The Parallel Exchange Rate Problem: The World Bank's Approach to Helping People in Developing Countries

The deterioration of economic conditions over the past few years and the growing depreciation pressures facing developing countries have led to a rise in the number of countries with active parallel currency markets.  Currently, around 24 emerging and developing economies (EMDEs) have active parallel currency markets. In at least 14 of them, the exchange rate premium—the difference between the official and the parallel rate—is a material problem, exceeding 10 percent (see the table).

The economics on parallel exchange rates is clear: they are expensive, highly distortionary for all market participants, are associated with higher inflation, impede private sector development and foreign investment, and lead to lower growth.  They benefit the group that has access to foreign exchange at the subsidized rate, paid for by everyone else (which may include the World Bank Group and its stakeholders).  Hence, there is also a strong correlation, if not causation, between the existence of parallel rates and corruption. 

Often, countries adopt parallel exchange rates during balance-of-payments problems. IMF policies call for addressing exchange rate distortions, but progress has been limited in several countries with wide spreads, including Argentina, Ethiopia, and Nigeria. In some countries, authorities have embarked on a unification process but are reluctant to move quickly enough because vested interests will be giving up a subsidy. The gradual approach to FX unification often results in no unification despite repeated Fund arrangements.

Parallel exchange rate markets can also significantly diminish the impact of World Bank projects. A primary problem is the lack of value-for-money when financing projects that have local currency expenses. When World Bank dollar-denominated loans are converted into local currency at the overvalued official rate, fewer local-currency resources are available than if the exchange had happened at the parallel market rate. This reduces the development impact of World Bank operations. For example, if the World Bank operation is financing cash transfers for the poor paid in local currency, this means fewer people will enjoy the benefit. A second problem is that some of the proceeds from the World Bank loan (which are in dollars) can be diverted by governments to finance expenditures not related to the project and could lend themselves to corrupt practices. A related problem is that the government incurs higher foreign-currency debt to achieve a given level of local-currency spending on the project, making future debt service payments more burdensome and increasing the risk of debt distress. On a larger scale, there is a risk that sizable World Bank financing that provides funding through the parallel market regime perpetuates it.

We have taken a set of measures at the World Bank to discourage the subsidized rate, or at a minimum mitigate the impact of parallel exchange rates on our operations. This is to ensure that our financing benefits rather than harms people in developing countries. First, we do not provide budget support assistance to countries with sizeable and persistent foreign exchange rate premiums, unless the distortion is addressed through a program of exchange rate reforms in collaboration with the IMF. Second, we try to ring-fence available resources and protect the value-for-money for our investment loans. This can be done by requiring that loan resources be used only to finance “foreign expenditures,” and the government should finance any “cost of local expenditures” from its own resources. Another way is to ask the government to provide counterpart financing to partly compensate for the exchange premium between the official and the parallel foreign exchange rate in countries where the cost of the policy is most apparent and distortive. We have committed to being clear and transparent in all our loan documentation (which is available online) on the issue of parallel rates in affected countries, where we highlight and quantify the scale of the distortion and the impact on the economy, and summarize the policy dialogue with the authorities on this issue.

During her tenure as World Bank Chief Economist, Carmen Reinhart initiated a pilot data-collection program on parallel exchange rates to help highlight the potentially distortive effects on country statistics from parallel markets. The World Bank is endeavoring to account for the emergence of multiple markets in currency conversions in the World Development Indicators (WDI) economic series. And although information is sometimes incomplete and measurement is challenging, this initiative represents a step toward enhancing transparency and strengthening the quality of data. 

Countries with Multiple Currency Practices, March 2023

Notes: [1] There is evidence of deviations between the market and official exchange rates in some other countries, but information available is not recent, regular, or reliable. This includes Sierra Leone (premium about 4.5% in September 2022) and Turkmenistan (possibly 1840% over 2022). In Vietnam, premium was about 5% from mid-October to end-November 2022, almost 0% since then.

[2] Sources: IMF, National Statistical Offices, Central Banks, FAO

[3] There are two official exchange rates in Iran: the baseline official exchange rate reported in the IFS database maintained by the IMF and the “NIMA” rate.  NIMA is an online currency system launched by the central bank where exporters can sell foreign currency. Each is shown separately in this table in relation to the parallel market rate.