Recognizing Reality—Unification of Official and Parallel Market Exchange Rates

IMF Working Papers, February 5, 2021

Source details

Canonical URL: Recognizing Reality—Unification of Official and Parallel Market Exchange Rates

Some central banks have maintained overvalued official exchange rates, while unable to ensure that supply of foreign exchange meets legitimate demand for current account transactions at that price.
A parallel exchange rate market develops in such circumstances; and when the spread between the official and parallel rates is both substantial and sustained, price levels in the economy typically reflect the parallel market exchange rate.
“Recognizing reality” by allowing economic agents to use a market clearing rate benefits economic activity without necessarily leading to more inflation.
A unified, market-clearing exchange rate will not stabilize without a supportive fiscal and monetary context.
A number of country case studies are included; data for the country case studies and the production of the charts were assembled by Jie Ren.

Overvalued official exchange rates combined with insufficient foreign exchange supply for current account transactions lead to the emergence of parallel exchange rate markets.
When the spread between official and parallel rates is substantial and sustained, domestic price levels typically reflect the parallel market exchange rate rather than the official rate.
Allowing the use of a market-clearing exchange rate ("recognizing reality") can benefit economic activity without necessarily producing higher inflation—conditional on accompanying policies.
Exchange rate unification by itself is insufficient to stabilize the exchange rate; stabilization requires a supportive fiscal and monetary context.

Move toward a unified, market-clearing exchange rate to align official prices with market realities and support economic activity.
Ensure fiscal and monetary policies are supportive to stabilize the unified exchange rate; unification without supportive macroeconomic context is unlikely to produce lasting stability.