## 1. Summary of country case studies

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### Introduction: scope and definitions
- Single exchange rate for legitimate current account transactions is the norm; some countries have an “official” rate and a parallel market rate.
- Dual rates may contravene obligations under the IMF’s Article VIII: an exchange restriction or a Multiple Currency Practice (MCP) may arise if authorities require banks to operate at an exchange rate that does not clear the market, or create separate or segmented FX markets with excessive spreads.
- MCP definition (Fund framework): action by a member or its fiscal agencies that “of itself gives rise to a spread of more than 2 percent between buying and selling rates for spot exchange transactions between the member’s currency and any other member’s currency.”
- “Official” exchange rate: used here to mean an exchange rate that commercial banks and other regulated entities are legally required to use when recording actual transactions, and for instance when calculating customs and tax liabilities.
- Market-clearing rate: exchange rate at which demand and supply are in balance for legitimate current account transactions; does not necessarily require a free-floating regime.

### Why parallel FX markets emerge
- Balance of payments weakness and exchange rate pressures (including COVID-19 related) have increased cases with parallel rates.
- Capital controls nearly always result in a parallel FX market because some agents will pay to evade controls; spreads can range from “just a few percentage points under ‘normal’ conditions and if the financial account is not entirely closed, to a much larger spread if socio-economic conditions lead to demand for large movements of funds, and the financial account is fully closed.”
- Parallel markets can also exist for illegal transactions (money laundering, narcotics, human trafficking), but this note focuses on parallel markets used for legitimate current account transactions while recognizing overlap.
- Triggers for parallel market emergence include:
  - reluctance to allow the exchange rate to adjust fully in response to excessive fiscal stimulus or monetary financing leading to high inflation and balance of payments weakness;
  - shocks such as a substantial and persistent decline in commodity prices;
  - balance of payments weakness from falls in remittances or tourism (e.g., COVID-19).

### Economic distortions from persistent spreads
- Spreads between official and parallel rates create distortions and inefficiencies when the official rate is out of line with economic reality.
- Persistent spreads generate:
  - misallocation of FX rents and concentrated rents when access is privileged;
  - uncertainty about availability of FX and competitiveness distortions;
  - banks struggle to find good lending projects due to uncertain FX availability; viable companies may reduce capacity or cease operating because of inability to import spare parts;
  - FDI discouraged if non-residents fear operational FX constraints or expect substantial depreciation;
  - statistics and corporate accounts distorted by under- and over-invoicing; banks may add fees to transactions booked at the official non-market rate;
  - informal remittance channels widen the spread between official and parallel markets;
  - AML/CFT controls are hard or impossible to impose on parallel markets lacking audit trails;
  - interbank FX markets become thin or non-existent as banks hoard FX;
  - rent-seeking and dishonest practices proliferate; property markets and collateral valuations can be adversely affected.
- Maintaining a fictitious official rate provides little value if supply at that price is substantially insufficient.

### Moving to a market-clearing rate: effects and considerations
- “Recognizing reality” by abandoning an official rate not accessible to much of the economy and moving to a unified, market-clearing rate removes distortions and inefficiencies.
- In most cases, inflation consequences of the move—presumptively to the parallel market rate—are relatively small, since prices already reflect the parallel market rate.
- Unification alone will not end an inflation and depreciation cycle: supportive interest rate and fiscal policies are important determinants of the market-clearing rate at adjustment and thereafter.
- Official exchange rate should reflect the actual exchange rate used in market transactions; it should reflect the mid-market rate, recognizing buy-sell spreads and intra-day rate variation.
- Authorities may satisfy demand at a fixed exchange rate (example given: Gulf States with long-term fixed nominal rates against the USD), under a managed float, or use instruments other than FX transactions to influence the exchange rate.
- Hong Kong SAR China example: Linked Exchange Rate System (LERS) allows the rate to fluctuate between HK$7.75–7.85 to the US dollar and has been in place since October 1983.

