Black market premia, exchange rate unification, and inflation in sub-Saharan Africa

In countries where the black market premium on foreign exchange is exceptionally high, often more than 100 percent, lowering the black market rate to a level close to the market determined official rate will improve the balance of payments and increase exports. Floating the currency to depreciate the real exchange rate and make exports more competitive can raise inflation substantially, however, as governments replace the lost revenue from exports. Inflation will occur even if real government spending remains constant unless there are new taxes or spending cuts to compensate for the loss of implicit tax revenues. To avoid costly surges in inflation, exchange rate reform may have to proceed slowly, otherwise the depreciation is likely to meet with considerable political and social opposition as inflation rises. Once the government closes the spread between the official and black market rates, it faces a decision on whether to continue with a float permanently. Evidence from developing countries over the next few years should give some insights into this issue.