CBN Multiple Exchange Rates May Increase Debt Burden – W’bank

Posted by Samson Kankan Business News, Featured, Latest Headlines Thursday, June 1st, 2023

(AFRICAN EXAMINER) – The President of the World Bank Group, David Malpass, has warned that Nigeria’s parallel exchange rate is harmful as it worsens future debt service payments and increases the risk of debt distress.

Malpass said this in a blog post titled ‘Parallel Exchange Rates: The World Bank’s Approach to Helping People in Developing Countries’, published on Wednesday on the bank’s website.

According to Malpass, about 24 emerging and developing economies, including Nigeria, have an active parallel currency market.

He added that “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 per cent.”

In the blog post, it was disclosed that Nigeria has an exchange rate premium of 61.7 per cent as of March 2023.

The World Bank chief noted that parallel exchange rates are expensive and can drive corruption.

Malpass said, “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.”

He also noted that little progress has been made in countries like Nigeria, Argentina and Ethiopia in addressing the issue.

“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,” he said.

He further warned that parallel exchange rate markets adversely affect the impact of the bank’s projects while leading to more foreign debt.

“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.”

He added that the bank has set some measures to discourage subsidized rate and lessen the effect of such rates on the bank’s operations.

On some of the measures, he said, “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.”

The new president of Nigeria, Bola Tinubu, on Monday, affirmed that the Central Bank of Nigeria would aim at harmonising Nigeria’s multiple exchange rates.