### When and where to jump: empirical findings from case studies
- World Bank (2019) finding: non-linearities with larger depreciations leading to higher pass-through ratios; higher pass-through in emerging market economies than in AEs.
- As of December 2020, countries with a parallel market exchange rate some 25 percent or more weaker than the official rate include: Algeria, Argentina, Burundi, Ethiopia, Lebanon, Nigeria, Sudan, South Sudan, and Venezuela.
- Key observed patterns:
  - (i) Allowing the official exchange rate to move to a market-clearing level typically does not cause freefall—except if the parallel market rate was already in freefall and macro policies are not adjusted (examples: Argentina, Zimbabwe, and Lebanon).
  - (ii) The parallel market rate is a reasonable indication of the market-clearing rate at a given point in time but reflects multiple factors and is not a predictor of future market-clearing levels absent broader macro adjustments.
  - (iii) Context matters: tightening monetary policy at the time of adjustment and supportive fiscal policy help stabilization.
  - (iv) Price levels prior to adjustment tend to reflect the parallel market rate, so pass-through from unification tends to be muted.
  - (v) Banks and customers are less surprised if a well-known parallel market exists; state-owned banks pressured to take short FX positions may be more vulnerable.
  - (vi) Moral suasion to force agents to operate at an over-valued rate risks perpetuating distortions and violating IMF rules on official actions.

### Policy recommendations and operational guidance
- Pre-announcement and coherent policy package:
  - Announce new policy for exchange rate intervention and a coherent framework for domestic currency monetary policy operations.
  - Monetary policy tightening announced before or during adjustment helps re-anchor expectations and allows interest rates to normalize at sustainable levels.
- Monetary policy stance:
  - Signal tightening to guide expectations, even if reserve money balances or market responsiveness do not immediately change.
  - A policy rate above the expected future rate of inflation should influence agent behavior once the exchange rate has adjusted.
- Fiscal policy stance:
  - Supportive fiscal policy is essential; continuing fiscal stimulus and monetary financing will weaken the balance of payments and raise inflation.
  - Consider implications for debt servicing costs and distributional effects (e.g., loss of implicit taxes on exporters).
- Choice of adjustment speed:
  - Rapid unification likely less costly than gradual approaches, which can lead to FX hoarding, faster reserve depletion, higher interest rates for longer, persistent distortions, and possibly never reaching a new equilibrium.
  - Gradual approaches may be chosen to develop alternative monetary anchors but increase communication challenges and overshoot risks if not well managed.
- Market development and post-unification regime:
  - Priorities for a managed float or more flexible regime: develop deeper and more liquid FX market; design intervention strategies; establish alternative credible monetary anchor; provide instruments for managing FX risk; ensure appropriate regulation and supervision.
  - Re-peg option: a one-off devaluation to a sustainably market-clearing level requires fiscal and balance-of-payments sustainability and credible communication to avoid capital flight.
- Operational notes:
  - Guidance on FX provision (e.g., daily or weekly FX auctions) and domestic monetary policy should cover the medium-term (more than 12 months) to reduce short-term FX demand surges.
  - Avoid (im)moral suasion that signals return to direct rate management; this discourages FX supply into the market.

### Communication priorities
- Clarify exchange rate policy going forward and intended intervention policy (e.g., whether the central bank will be a net purchaser or net provider of FX).
- Explain how the central bank will implement interest rate policy and its policy reaction function.
- Provide medium-term guidance (more than 12 months) on FX provision and monetary policy to prevent short-term increases in FX demand.
- Ensure transparency and predictable actions in days and weeks following regime change to build credibility and active market participation.

