The IMF wants to address exchange rate distortions but progress has been limited in several countries including Nigeria, Ethiopia, and Argentina, David Malpass, World Bank Group president has said.
Countries with active parallel currency markets have increased in number due to the deterioration of economic conditions over the past few years. Growing depreciation pressures facing the developing countries have also contributed to the challenge.
According to Malpass, in a blog post titled ‘Parallel Exchange Rates: The World Bank’s Approach to Helping People in Developing Countries’, around 24 emerging and developing economies currently have active parallel currency markets.
“In at least 14 of the emerging and developing economies, the exchange rate premium which is the difference between the official and the parallel rate is a material problem, exceeding 10 percent,” he said.
Malpass maintained that such economies are expensive, highly distortionary for all market participants and associated with higher inflation.
He also said they impede private sector development and foreign investment, leading to lower growth.
“They benefit the group that has access to foreign exchange at the subsidised rate, paid for by everyone else which may include the World Bank Group and its stakeholders,” he said. “Hence, there is also a strong correlation, if not causation, between the existence of parallel rates and corruption.”
In some countries, where there is a balance of payment problems, parallel exchange rates have been introduced. However, when the authorities are ready to introduce a unification process, they have not been able to move quickly enough because vested interests will be giving up a subsidy, Malpass said. He added that the gradual approach to FX unification often results in no unification despite repeated fund arrangements.
The World Bank boss expressed concern that 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,” he said.
“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.”
He said this reduces the development impact of World Bank operations.
“If the World Bank operation is financing cash transfers for the poor paid in local currency, this means fewer people will enjoy the benefit,” he said.
“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.”
The World Bank’s president said 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.
“We have taken a set of measures at the World Bank to discourage the subsidised 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,” he said.
“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.
“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.”
Malpass said 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 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 summarise the policy dialogue with the authorities on this issue.”