Interactions Between the Formal and Informal Market for Foreign Exchange

Abstract

This paper builds a static framework model to demonstrate the interrelationship between the black and formal market for foreign exchange. There is fungibility in the two markets with a demand spillover from the formal to the black market. There are also reverse linkages through portfolio demand for foreign currency. The framework allows for policy analysis and shoWs that the black market rate should not be taken as an indicator of the underlying market exchange rate. The importance of remittances and portfolio demand for foreign exchange in the premium are clearly demonstrated. The model also points to various government policy tools that could reduce the significance of the black market for foreign exchange. (F31, F41, 011)