Exchange Rate Pass-Through in the Presence of Parallel Markets

Prior studies document the puzzle of limited retail price inflation following large exchange rate devaluations in emerging market and developing countries. This paper offers another partial solution to this puzzle: the presence of a significant parallel market. Using data from Nigeria, I find that the parallel market can be systemically important; estimates that only take into account the official rate understate true pass-through, as parallel rate movements have already caused inflation to occur. Overall, 12-month pass-through from parallel premium movements to aggregate retail prices is estimated to be 0.49, which is higher than from official rate adjustments alone. Furthermore, in contrast to the official market, the parallel market has robust pass-through to retail inflation across all sectors, especially food and energy. This broad-based impact also implies that the disparities in pass-through between the lowest- and highest-income households are more limited for parallel rate movements than for official rate adjustments