### Notable country-case numeric observations (selected examples preserved verbatim)
- Angola:
  - Oct 19–Sep 20: Size, percent 68.0; Prior to unification 16.3; Peak inflation 23.8; (E) = (D-C)/B 11.0; Prior to unification interest rate 14.5; Peak interest rate 30.00; Pre-emptive Yes; Fiscal Yes.
  - In October 2019 the nominal rate depreciated by some 30 percent during the month of October; the annualized inflation rate rose over the following twelve months by some 7 percentage points compared with September, to 24 percent.
- Azerbaijan:
  - Feb-Oct 15: Size, percent 24.5; Prior to unification 0.2; Peak inflation 3.50; Prior to unification interest rate 13.5; Peak interest rate 3.50.
  - Dec 15-Mar 17: Size, percent 62.4; Prior to unification 3.6; Peak inflation 14.5; Prior to unification interest rate 17.5; Peak interest rate 3.00; Pre-emptive Partial; Fiscal Broadly.
- Egypt:
  - Oct 15–Apr 17: Size, percent 103; Prior to unification 14.1; Peak inflation 32.9; Prior to unification interest rate 18.3; Peak interest rate 11.75; Pre-emptive Partial; Fiscal Broadly.
  - The Central Bank of Egypt increased its policy rate by 300bp at unification; inflation doubled to around 30 percent following the move.
  - Central Bank rebuilt FX reserves to $45 billion in October 2019 following unification.
- Ghana:
  - Jan-Sep 14: Size, percent 51.5; Prior to unification 13.5; Peak inflation 17.9; Prior to unification interest rate 8.5; Peak interest rate 16.00; Pre-emptive Yes; Fiscal Yes.
- Malawi:
  - Jul 11-Mar 13: Size, percent 156; Prior to unification 7.4; Peak inflation 34.6; Prior to unification interest rate 17.4; Peak interest rate 4.0; Pre-emptive No; Fiscal Yes.
- Myanmar:
  - Mar 12-Apr 12: Size, percent 14500; Prior to unification -1.1; Peak inflation 7.1; Prior to unification interest rate 0.1; Peak interest rate 10.0.
- Pakistan:
  - Nov 17-Dec18: Size, percent 31.6; Prior to unification 4.0; Peak inflation 6.2; Prior to unification interest rate 7.0; Peak interest rate 5.75; Pre-emptive Partial; Fiscal No.
  - Mar-Jun 19: Size, percent 15.6; Prior to unification 9.4; Peak inflation 12.3; Prior to unification interest rate 18.6; Peak interest rate 10.25; Pre-emptive Yes; Fiscal Broadly.
- Uzbekistan:
  - Aug-Sep 17: Size, percent 86; Prior to unification 15.8; Peak inflation 20.1; Prior to unification interest rate 5.0; Peak interest rate 9.0; Pre-emptive Yes; Fiscal OK.
- Belarus (2011): devaluation by 65 percent as the official rate realigned with the parallel rate; inflation shot up during the first period of adjustment in 2011 by approximately 100 percentage points; policy rate was raised from 10 percent in early 2011 to 45 percent in January 2012.
- Zimbabwe: RBZ overnight lending rate of 35 percent annualized; medium-term lending rates of 15–18 percent noted as insufficient in a prior discussion.

### Key trade-offs and cautions
- If underlying causes of parallel market pressures persist, a unified market-clearing rate may continue to depreciate; depreciation should slow as root causes are tackled, and initial overshoot may later be reversed as markets recognize overshoot.
- The existence of a large official-parallel spread (e.g., more than 50 percent) implies that abandoning the official rate need not cause a jump in inflation or depreciation expectations if done credibly and as part of a policy package.
- Losses will occur for those with privileged access to FX at the official rate, but significant net benefits accrue to the broader economy from a unified, market-clearing rate that facilitates legitimate transactions and supports growth.

*Source: 1. Summary of country case studies, wpiea2021025-print-pdf*

### 1. Summary of country case studies .....................................................................................

### 1. Summary of country case studies

### Introduction: scope and definitions
- For all legitimate current account transactions, there should be a single exchange rate; in some countries there are two (or more): an “official” rate at which demand for FX is not fully satisfied, and a parallel market rate.
- Such dual rates may contravene obligations under the IMF’s Article VIII: an exchange restriction or a Multiple Currency Practice (MCP) may arise if the authorities require banks to operate at an exchange rate that does not clear the market, or create separate or segmented FX markets with excessive spreads.
- Under the Fund framework, an MCP is defined as action by a member or its fiscal agencies that “of itself gives rise to a spread of more than 2 percent between buying and selling rates for spot exchange transactions between the member’s currency and any other member’s currency.”
- An “official” exchange rate is used here to mean an exchange rate that commercial banks and other regulated entities are legally required to use when recording actual transactions, and for instance when calculating customs and tax liabilities; it may also be used for statistical purposes.
- A market-clearing rate implies an exchange rate at which demand and supply are in balance: those seeking FX for legitimate current account transactions can obtain it freely when demanded, and those holding FX surplus to their immediate needs are willing to sell it. This does not necessarily require a free-floating regime.

