Dollarizing means replacing your local currency with a foreign currency (with U.S dollars) and accepting it as official currency. Countries like Panama and Ecuador officially replaced their currency with U.S dollar. Many countries unofficially use dollar as their currency by using it parallel to their local currency. They use it in their major transactions and also use it in savings. These countries using dollar parallel to their local currency are partially dollarized and legal tender in these countries includes U.S dollar.
Applying dollarization in Pakistan means that financial authorities (State Bank of Pakistan) will accept U.S dollar as formal currency and U.S dollar will be in circulation as legal tender. There are few advantages of full dollarization but they come with certain disadvantages. They are
A Stabilizing Factor
When a country's currency is issued by its own central bank it has the advantage of changing the interest rate according to the economic position of the country, can increase or decrease the money supply in its own best interest, and also can change the exchange rates to some extent for its own benefit. The Central bank can use the currency as a stabilizing factor. Now in some countries where central bank is unable to keep this factor in its control or according to its plan due to may be of less experience or adequate knowledge to cover all these aspects of central bank can opt for full dollarization.
But in Pakistan where central bank is quiet active and is performing its duties well enough, going for dollarization will be like giving up our monetary sovereignty. The currency not only fulfill economic function but it also expression of social and creative reality. If we do adopt dollar as our currency, our national identity in terms of currency would be t stake.
Budgetary and Fiscal Discipline
One advantage of dollarization would be reduction in inflation or nominal inflation because of nominal inflation in dollar. The Government would not be able to work on the expansionist budgetary policy which is the basic reason of inflation. The government will be unable to print the currency notes on its will and cop with its budget deficit or trade deficit by simply printing the currency.
The government of Pakistan normally involve in this practice of printing money to cope with the shortage of money which results in the depreciation of the currency. So by replacing dollar as currency no more printing of currency, means very little inflation.
Confidence of Investor
The fact that our currency 'rupee' is very unstable shakes the confidence of investor local as well as foreigner. Sometimes we did gained the confidence of investor and brought some stability but often its other way round and investment in our country often remained under target.
Adopting dollar as currency will bring confidence in investor to invest from abroad as well as local investment will rise. Moreover our politicians as well as business personal will keep their currency reserve in Pakistan as a result financial position of the country will get better.
Independent Monetary Policy
A country device its monetary policy according to its own need. The monetary policy is made in accordance with own need. The monetary policy is made in accordance to a country economic situation. When a country adopts a foreign currency (dollar) the monetary policies like printing money goes to the donor (U.S) country of currency. The monetary policies like printing currency lies with the U.S. So, as a result Pakistan State Bank be no longer in the situation of independent monetary policy but would rather rely on America for the supply of currency. Though the regulation of banking system still be with Pakistan central bank to ensure sound banking practice. The depreciation or appreciation in dollar would then directly affect Pakistan. It would probably have no affect on Pakistan trade with U.S but definitely will affect our trade with other countries.
Dollar supply and other policies regarding dollar are made by FED in accordance with U.S economic situation. So this would also affect the Pakistan economy and its trade with non-U.S dollar countries. In contrast to Euro-zone, where countries have a seat and power to influence the policy of European central bank, the dollarized countries have no participation in the FED or U.S monetary policy making.
Saigniorage Effects
A country benefits or earns revenues from the issuing of currency, but when you start importing currency, you would not be able to generate revenue from this source. On one hand it will cost Pakistan if it dollarized because there will be a cost attached to this (interest). On the other hand Pakistan would have earned interest with those dollars.
Lender of the Last Resort Facility
When a commercial bank is in crisis, the central bank can help the bank in crisis, but when the central banks have no power of issuing money, the central bank would be unable to help a bank in crisis or help its liquidity.
