Central America: To Dollarize Or Not To Dollarize?

Central America is split between nations that want to join the de-dollarization effort led by BRICS and others like Costa Rica which is considering formal dollarization.

August’s 15th annual BRICS countries summit in South Africa is reigniting talk of de-dollarization, a topic that is at the center of the agenda. Russia’s invasion of Ukraine and the resulting sanctions by the US and its allies renewed calls for an alternative reserve currency. Argentina’s and Pakistan’s governments agreed to use China’s yuan for Chinese trade.

Central America is split: Honduras recently requested to join the de-dollarizing BRICS—Brazil, Russia, India, China and South Africa along with Belarus and Ethiopia. In Costa Rica, some are calling for formal dollarization, on the other hand, due to currency volatility of 550-650 colónes per US dollar, along with major purchases in dollars.

“With remittances being a principal form of the region’s economies, the destination of exports being mainly the US, and the US being one of the main sources of foreign investment, you can see why the dollar’s influence is very, very strong,” says Ricardo Castaneda, senior economist with the Central American Institute for Fiscal Studies who sees the move as more political than economic. “That’s not going to change with this BRICS initiative.”

Two decades ago, El Salvador led the way in making the dollar legal tender. Its decision has been associated with a significant reduction in the currency-risk premium implicit in Salvadoran interest rates, generating four to five percentage points lower lending and deposit rates than if it had kept a dollar-pegged colón.

However, Castaneda argues that El Salvador lost control of monetary policy by dollarizing.

And a new multipolar era offers alternatives. At the end of 2022, Chinese President Xi Jinping visited Saudi Arabia to discuss using the yuan for Saudi oil exports. In April, Brazil and China also opened offshore clearing banks to facilitate trade. The yuan accounts for a record 7% of foreign exchange trading volume. The dollar and euro maintain their 40%–50% shares of trade invoicing. The yuan represents 2.3% of the total transaction volume for SWIFT payments, while the dollar and euro shares are 43% and 32%, respectively.

Any further momentum for de-dollarization depends on what the BRICS countries offer during the summit. China’s internationally traded assets and liabilities amount to 4% of the world’s total, meaning the yuan is not yet a serious challenger to the dollar.