Dollarizing the Argentine economy and closing the country's central bank were two of President Javier Milei's flagship campaign proposals. Doing both, he said, would halt the long-standing central bank practice of printing money to finance government deficits and break the cycle of rapid monetary-supply expansion, high inflation, and currency depreciation.

In the past few months, the Argentine government has indicated that it may pursue a dual-currency approach, using both Argentine pesos and U.S. dollars. More recently, President Milei introduced a strategy called "endogenous dollarization," which involves reducing the supply of pesos, effectively pushing people to use dollars for everyday transactions.

S&P Global Ratings believes dollarization could help cool inflation in Argentina and limit debt monetization, like it did in other Latin American economies. But past cases in the region also suggest that the long-term viability of dollarization in Argentina would hinge on whether the country can implement other economic and institutional reforms--including reforms focusing on fiscal discipline.

Argentina's Road To Potential Dollarization

Significant challenges remain for Argentina in the lead-up to potential dollarization, even though it has reduced its monthly inflation rate to 3.5% as of September, achieved consecutive budget surpluses, and partially cleared the central bank's balance sheet.  The Milei administration has taken many steps to stabilize the economy during its first nine months in office. The strategy includes:

• Managing the high level of public debt by improving the country's fiscal position,
• Reducing inflation,
• Better aligning the official and parallel exchange rates,
• Clearing the central bank's balance sheet to restore macroeconomic stability and market confidence, and
• Continuing to loosen some capital controls.

Despite these actions, the annual inflation rate was 209% as of September 2024, and the gap between the parallel and official exchange rates remains significant. Consequently, the Catholic University of Argentina estimated that the poverty rate had risen to 55% in the first quarter, the highest in the last two decades.

Moreover, the central bank has only gradually acquired foreign exchange reserves. These are critical for boosting investor confidence and determining the initial peso-to-dollar conversion rate if the government moves to dollarization.

This isn't the first time Argentina has turned to the dollar to stabilize its economy.  In 1991, the Argentine peso was pegged to the dollar at a one-to-one exchange rate to control hyperinflation (also known as the Convertibility plan).

While this approach initially succeeded in reducing inflation and boosting economic growth, the currency board--the monetary authority in charge of keeping the currency peg--faced significant challenges during the deep economic crisis of the late 1990s and early 2000s, ultimately leading to the collapse of the dollar peg. The combination of high debt levels, a loss of investor confidence, and an inability to devalue the currency led to a sovereign debt crisis in 2002.

Some Cases Of Dollarization In Latin America

In Latin America, the countries that have implemented full dollarization--such as Ecuador, El Salvador, and Panama--are all smaller economies than Argentina based on GDP. Their experiences with dollarization show that it can create monetary stability in the short term. However, its long-term success depends on sustained structural reforms, to boost economic growth as well as address fiscal imbalances and external vulnerabilities.

Ecuador

Sudden dollarization initially posed challenges to Ecuador: It took over three years for inflation to fall to the single digits. But it has now stayed in the single digits for more than a decade. Still, the country remains vulnerable to fluctuations in oil prices, and it has elevated public debt levels.

Ecuador dollarized in 2000 as an emergency measure, with the aim of avoiding hyperinflation and further economic decline amid severe monetary instability. In 1999, the economy contracted 6% and inflation surpassed 50%. Contributing to this was the collapse of the country's banking system; a sharp depreciation of the national currency, the sucre; and its total public debt, which ballooned to 130% of GDP.

Over time, dollarization successfully anchored inflation expectations in Ecuador and restored confidence.  Inflation plummeted to 7.9% in 2003 from 96% in 2000, and GDP started to recover in the second quarter of 2000, with the country achieving 5.1% GDP growth in full-year 2000 and 4.2% growth in 2001.

As a result, the benchmark effective interest rate for lending dropped to 9% at the end of 2004 from over 60% in 1999, and total public debt plunged to 12% of GDP in 2009 from 65% of GDP in 2000, partly aided by rising oil prices.

But dollarization didn't quell Ecuador's chronic political instability, nor did it result in stable GDP growth.  Later governments failed to diversify the economy, leaving the country overly dependent on oil revenue. This led to poor fiscal policy and mounting public debt.

At the same time, dollarization undermined the competitiveness of existing non-oil exports.  The dollar's appreciation against other Latin American currencies often weakened the competitiveness of non-oil exports, hindering economic growth. It made it even more difficult for Ecuador when a strong dollar was coupled with low oil prices.

Finally, dollarization hasn't prevented the Ecuadorian central bank from financing the government.  A series of policy changes allowed the central bank to expand its balance sheet to fund government spending.

This contributed to elevated public debt levels, leading to a sovereign default in 2008 amid the global financial crisis, as well as another default in 2020, exacerbated by the collapse in oil prices and the economic fallout from the COVID-19 pandemic (see chart 1).

Chart 1

El Salvador

Although dollarization in El Salvador helped it maintain monetary stability, political turmoil and limited microeconomic reforms hindered productivity growth. And given the country's close economic ties with the U.S., it was left vulnerable to U.S. policy shifts.

El Salvador dollarized in January 2001 to attract foreign investment, enhance trade, lower interest rates, and accelerate economic growth. Unlike Ecuador, El Salvador was building on a foundation of sound macroeconomic policies. Structural reforms that it implemented in the early 1990s, including pegging the national currency to the dollar, had led to stable, low inflation; economic growth; and balanced external accounts.

Following dollarization, El Salvador saw less volatile inflation and lower interest rates.  The country benefited from its strong trade ties with the U.S. and aligned economic cycles. As a result, interest rates on 180-day deposits fell to roughly 3% in 2002 from over 6% before 2001.