### Why parallel FX markets emerge
- Balance of payments weakness and associated exchange rate pressures, including those related to COVID-19, have seen an increase in cases with parallel rates.
- Where capital controls are in place, controls nearly always result in a parallel FX market because some agents will pay to evade controls; spreads can range from “just a few percentage points under ‘normal’ conditions and if the financial account is not entirely closed, to a much larger spread if socio-economic conditions lead to demand for large movements of funds, and the financial account is fully closed.”
- A parallel FX market may also exist for illegal transactions (e.g., money laundering, narcotics trades, human trafficking) even without capital controls.
- The note focuses on parallel markets used for legitimate current account transactions; it recognizes that the same parallel market will likely be used for some capital account and illegal transactions, and that inclusion of such transactions affects the parallel rate, though this note does not attempt to estimate that effect.

### Economic distortions from persistent spreads
- Spreads between official and parallel market exchange rates create distortions and inefficiencies when the official rate is out of line with economic reality.
- Persistent spreads give rise to misallocation of FX rents, uncertainty about availability of FX, and competitiveness distortions.
- If the official (over-valued) exchange rate benefits a relatively small group with privileged access, those rents are concentrated; moving to a unified rate can spread benefits more widely and reduce inequality to some extent.

### Moving to a market-clearing rate: effects and considerations
- “Recognizing reality” by abandoning an “official rate” that is not accessible to a significant part of the economy and moving to a unified, market-clearing rate removes distortions and inefficiencies imposed by the official rate.
- In most cases, the inflation consequences of the move—presumptively to the parallel market rate—are relatively small, since prices already reflect the parallel market rate.
- However, unification at a market-clearing rate will not by itself end an inflation and depreciation cycle: supportive interest rate and fiscal policies are important determinants of the market-clearing rate both at adjustment and thereafter.
- The official exchange rate should reflect the actual exchange rate used in market transactions; the official rate should reflect the mid-market rate, recognizing buy-sell spreads and intra-day rate variation.
- Authorities may satisfy demand at a fixed exchange rate (example: Gulf States with long-term fixed nominal rates against the USD), under a managed float, or use instruments other than FX transactions to influence the exchange rate.
- Hong Kong SAR China is cited as an example of a market-clearing nominal exchange rate peg supported by fiscal policy: the Linked Exchange Rate System (LERS) allows the rate to fluctuate between HK$7.75–7.85 to the US dollar and has been in place since October 1983.

### Experience from case studies and broader implications
- Case studies of countries that unified the exchange rate at a market-clearing level over the past 10 years suggest that moving to a market-clearing official rate is not in itself likely to lead to a sharp increase in inflation, because prices in the real economy tend to already reflect the parallel market exchange rate.
- Eliminating distortions can give a substantial boost to economic development by removing uncertainty about FX availability and strengthening competitiveness.
- Authorities should be aware of legal implications under Article VIII and the MCP framework; they are encouraged to consult with IMF staff before implementing reforms discussed in this note.

*Source: 1. Summary of country case studies, wpiea2021025-print-pdf*

### section VII touches on the importance of good communication of such a move, and section

II. WHY DOES A PARALLEL MARKET RATE EMERGE?

### Emergence mechanisms
- Many central banks operate a managed exchange rate policy: typically a peg against a single currency (normally the USD or EUR), or against a basket of currencies, and typically with a narrow trading range (e.g., +/-30 basis points); or a stabilized real effective exchange rate.
- Maintaining a single exchange rate market requires the central bank to ensure that demand and supply for FX against the domestic currency are balanced over time.
- If the central bank has ample FX reserves, and FX inflows at least equal outflows, the central bank is the price maker; otherwise it may be a price taker and use FX reserves as a short-term buffer.
- A parallel market emerges when the central bank can no longer ensure that supply of FX is sufficient to meet demand at the official price. Triggers include:
  - reluctance to allow the exchange rate to adjust fully in response to excessive fiscal stimulus or monetary financing leading to high inflation and balance of payments weakness;
  - shocks such as a substantial and persistent decline in commodity prices;
  - balance of payments weakness from falls in remittances or tourism (e.g., associated with the COVID-19 crisis).
- Authorities sometimes maintain an overvalued official exchange rate while attempting to restrict demand administratively (prioritizing transactions; rationing FX; allowing queues; setting ceilings or prohibiting certain current payments).
- Multiple preferential official rates for different sectors/items can create a multiplicity of official exchange rates and likely give rise to a multiple currency practice (MCP) under Article VIII of the IMF’s Articles of Agreement.
- Rent-seeking and expectations of reversal after an exogenous shock can also sustain an overvalued official rate.
- The wider the spread between official and parallel rates, the greater the incentive to channel FX to the parallel market; at the extreme the parallel market may be the only reliable source of FX.

