Currency substitution and financial sector developments in Cambodia

Abstract

The tendency to substitute domestic for foreign currency (as a way of holding wealth and a means of transaction for goods and services) is common throughout the world, and particularly so in countries attempting to overcome thin financial institutions or errant monetary policy. This paper uses monthly data to analyze the phenomenon of currency substitution in Cambodia during the recent economic and financial reform process, 1993-2001. Results show that there is a significant long run relationship between the expected rate of depreciation in market exchange rates and holdings of US dollars. The implications of this result for macroeconomic policy and broader financial sector developments in Cambodia are also examined.