Distortions in the foreign exchange market in Zimbabwe

Abstract

The existence of the parallel market in Zimbabwe has been a prevailing issue for policymakers for many years. The parallel market rate premium has continued to increase which has caused significant price distortions in the real economy. This quantitative study used monthly data to examine the determinants of the parallel market rate premium in Zimbabwe for the period 2019 to 2023 using the monetarist approach. The ARDL methodology was used to investigate the effect that inflation rate, money supply, and expected rate of devaluation have on the parallel market rate premium. The empirical results showed that all three variables had a long run relationship with the parallel market rate premium whilst only money supply, and inflation rate had a short run relationship with the premium. The inflation rate and expected rate of devaluation both had positive effects on the premium in the long run. Whilst money supply, unexpectedly had a negative relationship with the premium in the long run. In the short run the inflation rate had a negative impact on the premium, and money supply had a positive effect. The paper concluded that the government policy that aims to reduce inflationary pressures in the economy is vital in narrowing the parallel market rate premium.