### Character of the parallel market and pricing
- The parallel market often reflects economic agents’ solution to a problem created by the central bank; price levels in the economy are likely to reflect the parallel market rate (causality likely bi-directional).
- The parallel market may represent a market-clearing rate but could be weaker than a market-clearing rate for legitimate current account transactions because it is also used for illegal transactions (e.g., evasion of capital controls, criminal activities).
- In a few cases, the parallel market is small and the spread to the official rate is small (e.g., less than 10 percent); authorities should seek to understand such cases.

### A large spread between official and parallel market rates creates distortions
- A persistent and substantial divergence of the official rate from the market-clearing rate reflects underlying macroeconomic policy imbalances and leads to distortions and lower GDP growth.
- An official rate markedly stronger than the market-clearing rate implies demand will always exceed supply, generating backlogs and delays in access and a parallel market over which the central bank has no control.
- Distortions reported by IMF member countries include:
  - Banks struggle to find good lending projects because of uncertain FX availability; viable companies may reduce capacity or cease operating due to inability to import spare parts.
  - Potential new ventures are deterred by uncertainty of FX access even if most inputs are domestic.
  - FDI discouraged if non-residents fear operational FX constraints or expect substantial depreciation; some foreign firms receive exemptions from the FX regime.
  - Statistics and corporate accounts are distorted by under- and over-invoicing; banks booking transactions at the official non-market rate may add fees to reflect real exchange rates, complicating corporate accounts and reducing reported taxable profits.
  - Overvalued official rates motivate some remittance senders to use informal channels, widening the spread between official and parallel markets.
  - AML/CFT controls are hard or impossible to impose on parallel markets lacking audit trails.
  - Interbank FX markets become thin or non-existent as banks hoard FX; agents have incentives to keep FX out of the market.
  - Rent-seeking and dishonest practices proliferate; large parallel premiums create microeconomic distortions and privileges for those with access to official FX.
  - Property markets may be affected as investors postpone entry awaiting depreciation; collateral valuations fall, constraining bank credit.
  - Generally, uncertain FX availability may impede business development more than the price of FX or interest rate levels.
- Maintaining a convenient fiction of an official rate that is not market-relevant provides little value if supply at that price is substantially insufficient.

### Central banks, ministries of finance, and the decision to unify rates
- Authorities may value a stable official rate or multiple rates as tools to achieve goals (including providing implicit subsidies), but multiple rates are inefficient, hard to target, and susceptible to corruption.
- A stable exchange rate only brings real benefits if it represents a price at which agents are willing and able to transact; fictitious stability can produce opposite outcomes.
- Reluctance to unify may stem from concerns about the transition path and its social or political consequences; lack of clarity about the adjustment path can prevent action.
- Governments face uncertainty on net budgetary impact of unification: depends on government FX needs (including debt service); whether imported goods are subsidized; the extent of hidden taxable profits due to distortions; and longer-term tax base improvements.
- Even if convinced of unification benefits, authorities must consider:
  - whether banks and intermediaries are exposed to large changes in the official exchange rate (e.g., borrowers in FX who are unhedged);
  - impact on government budget and official FX-denominated debt (though both should benefit in the long run when distortions are removed);
  - impacts on vulnerable population groups and need for case-by-case assessment and appropriate safety-nets.
- Management of the adjustment process is important: smoother transitions when fiscal and monetary policies are clearly supportive and the move is well communicated to financial markets and the public.
- The exchange rate will not stabilize unless underlying causes of parallel market weakness are addressed; devaluation by itself cannot be a complete solution without serious fiscal adjustment and credibility.

