Exchange rates analogy: official and parallel

19 May, 2023 - 00:05 0 Views
Exchange rates analogy: official and parallel

eBusiness Weekly

Dr Keen Mhlanga

The economic performance of countries with parallel exchange rate markets has often been exceptional in all the wrong ways.

This category is characterised by high and chronic inflation, poor growth, and a lack of corruption control.

Capital controls, which are frequently implemented or increased in response to a negative shock or a significant deterioration in economic conditions, cause the emergence of parallel markets.

But, despite the context or core cause, a scarcity of foreign money available to the public is the primary reason for the creation and maintenance of parallel or illegal markets, and the result is frequently distortionary. Worryingly, alternative marketplaces are on the rise.

Nearly a fifth (28) of emerging and developing economies (EMDEs) are now equipped with active parallel currency markets, the most in more than two decades. Parallel markets have lately intensified due to the Covid-19 pandemic’s early influence on commodities pricing and longer-term supply chain disruptions for key goods and services.

The Russia-Ukraine conflict, as well as the resulting sanctions and financial system fragmentation, definitely add more countries to that list, including those in the Caucasus and Central Asia.

Parallel-exchange-rate economies are typically inflationary. More than three-quarters of the twenty countries with the highest inflation rates have parallel markets. In countries with parallel currency markets, the track record of inflation is equally dismal. Between 1970 and 2001, average inflation in nations with parallel markets was six times greater than in countries with unified rates.

Growth performance under parallel exchange rate regimes has likewise been low in the past (1970-2001). Nations with parallel exchange rates saw less than half the real per capita GDP growth of nations with unified rates.

Recent evidence supports this theory. Most EMDEs’ per capita incomes have fallen since the beginning of Covid-19, and for many, the drop began well before the pandemic. The decline from 2019 to 2021, on the other hand, is more severe for countries with parallel exchange rates than for other EMDEs.

The recurring trend is one of multi-year secular recession. Furthermore, per capita GDP is proven to connect with a wide range of social and economic indices. It is thus logical to speculate that the bad performance of countries with parallel markets extends to other dimensions.

Nations are more likely to impose capital controls during poor times, resulting in parallel markets, which frequently exacerbate the problems, leading to ‘‘doom loops,’’ hence causation is rarely unidirectional.

These incentives are also clear signals of external sector pressures and frequently foreshadow external debt crisis. For example, between 2006 and 2021, five low-income nations had large parallel currency markets emerge, bringing the total to 115. Nine of these are currently at high risk of, or in, financial crisis.

More broadly, all sovereigns with parallel currency markets evaluated by the major agencies are classified as highly to extremely speculative.

Opportunities to profit arise wherever a desired item or currency, in this example is available at a controlled price to a portion of the population; the link between corruption and parallel currency markets is not new.

Whenever the official exchange rate for current account transactions is allowed to move to a market-clearing level, it does not fall into free-fall, unless the market-clearing parallel market rate is already in free-fall.

Argentina, Lebanon, and Zimbabwe are recent examples of parallel market depreciation. If the reasons that have put pressure on the exchange rate continue, the exchange rate should continue to fall.

A lot of central banks and governments fail to wait long enough, or make enough modifications to policy for markets to stabilise and economic advantages to be realised. Several revert to governing control and/or monetary finance or financial repression or arrears and later undertake a second shift.

Despite a proper policy response can cause the real effective exchange rate to substantially settle or even appreciate in a short amount of time assuming the initial adjustment results in a big overshoot of the equilibrium rate, the benefits to the real economy will take a little longer.

If fiscal or monetary tightening is insufficient, or the economy is hit by an exogenous shock, the exchange rate path will eventually reflect this.

In other cases, whether or not an explicit policy change is proclaimed, the exchange rate adjustment is clearly specified.

In many cases, the adjustment was completed in a matter of months or less, though it was frequently preceded by a longer period of policy ambiguity or preparation for the shift.

In others, the operation was extensive and took years. The central banks of Azerbaijan and Kazakhstan appear to make insufficient initial exchange rate adjustments, followed by a bigger and more sustained movement in the exchange rate.

In some cases, the reaction of monetary policy was slow and inclined to lag inflation developments, whereas in others, such as Kazakhstan in 2015, it was swift and sharp.

The Covid- 19 problem ought not to discourage policymakers from pursuing a uniform, market-clearing exchange rate for current account transactions.

Increased uncertainties in the Covid-19 scenario make it much more difficult for the government to consider a change in the exchange rate system.

The policymakers’ initial priority must, of course, be on dealing to the pandemic’s impact on the public, followed by some assistance to the most vulnerable sectors of the economy and resolving financial stability issues.

Postponing an inevitable exchange rate adjustment, on the other hand, may intensify rather than alleviate constraints on the economy and financial sector — pressures that will grow over time.

And, while wishing for the best (an early recovery of the world and domestic economies), it is prudent to take precautions.

Dr Keen Mhlanga is an Investment Advisor with high skills in Finance. He is the Executive Chairman of FinKing Financial Advisory. Send your feedback to [email protected] <mailto:[email protected]>, contact him on 0777597526.

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