An empirical analysis of dollarization on financial development in the developing economies

One of the important issues in developing countries is currency substitution, which can also be called dollarization. The concept of dollarization has evolved over the years with many changes in the financial world such as the growing international trade, the removing of legal restrictions on foreign currency deposits, and the integration of economy's domestic financial system with the global financial markets. The existing literature concerning dollarization issues has tried to concentrate on economies with high inflation in which the use of strong foreign currencies have gained significance for nearly three decades. In this vein, the existing studies on currency substitution have focused on the link between dollarization and the dynamics of money demand, institutional quality, inflation, and exchange rate. However, little research has been done on assessing directly the effects of dollarization on financial development. For this reason, the purpose of this study is to empirically investigate the impacts of dollarization on financial deepening using panel data analysis of 60 selected transition and developing economies over the period 2004-2012. The results of study revealed that dollarization has the positive impacts of dollarization on financial development in countries with high inflationary environments.