### Country experience (summary of lessons and analytical focus)
- Distinction: (a) parallel market for legitimate current account transactions substantially weaker than official rate (real economy already functions around the parallel rate), versus (b) a pegged/tightly-managed exchange rate that is market-clearing but may need adjustment (market less likely to expect a move; more inflation expected).
- Case studies focus on the former scenario; where good time-series for parallel market rates exist they are included.
- Geographic focus over past 10 years includes more African countries; IMF (2018) notes a shift from Latin America to other regions, notably Africa, with parallel premia recently emerging in some commodity-exporting countries after terms-of-trade shocks.
- Case study questions:
  - Is the parallel market a good indicator of the equilibrium exchange rate? Will the exchange rate fall to the parallel market level or only part-way (e.g., if parallel reflects a premium to evade capital controls)?
  - If depreciation is sharp, will it quickly find a new level or continue weakening beyond an estimated “equilibrium” rate? If overshooting occurs, how quickly will it revert?
  - What will happen to inflation? Will interest rate levers stabilize expectations, and how far might nominal (and real) rates have to rise?
- Empirical comparisons use:
  - (i) nominal exchange rate against the USD and the price level with two CPI series: CPI1 (CPI set equal to the nominal exchange rate at the start of the period) and CPI2 (CPI set equal to the nominal exchange rate after a significant adjustment) to indicate whether the exchange rate moved in line with CPI and the inflation differential with the USA; CPI2 aids comparison after step changes.
  - (ii) rate of inflation and the short-term domestic interest rate to indicate whether interest rates were positive in real terms and whether monetary policy tightened when the exchange rate adjusted; where possible both policy rate and interbank rates are shown.
- Observations from case studies:
  - Some adjustments are rapid and identifiable (e.g., Myanmar in March, 2012); others are protracted, taking months or years.
  - Protracted adjustments may involve policy changes from controlled depreciation with parallel market development to later market-based approaches.
  - Some countries alternate between periods of stable nominal exchange rates and sharp adjustments (e.g., Ghana, Malawi, Myanmar post 2012, Tajikistan); others initially make insufficient adjustments followed by larger changes about a year later (e.g., Azerbaijan, Kazakhstan, Uzbekistan).
  - The inflation metric used records the month of initial adjustment and then the highest rate of inflation in the following 12 months.
  - Monetary policy responses varied: some were protracted and lagged inflation (“partial” responses, e.g., Azerbaijan and Egypt); others were quick and sharp (e.g., Kazakhstan in 2015).
  - Pass-through from depreciation to inflation varied significantly; where the official exchange rate was already irrelevant or monetary tightening produced positive real interest rates, pass-through appears relatively muted.
  - A change in the official rate can affect expectations and feed through to the parallel market unless monetary and fiscal policy are clearly supportive and well communicated.

*Source: wpiea2021025-print-pdf — https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021025-print-pdf.pdf*

### 0.4 found by a World Bank paper in cases where the depreciation was over 20 percent.

### When and Where to Jump

### Summary of empirical findings from case studies
- A World Bank (2019) paper suggests non-linearities, with larger depreciations leading to higher pass-through ratios, and in general a higher pass-through in emerging market economies than in AEs.
- As of December 2020, countries with a parallel market exchange rate some 25 percent or more weaker than the official rate include: Algeria, Argentina, Burundi, Ethiopia, Lebanon, Nigeria, Sudan, South Sudan, and Venezuela.
- Key observed patterns:
  - (i) When the official exchange rate is allowed to move to a market-clearing level, it does not go into freefall—except perhaps if the market-clearing (parallel market) rate was already in freefall and macro policies are not adjusted appropriately (Argentina, Zimbabwe, and Lebanon provide recent examples).
  - (ii) The parallel market rate is likely to be a reasonable indication of the market-clearing rate at a given point in time, but it reflects multiple factors (insufficient supply at the official rate; evasion of capital controls; illegal transactions; uncertainty about authorities’ future policy actions) and is not a predictor of future market-clearing levels absent broader macro adjustments.
  - (iii) The context is crucial: tightening monetary policy at the time of the adjustment and supportive fiscal policy are important in helping the market stabilize.
  - (iv) The price level prior to the exchange rate adjustment tends to reflect the parallel market rate, so the inflation pass-through from unification tends to be muted; monetary and fiscal stances remain crucial to future inflation developments.
  - (v) Banks and customers are less likely to be surprised if a well-known parallel market exists; state-owned banks that were pressured to take short FX positions may be more vulnerable.
  - (vi) Authorities that use moral suasion to force agents to operate at an over-valued rate risk perpetuating distortions and violating IMF rules on official actions.