Other expected benefits of dollarization didn't materialize, largely because persistent political polarization stifled growth--but that polarization was disrupted by Nayib Bukele's rise in 2019.  The divide between the two parties from the 1992 civil war discouraged investment, hindered economic growth, and strained public finances.

President Bukele, by challenging the traditional parties, ended the political deadlock, consolidated power, and cracked down on crime. While his government is more dynamic, boosting investment and economic growth remains challenging despite the possibility of an IMF program, which has been under discussion for a long time.

Governments over the years have struggled to maintain fiscal discipline (because of limited revenue generation) and have increasingly relied on external financing, while exports haven't expanded substantially.  Expansionary fiscal policies drove public debt to an average of 75% of GDP over the past decade, putting upward pressure on interest rates and discouraging investment (see chart 2).

This fiscal strain led to two sovereign defaults in 2017 and one in 2023, all related to pension debt.

Chart 2

The country's structural strengths and weaknesses have persisted post-dollarization.  While previous reforms have ensured a strong and well-regulated banking system, the economy's heavy reliance on remittances (which were 24% of GDP in 2023) and exports (with 45% of exports, on average, being directed to the U.S. in 2012-2021) renders it vulnerable to shifts in U.S. migration and trade policies.

Panama

Panama's long-term economic prospects remain strong, boosted by private and public investment that could offset the closure of a copper mine last year. Dollarized since 1904, the country has enjoyed over a century of price stability, in line with U.S. inflation. Over the last 10 years, Panama's diversified economy has benefited from sustained growth (with GDP growth averaging 4.7%).

Panama has been able to maintain its external competitiveness, sustain investor confidence, attract foreign direct investment, and grow rapidly while using the dollar as its only currency. The country's consolidating democracy, coupled with its predictable economic policies and a broad consensus among its political parties, also helps to sustain investor confidence.

A rigid fiscal structure strains Panama's ability to absorb external shocks.  Until the early 2000s, Panama struggled with large fiscal imbalances and was heavily reliant on IMF funding. Between 2010 and 2019, Panama maintained a moderate fiscal deficit and general government debt burden (38% of GDP, on average).

However, the COVID-19 pandemic disrupted Panama's fiscal trajectory in 2020, pushing public debt to an average of 60% of GDP in 2020-2023 (see chart 3). Given the country's ongoing difficulties in implementing fiscal corrections--stemming from low revenue collection, a pension system deficit, and a high interest burden--we anticipate that public debt will remain at roughly 55% of GDP over the next three years.

Chart 3

Lessons For Argentina

In our view, dollarization in Argentina could curb high inflation and limit debt monetization.  Like it did in Ecuador, dollarization can stabilize inflation in Argentina and restore market confidence by reducing the uncertainty around currency depreciation and by eliminating the option of monetizing government debt (see chart 4).

However, its long-term viability in Argentina hinges on the implementation of many economic and institutional reforms, particularly those that involve maintaining fiscal discipline, boosting productivity, and attracting capital inflows.  Argentina's experience highlights the high costs of external shocks without fiscal discipline and structural reforms when a country is in a rigid exchange-rate regime such as a currency board.

Chart 4

Maintaining fiscal discipline has been a persistent challenge in dollarized economies that have relied on IMF financing, as it has been for Argentina.  Ecuador, El Salvador, and Panama are among the 11% of IMF member states that had more than 20 lending commitments as of July 2024. (The average number of lending commitments globally is eight.)

With the loss of monetary policy flexibility, fiscal policy becomes the primary tool for economic management. But without prudent fiscal practices--which dollarization doesn't guarantee--fiscal imbalances can quickly escalate, leading to higher borrowing costs and the potential for a debt crisis.

This is especially relevant for Argentina, given how the role of Ecuador's central bank was stretched to indirectly finance the government. That case challenges the notion that dollarization unequivocally restrains central bank actions.

Furthermore, Argentina risks being caught between a strong dollar and lower commodity prices, which often coincide.  On one hand, if it's dollarized, Argentina could lose export competitiveness. When a country loses the ability to devalue its currency, it risks becoming less competitive in international markets if it can't maintain high productivity. Whether it can depends on government policies, and it's something that dollarization doesn't guarantee.

On the other hand, since Argentina is a commodity exporter, lower commodity prices could reduce revenue, complicating its efforts to preserve reserves and meet debt obligations.

Related Criteria

• Criteria | Governments | Sovereigns: Sovereign Rating Methodology, Dec. 18, 2017

Related Research

S&P Global Ratings

• Credit FAQ: Argentina's Economic Vulnerabilities Remain Substantial Despite Recent Progress, Aug. 26, 2024
• Panama, Aug. 22, 2024
• Ecuador, Aug. 12, 2024
• Research Update: Argentina 'CCC/C' Global Scale And 'raB+' National Scale Ratings Affirmed; Outlook Remains Stable, Aug. 8, 2024
• El Salvador, June 26, 2024
• Bulletin: Panama's President-Elect Faces Difficulties In Restoring Growth And Stopping Fiscal Slippage With A Fragmented Assembly, May 6, 2024
• Bulletin: Complex Political Dynamics Continue To Weigh On Ecuador's Creditworthiness, May 17, 2023

External research

• Official Dollarization in El Salvador as an Alternative Monetary Framework, from the book "Central America, Panama, and the Dominican Republic," published by the IMF on July 16, 2012
• Official Dollarization as a Monetary Regime: Its Effects on El Salvador, published by the IMF in June 2011
• Crisis and Dollarization in Ecuador: Stability, Growth, and Social Equity, published by the World Bank in June 2002
• Dollarization and Semi-Dollarization in Ecuador, published by the World Bank in July 2001
• Dollarization in Argentina, published by the Federal Reserve Bank of Chicago in June 1999