The black market in currencies refers to the illegal or parallel market in foreign exchange in various countries around the world. The currency black market forms part of the underground economy by virtue of operating outside legal banking channels. In a currency black market, cash transactions are almost always the norm, since participants would be obviously reluctant to leave any trace of their involvement in such transactions.
 
Why Do Currency Black Markets Exist?
Currency black markets typically spring up in countries that have the following characteristics in common:  

  • Weak economic fundamentals, such as a high rate of inflation and limited foreign exchange reserves.
  • Strict currency controls that limit the amount of foreign currency available to residents.
  • A fixed exchange rate regime where the domestic currency is pegged at an unrealistically high exchange rate to the U.S. dollar or another global currency.
  • A lack of confidence among the citizenry in the value of the domestic currency. 

As a result, substantial demand for foreign currencies is created in a nation with these attributes, as its citizens seek to hedge the value of their cash holdings. However, the currency controls make it extremely difficult for people to buy foreign currencies with their domestic currency at the official exchange rate. A black market, therefore, develops for foreign currencies that would generally be priced at a significant premium to the official exchange rate, because of its artificial value and the demand-supply imbalance.
 
Where Is It Becoming Prevalent?
Black market currency trading is prevalent in a significant number of countries worldwide. However, some of the larger economies where it is currently proliferating include Egypt, Iran, Argentina and Venezuela, as summarized below.
 
Egypt
The currency black market in Egypt has been flourishing since former President Hosni Mubarak was toppled in February 2011. The Egyptian pound lost 13.4% of its value against the U.S. dollar in the subsequent two years, as foreign currency inflows from tourists and investors dried up because of political instability and violent protests. By January 2013, the nation’s foreign exchange reserves had fallen to $13.6 billion, from $36 billion two years earlier. While the Egyptian pound was officially quoted at 6.7 to the USD in February, it was at about 6.9 in the black market, having recovered from a low of 7.5 in late January when street protests sent the currency plunging.
 
Iran
The Middle Eastern nation’s currency, the Iranian rial, has been in free fall since new economic sanctions were imposed on it by the United States and European Union in July 2010. These sanctions have cut Iran’s oil exports by half, severely curtailing foreign currency inflows, thereby devaluing the rial and pushing up inflation.  While the official exchange rate is 12,260 rials to the U.S. dollar, the black market value of the rial plunged 60% to 39,000 in a single week between Sept. 24 and Oct. 2, 2012, after the Iranian government said that the official rate would only be available to importers of essential items such as food and medicine. The unofficial rate subsequently improved to 31,000 as the Iranian government cracked down on the currency black market.
 
Argentina
The currency black market in Argentina has been operating for more than a decade, ever since the nation defaulted on its external debt in 2002. While Argentina has currency controls in place to conserve precious foreign exchange reserves and prevent capital flight, these restrictions have only served to stimulate black market currency trading in a nation where inflation is approaching 25%. In the black market, 6.7 Argentine pesos are required to purchase a U.S. dollar, a premium of about 35% to the official rate of 5 pesos per USD.
 
Venezuela
 In this South American nation, dwindling foreign exchange reserves and an annual inflation rate of 28% have led to unprecedented demand for U.S. dollars. The Venezuelan bolivar has resultantly fallen to a value of 9.25 versus the USD in the black market, less than half the official rate of 4.3 bolivars per USD.
 
The Bottom Line
A currency black market in a nation will exist as long as the adverse economic factors mentioned earlier remain in force. However, its importance may gradually erode as the economy becomes more open, foreign exchange reserves increase and confidence in the domestic currency returns. India is a classic example of a nation that has managed to all but eliminate its currency black market over the past two decades as it transitioned to a market economy and implemented a floating rate policy for its Rupee. Booming international trade and healthy economic growth have resulted in India’s foreign exchange reserves amounting to US$295 billion by February 2013, compared with a low point of about $1 billion in 1990. 

Related Articles
  1. Economics

    The Mechanics Of The Black Market

    Black markets will continue to exist as long as we have regulations and taxes. Discover how they work.
  2. Personal Finance

    Countries With The Largest Shadow Markets

    These nations have the largest informal economies relative to their respective GDPs.
  3. Investing Basics

    Some Thoughts On The Shadow Market

    The "shadow market" is a broad-based moniker with both positive and negative connotations.
  4. Economics

    The Big Business Of Black Markets

    Black markets are alive and kicking in all corners of the world, sometimes in plain view. And they are big business.
  5. Mutual Funds & ETFs

    ETF Analysis: WisdomTree Bloomberg US Dllr Bullish

    Explore an analysis of information on the WisdomTree Bloomberg U.S. Dollar Bullish Fund, a currency ETF that tracks the overall performance of the U.S. dollar.
  6. Technical Indicators

    Using Moving Averages To Trade The Volatility Index (VIX)

    VIX moving averages smooth out the natural choppiness of the indicator, letting traders and market timers access reliable sentiment and volatility data.
  7. Technical Indicators

    Detrended Price Oscillator Trading Strategies

    The detrended price oscillator (DPO) offers a simple approach to cycle analysis, removing momentum and long-term trends from the equation.
  8. Economics

    3 Reasons Germany Would Be Better Off Without the Euro

    Explore the arguments in favor or against the idea that Germany would be better off leaving the European Union and abandoning the euro.
  9. Mutual Funds & ETFs

    Top 3 Japanese Yen (JPY) ETFs

    Find out about currency exchange-traded funds, and learn about some of the best available ETFs that are focused on the Japanese yen.
  10. Mutual Funds & ETFs

    Top 3 British Pound (GBP) ETFs

    Learn more information about currency exchange-traded funds, and about currency ETFs that are focused specifically on the British pound.
RELATED TERMS
  1. Fractal Markets Hypothesis (FMH)

    An alternative investment theory to Efficient Market Hypothesis ...
  2. Currency Depreciation

    A decrease in the level of a currency in a floating exchange ...
  3. Spot Rate

    The price that is quoted for immediate settlement on a commodity, ...
  4. Capitalism

    A system of economics based on the private ownership of capital ...
  5. Competitive Devaluation

    A series of sudden currency depreciations that nations may resort ...
  6. Sterilized Intervention

    The purchase or sale of foreign currency by a central bank to ...
RELATED FAQS
  1. How are NDFs (non-deliverable forwards) priced

    The price of non-deliverable forward contracts, or NDFs, is commonly based on an interest rate parity formula used to calculate ... Read Full Answer >>
  2. What are the goals of covered interest arbitrage?

    The goals of covered interest arbitrage include enabling investors to trade volatile currency pairs without risk as well ... Read Full Answer >>
  3. How do you calculate a reverse split using Excel?

    A reverse stock split is a corporate action a company may take to meet exchange requirements. A reverse split reduces the ... Read Full Answer >>
  4. What is the difference between a Nostro account and a regular bank account?

    The term nostro account is a bit of an umbrella term and can have different meanings for different contexts. For instance, ... Read Full Answer >>
  5. What types of companies benefit from reporting results utilizing constant currencies ...

    Any company that does a substantial amount of business in foreign countries, and is therefore subject to foreign currency ... Read Full Answer >>
  6. What are the benefits of financial netting?

    Financial "netting" is a general and somewhat colloquial term. It is used to describe the act of consolidating multiple transactions ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!