### Policy recommendations and operational guidance
- Pre-announcement and coherent policy package:
  - Announce a new policy for exchange rate intervention and a coherent framework for domestic currency monetary policy operations.
  - If a central bank announces a monetary policy tightening before or during the adjustment, expectations should re-anchor faster and allow interest rates to normalize more quickly at sustainable levels.
- Monetary policy stance:
  - Monetary policy tightening should be signaled to guide market expectations, even if it does not immediately change reserve money balances or market responsiveness when large exchange rate moves are underway.
  - A policy rate above the expected future rate of inflation should impact behavior of economic agents once the exchange rate has adjusted.
- Fiscal policy stance:
  - Supportive fiscal policy is essential for stabilization; continuing fiscal stimulus and monetary financing will tend to weaken the balance of payments and raise inflation.
  - Governments should consider the implications for debt servicing costs and the distributional effects (e.g., loss of implicit taxes on exporters).
- Choice of adjustment speed:
  - A rapid exchange rate unification is likely to be much less costly than a gradual approach, which can lead to FX hoarding, faster reserve depletion, higher interest rates for longer, persistent distortions, and possibly never reaching a new equilibrium.
  - A gradual approach may be chosen to develop alternative monetary anchors, but it increases communication challenges and risks greater volatility and a larger overshoot if not well managed.
- Market development and post-unification regime:
  - For a managed float or more flexible regime, priorities include: developing a deeper and more liquid FX market; designing intervention strategies; establishing an alternative credible monetary anchor; providing instruments for managing FX risk; and appropriate regulation and supervision.
  - Re-peg option: a one-off devaluation to a sustainably market-clearing level requires fiscal and balance-of-payments sustainability and credible communication to avoid capital flight.
- Operational notes:
  - Guidance on provision of FX to the market (e.g., daily or weekly FX auctions) and on domestic monetary policy should cover the medium-term (more than 12 months) to reduce short-term FX demand surge.
  - Avoid (im)moral suasion that signals a return to direct rate management; this will discourage FX supply into the market.

### Communication priorities
- Clarify exchange rate policy going forward and the intended intervention policy (e.g., whether the central bank will be a net purchaser or net provider of FX).
- Explain how the central bank will implement interest rate policy and its policy reaction function.
- Provide medium-term guidance (more than 12 months) on FX provision and monetary policy to prevent short-term increases in FX demand.
- Transparency and predictable actions in the days and weeks following regime change are crucial to build credibility and active market participation.

