Parallel exchange rates in
            developing countries : lessons from eight case studies
In parallel (dual) foreign-exchange
            markets - extremely common in developing countries - a
            market-determined exchange rate coexists with one or more
            pegged exchange rates. The authors report the main lessons
            from a World Bank research project on how these systems
            work, based mainly on case studies in Argentina, Ghana,
            Mexico, Sudan, Tanzania, Turkey, Venezuela, and Zambia. On
            the whole, the experiences were disappointing. Most
            countries tolerated high premiums for long periods, which
            harmed the allocation of resources and growth. The studies
            indicate no clear gains from prolonging a dual system. The
            case for a dual foreign exchange system is stronger when the
            system is adopted as a temporary option to deal with a
            severe balance of payments crisis. Argentina, Mexico, and
            Venezuela resorted to a dual system at the time of the debt
            crisis, to smooth out the devaluation in the exchange rate
            to achieve the needed real depreciation. This helped to
            maintain limited control over domestic inflation, and
            avoided a sharp drop in real wages while protecting the
            balance of payments. In the longer term, not much was
            gained. In the cases studied, the dual system was misused
            more often than not: it was used too long and the premium
            was higher than is should have been. Venezuela, for example,
            used the system for six years with an average 120 percent
            premium, Mexico for five years (average 30 percent), and
            Argentina for eight years (average 44 percent). In Argentina
            and Venezuela, the dual system was used to avoid
            macroeconomic adjustment while protecting international
            reserves. It is doubtful the macroeconomic gains (in terms
            of keeping equilibrium in the balance of payments and lower
            inflation) were greater than the costs in terms of
            misallocation of resources. In Ghana and Tanzania, the dual
            exchange rate system was prolonged to maintain overvalued
            real exchange rates and expansionary macroeconomic policies.
            The large premium in those countries (at times more than
            1,000 percent) shows the dramatic inconsistency between
            exchange rate policy and monetary and fiscal policies. On
            determinants of the parallel exchange rate, the evidence
            indicates that macroeconomic fundaments (such as fiscal
            deficit, credit policies, and so on) matter most. In the
            short run the premium is driven by expectation about the
            evolution of these macroeconomic factors. Overall, in the
            countries examined in the project, the existence of a
            parallel foreign exchange market generated fiscal losses.
            These losses resulted because the public sector was a net
            seller of foreign exchange rate. This means that unification
            has some pleasant fiscal arithmetic. The experience with
            unification indicates that it usually takes place at the
            parallel exchange rate. Most countries unified to a crawling
            peg system, though some opted for floating exchange rates.
            Successful unification to a fixed exchange rate was less
            frequent, and it required strong adjustment in fiscal and
            monetary policies. Regarding speed, unification was quick in
            countries where the parallel system was used temporarily,
            and gradual in those where the system existed for long
            periods and with a tradition of widespread foreign exchange controls.