Pandemic thwarts efforts to end currency black markets, study says

© Reuters. Saudi riyal, yuan, Turkish lira, pound, U.S. dollar, euro and Jordanian dinar banknotes are seen in this illustration

LONDON (Reuters) – The financial hit of the COVID-19 pandemic has slowed efforts by central banks in a range of countries to unify parallel exchange rates, leaving states such as Lebanon and Iran with currency black markets that cause more economic damage, a study found.

Twenty-two countries now have more than one exchange rate, the Institute of International Finance (IIF) found in a report. Where official rates differ sharply from the rates available to ordinary people or businesses, that can cause a range of economic problems.

“An official exchange rate significantly stronger than a market-clearing rate will discourage FDI (foreign direct investment), reduce the interbank FX market, encourage rent-seeking, and impede business development,” said Garbis Iradian, IIF chief economist for the Middle East, North Africa, Caucasus and Central Asia.

“In the current difficult global environment, confronted by both global (COVID-19) and country-specific challenges (sanctions in Iran and Syria, political paralysis in Lebanon), central banks in some countries with multiple exchange rates have held back from tightening monetary policy and from undertaking the reforms to their exchange rate systems necessary to achieve successful unification,” the report said.

Parallel market rates in March 2021 exceeded the official exchange rates by 720% in Lebanon, 520% in Turkmenistan and 490% in Iran, it added.

IIF parallel exchange rates

Lebanon joined the “club of problematic currencies” in late 2019 when political paralysis led to a sharp loss of confidence, the report said.

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“Large premia encourage smuggling or illegal trade,” wrote Iradian, adding subsidies for basic products like fuel saw a high proportion of it end up in neighbouring Syria.

While Iran has had a number of failed attempts at unifying its exchange rates in recent years, the currency could appreciate in the parallel market significantly in the second half of 2021 if an agreement is reached to restore its nuclear deal with world powers.

“Such an agreement combined with tighter monetary stance and structural reforms would enable the authorities to unify the two rates by mid-2022,” Iradian said.

Looking at a number of case studies from Angola to Egypt, the IIF found that adjusting the official rate to a market-clearing level did not necessarily lead to further depreciation. But tight monetary and fiscal policies as well as structural reforms were necessary to stabilize a unified exchange rate beyond the near-term, the IIF said.

Meanwhile attempts by policy makers to enforce capital controls have proven to be ineffective.

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