José Saul Lizondo
A number of countries use more than one exchange rate to settle their foreign exchange transactions. While most of these countries use two exchange rates, some of them employ three or more. At the end of 1984, 25 Fund member countries were maintaining multiple exchange rate systems (see table). (The Fund’s Articles of Agreement prohibit members from engaging in multiple currency practices without the Fund’s approval.)
Exchange rates, here defined as the domestic currency price of foreign currency, are set differently in different countries. In some, all the exchange rates are determined officially—being fixed to one currency or to a basket of currencies, allowed to crawl, or managed without a specific intervention rule. In other countries, rates determined by official intervention coexist with an exchange rate freely determined by market forces. Differentials among the various exchange rates also vary widely; in some countries, they are only a few percentage points, but in others the highest exchange rate is equal to several times the lowest one.
Under a multiple exchange rate system, the different rates are used for different types of transactions. In general, activities that the country’s authorities want to encourage are allowed to buy foreign exchange at a relatively low exchange rate, or to sell the foreign exchange they earn at a relatively high exchange rate, while the opposite is true for activities the country wants to discourage.
A variety of taxes, subsidies, regulations, and restrictions can produce the same effect as a multiple exchange rate system. For example, the effects of a given multiple exchange rate structure can be reproduced by using a given uniform exchange rate and: (1) subsidizing the purchase and taxing the sale of foreign exchange for transactions that under the multiple system would take place at an exchange rate lower than the uniform exchange rate; and (2) taxing the purchase and subsidizing the sale of foreign exchange for transactions that under the multiple system would take place at an exchange rate higher than the uniform exchange rate. In each case, the tax or subsidy rate must be equal to the difference between the relevant exchange rate under the multiple system and the uniform exchange rate. Other types of regulations with the same effect as explicit multiple exchange rate systems include provisions for advance import deposits that pay no interest, or pay interest below market rates. These provisions increase the effective domestic currency price of the foreign currency used for the imports they cover. And, abstracting from the legal issues involved, illegal markets for foreign exchange pose similar issues to those posed by officially recognized multiple exchange rates. (For a discussion of illegal foreign exchange markets, see “Black markets in foreign exchange: their causes, nature, and consequences,” by Michael Nowak, Finance & Development, March 1985.) The present article, however, is mainly concerned with explicit multiple exchange rate systems, the reasons for their adoption, their effects, and the issues that must be faced when they are replaced by a uniform exchange rate.