, currency holding, Currency markets, currency ratio, Dollarization, exchange rate, foreign currency, foreign-currency bond, Middle East, Multiple currency practices, ratio target, unit of account, WP

Source: Foreign Currency Deposits and the Demand for Money in Developing Countries, Mohsin S. Khan and Pierre-Richard Agénor, January 1, 1992, IMF Working Paper No. 1992/001, Pages: 40, DOI: https://doi.org/10.5089/9781451931303.001