### Notable country-case numeric observations (selected examples preserved verbatim)
- Angola:
  - Oct 19–Sep 20: Size, percent 68.0; Prior to unification 16.3; Peak inflation 23.8; (E) = (D-C)/B 11.0; Prior to unification interest rate 14.5; Peak interest rate 30.00; Pre-emptive Yes; Fiscal Yes.
  - In October 2019 the nominal rate depreciated by some 30 percent during the month of October; the annualized inflation rate rose over the following twelve months by some 7 percentage points compared with September, to 24 percent.
- Azerbaijan:
  - Feb-Oct 15: Size, percent 24.5; Prior to unification 0.2; Peak inflation 3.50; Prior to unification interest rate 13.5; Peak interest rate 3.50.
  - Dec 15-Mar 17: Size, percent 62.4; Prior to unification 3.6; Peak inflation 14.5; Prior to unification interest rate 17.5; Peak interest rate 3.00; Pre-emptive Partial; Fiscal Broadly.
- Egypt:
  - Oct 15–Apr 17: Size, percent 103; Prior to unification 14.1; Peak inflation 32.9; Prior to unification interest rate 18.3; Peak interest rate 11.75; Pre-emptive Partial; Fiscal Broadly.
  - The Central Bank of Egypt increased its policy rate by 300bp at unification; inflation doubled to around 30 percent following the move.
- Ghana:
  - Jan-Sep 14: Size, percent 51.5; Prior to unification 13.5; Peak inflation 17.9; Prior to unification interest rate 8.5; Peak interest rate 16.00; Pre-emptive Yes; Fiscal Yes.
- Malawi:
  - Jul 11-Mar 13: Size, percent 156; Prior to unification 7.4; Peak inflation 34.6; Prior to unification interest rate 17.4; Peak interest rate 4.0; Pre-emptive No; Fiscal Yes.
- Myanmar:
  - Mar 12-Apr 12: Size, percent 14500; Prior to unification -1.1; Peak inflation 7.1; Prior to unification interest rate 0.1; Peak interest rate 10.0.
- Pakistan:
  - Nov 17-Dec18: Size, percent 31.6; Prior to unification 4.0; Peak inflation 6.2; Prior to unification interest rate 7.0; Peak interest rate 5.75; Pre-emptive Partial; Fiscal No.
  - Mar-Jun 19: Size, percent 15.6; Prior to unification 9.4; Peak inflation 12.3; Prior to unification interest rate 18.6; Peak interest rate 10.25; Pre-emptive Yes; Fiscal Broadly.
- Uzbekistan:
  - Aug-Sep 17: Size, percent 86; Prior to unification 15.8; Peak inflation 20.1; Prior to unification interest rate 5.0; Peak interest rate 9.0; Pre-emptive Yes; Fiscal OK.
- Belarus (2011): devaluation by 65 percent as the official rate realigned with the parallel rate; inflation shot up during the first period of adjustment in 2011 by approximately 100 percentage points; policy rate was raised from 10 percent in early 2011 to 45 percent in January 2012.
- Egypt: Central Bank rebuilt FX reserves to $45 billion in October 2019 following unification.
- Zimbabwe: RBZ overnight lending rate of 35 percent annualized; medium-term lending rates of 15–18 percent noted as insufficient in a prior discussion.

### Key trade-offs and cautions
- If underlying causes of parallel market pressures persist, a unified market-clearing rate may continue to depreciate; the rate of depreciation should slow as root causes are tackled, and initial overshoot may be later reversed as markets recognize overshoot.
- The existence of a large official-parallel spread (e.g., more than 50 percent) implies that abandoning the official rate need not cause a jump in inflation or depreciation expectations if done credibly and as part of a policy package.
- Losses will occur for those with privileged access to FX at the official rate, but significant net benefits accrue to the broader economy from a unified, market-clearing rate that facilitates legitimate transactions and supports growth.

*wpiea2021025-print-pdf - 0.4 found by a World Bank paper in cases where the depreciation was over 20 percent.*

### References

### wpiea2021025-print-pdf - References

### References
- Carstens, Agustin: Lecture at the LSE, May 2, 2019
- IMF (1991): “Macroeconomic models for adjustment in developing countries”, Chapter 8.
- IMF (2018): “Review of the Fund’s policy on multiple currency practices: initial considerations—economic context and experiences—background paper II”, August 2018.
- IMF (2019): IMF Policy Paper “Review of the Fund’s Policy on Multiple Currency Practices: initial considerations”, June 2019.
- Kiguel and O’Connell (1995): “Parallel exchange rates in developing countries,” February 1995.
- Morris (1995): Journal of Development Economics Vol. 46 (1995) 295-316 “Inflation dynamics and the parallel market for foreign exchange”, Stephen Morris
- Pinto (1988): “Black market premia, exchange rate unification, and inflation in Sub-Saharan Africa”, World Bank Working Paper Series WPS37, July 1988.
- Pinto, Brian (2016): Brookings blog, January 11, 2016
- World Bank (2019): “Inflation and Exchange Rate Pass-Through”, World Bank Policy Research Working Paper 8780, March 2019.

*Source: wpiea2021025-print-pdf - References; https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021025-print-pdf.pdf*

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_Source: https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021025-print-pdf.pdf_