BY GETACHEW MINAS
The black market, underground or shadow economy, is a clandestine business or a series of transactions that has some aspect of illegality. It is characterized by some form of noncompliant behavior toward an institutional set of rules. Its legal definition is a set of goods and services whose production and distribution is prohibited by law. Noncompliance with the law constitutes an illegal operation, including transactions in black market trade. Parties engaging in the production or distribution of prohibited goods and services are considered partners in the illegal economy. The illegal operations include drug trade, prostitution, currency transactions and human trafficking. Black market has been expanded in Ethiopia during the rule of the TPLF in the past two decades.
Violations of the law related to income tax evasion constitute unreported or illegal economy. Since tax evasion or participation in a black market activity is illegal, its participants will attempt to hide from the government or regulatory authority. For them, cash is the preferred medium of exchange in their illegal transactions since it does not leave a footprint. Common motives for operating in black markets are trading in contraband, avoiding taxes and regulations or avoiding price controls or rationing. Typically the totality of such activities is referred to as an illegal component of the economy. Illegal financial activities are taking place in developing countries, including Ethiopia. The TPLF and its agents are engaged in illicit financial activities, causing capital flight out of the country.
The black market is “distinct” from the official market, in which commodities are distributed through channels that are legal and acceptable by manufacturers and authorities. Black money is the proceeds of an illegal transaction, on which income and other taxes have not been paid. It is acceptable only among money launderers. Because of the clandestine nature of the black economy it is “not” possible to determine its size and scope. The causes, effects and policy implications of the underground economy, in both developed and developing countries have attracted attention in recent years.The “parallel” economy or the black economy, in Ethiopia has been expanded by the TPLF to have adverse effects on the official economy in the past decades.
The effects of the parallel economies are of particular concern to policy makers in developing countries. These countries are confronted with growing informal engagements, parallel markets in goods and financial assets that deal in foreign exchange, causing capital flight. As pointed out by D. Degefa, the parallel market for foreign exchange has reached a remarkable size in some developing countries, including Ethiopia. The existence of a large parallel foreign exchange market in developing countries is attributed to the “deficiency” of the legal institutions, which make operating in the formal sector excessively expensive. It is argued that a large parallel market for foreign exchange with a high charge is indicative of a basic “disequilibrium” in the foreign exchange regime, incurring substantial economic and social costs.
The expansion of the parallel market leads to the “loss” of government control over the economy as more and more of the official transaction is diverted to the illegal market. The parallel charge for foreign exchange is an implicit tax on exports. It is also a “disincentive” to production for export and ahidden fiscal distortion. The parallel charge is an important price influencing key macroeconomic variables. The parallel market charge acquires importance not only from its direct trade linkages, but also as an indicator of inconsistency between macroeconomic policy and the foreign exchange regime.
Inflation and disequilibrium: The black market is a reflection of economic inconsistency. Its role is likely to feed back into macroeconomic outcomes by influencing government policy. It causes the private sector to expectpolicy change such as devaluation of currency. In addition to the efficiency costs, high and persistent parallel market charges can substantially undermine the allocation role of the real exchange rate in the economy. It also exposes the credibility problem of economic policy. Economists concluded that a rising parallel market charge has negative impacts on official exports and foreign trade taxes, as well as a “positive” effect on capital flight. Currently, this is happening in Ethiopia, encouraged by the TPLF and its financial functionaries.
Rising and expanding black market charges may have serious fiscal and commercial policy implications. They squeeze the tax base in foreign trade transactions and expand the opportunities for large scale “rent seeking” activities. High black market charge also aggravates the debt problem and the foreign exchange constraint. Through its effects on capital flight it worsens the constraint.
Also controlling “inflation” could become more difficult under high black market charges. It is believed that the parallel exchange rate feeds back into the economy through illegal trade and prices. Also, high charges have detrimental effects on official exports and hence on growth. They provide only limited insulation from external shocks as construed by the TPLF experts.
It is important to note that authorities of some developing countries argue that parallel foreign exchange markets may be socially desirable. These markets accommodate operators whose demand for foreign exchange is “not” met by the official market. They also increase employment by increasing the domestic availability of “imported inputs.” As pointed out by D. Degefa, Ethiopia’s parallel market for foreign exchange had been high. However, after a massive devaluation and the introduction of the foreign exchange auction system, the charge drastically reduced to a declining trend over time. Despite the attempts made to “unify” the official and parallel foreign exchange markets, parallel market still exists, with fast growth.
