Dollars, Debt and the IFIs: Dedollarizing Multilateral Lending

Financial dollarization (FD) has been increasingly seen as a concern due to its negative impact on crisis propensity and output volatility, shifting the center of the FD debate towards a more proactive dedollarization stance. While often neglected, lending from International Financial Institutions (IFIs) is an important source of FD in emerging economies, and as such a dimension that cannot be overlooked by any dedollarization strategy. This paper revisits old and new arguments in favor of IFI lending in the local currency, and argues that any such initiative should rely, at least at an early stage, on the demand from residents in search for stable returns in units of the local consumption basket, but reluctant to take on sovereign risk. Due to their superior enforcement capacity, IFIs can intermediate these savings, currently invested in dollarized foreign assets, back into the local economy by offering investment grade local currency bonds and using the proceeds to dedollarize their own lending to non-investment grade countries, thereby contributing to reduce FD while fostering the development of local currency markets.