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Do Foreign Currency Deposits Promote or Deter Financial Development in Low-Income Countries? An Empirical Analysis of Cross-Country Data

Discussion Papers

No.087

January 2007

ABSTRACT

Foreign currency deposits (FCD) are prevalent in many low-income developing countries, but their impact on bank lending has rarely been examined. An examination of cross-country data indicates that a higher proportion of FCD in total deposits is associated with growth in private credit only in inflationary circumstances (over 24 percent of the annual inflation rate). FCD can lead to a decline in private credit below this threshold level of inflation. Given that FCD exhibit persistence, deregulating them in low-income countries may do more harm than good on financial development in the long term, notably after successful containment of inflation.

Keywords: foreign currency deposits, financial development, low-income countries, inflation, dollarization
JEL classification: G21, F36

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