The persistence of the parallel market is indicative of disequilibrium in the foreign exchange market as mentioned earlier. It has the tendency to cause the auction exchange rate to rise and it “induces” a leakage of foreign exchange from the auction to the parallel market. It reduces the incentive to produce for export and encourages smuggling, contraband activities and capital flight. In response to the adoption of the auction system in the official foreign exchange market, the official exchange rate has been approaching the parallel exchange rate after a long period of time. But it “deviated” again due to the nature of the auction itself and involvement of the TPLF saboteurs. It may also diverge if the IMF and WB “withdraw” their foreign exchange backup to Ethiopia. Such acts may favor the TPLF. The concerned government agency should, therefore, look into such intrigues prudently and cautiously.
Characteristics of parallel markets: Although the “general” behavior of the parallel foreign exchange markets is similar within developing economies, there are minor differences among countries. However, there are similarities in the relationships between the size of the parallel market and the macroeconomic variables. The relationship between the parallel foreign exchange and the factors that affect it are expected to be similar in countries with high foreign exchange charges. Besides, it is argued that countries with high foreign exchange “charges”are also subject to macroeconomic imbalances.
Ethiopia is among the countries that had high parallel market charges for foreign exchange in recent years. Despite the devaluations that are followed by adoption of an auction system for foreign exchange and gradual trade liberalization “reforms,” the parallel market charges remained “high”. The rationale behind these policy reforms is to achieve unification of the official and the parallel exchange rates for integrating the parallel market into the formal economy. There is, however, a need to identify the determinants of the gap between the parallel and the official exchange rates in Ethiopia.
Characteristics of the parallel markets are reflected through supply of and demand for foreign exchange. These differ from country to country and depend on the nature and effectiveness of exchange “restrictions” imposed. The supply of foreign currency in the parallel foreign exchange market generally has five principal sources. These are smuggling of exports, under-invoicing of exports, over-invoicing of imports, foreign tourists and the diversion of remittances from abroad into unofficial channels. TPLF is an actor in some of these activities. Besides, government officials may also divert foreign currency from official to the parallel market through corruption. Despite the variety of sources of supply of foreign exchange in the parallel market, there is a dominant source in each country.
In Ethiopia, the dominant sources of supply of foreign exchange for the parallel market are largely “contraband or smuggled” exports of goods and unofficial private transfers. On the other hand, legal and illegal imports, capital flight, and travel abroad are generally the principal sources of demand for foreign exchange. Contraband importers want to escape import taxes; they continue to engage in illegal import as a worthwhile venture. Invisible payments such as expenses for medical, educational and travel services abroad are the dominant sources of demand for foreign exchange in the parallel market in Ethiopia.
Conclusion: A large portion of francovaluta import is financed with the foreign exchange obtained in the parallel market. According to Kiguel and O’Connel, the high “cost” of law enforcement coerces the governments of developing countries to tolerate a substantial amount of “illegal” parallel foreign exchange market activity. In Ethiopia, however, this market has never been tolerated and the government has tried to eliminate it with intensive policing and controls. When governments in developing countries fail to react to the excess demand created in the official foreign exchange markets, a chain reaction sets in.
In response to foreign exchange scarcity due to limited foreign exchange earning capacity of the economy, importers are forced to enter the parallel market. They are willingto pay higher prices depending on the intensity of demand for foreign exchange. Buyers enter the parallel market to avoid high customs duties.
They also evade limitations on the acquisition of foreign exchange for invisible payments. A ban on the importation of prohibited goods and services forces traders to dodge and elude certain regulations on imports. Also, inefficient foreign exchange market encourages buyers to enter the black market. Buyers weigh the benefits of acquiring foreign currency in the parallel market against all costs including the risk of participating in an illegal activity. The NBE has to device strategies with stakeholders on how to productively allocate and improve foreign exchange earning capacity of the economy thereby reducing the impact of black markets.
THE ETHIOPIAN HERALD AUGUST 26/ 2021
