Partial Dollarization, Exchange Rates, And Firm Investment In Paraguay

Between 1989 and 1993 the government of Paraguay removed most restriction on financial transactions in domestic and foreign currency. The resulting financial deepening also involved partial dollarization. This investigation sought to determine whether partial dollarization led to negative balance sheet effects (in the form of reduced access to investment credit due to depreciation‐induced reduction in firms’ net worth as a result of currency mismatches on their balance sheets) and, therefore, to investment contractions, at the firm level, in the face of real currency depreciations. Support was found for that thesis. However, there was also evidence that banks expanded credit more rapidly in the face of currency depreciations. These apparent contradictory movements in credit and investment were shown to be a result of the absence of any clear causal link (in a Granger sense) between bank credit to the private sector and private investment in Paraguay.