Black Market Exchange Rate and Exchange Rate Path Stability: a Dynamic-Stochastic Model Analysis for Ukraine

As the Russo-Ukrainian conflict persists in an intense phase, the National Bank of Ukraine (NBU) has implemented a pegged exchange rate regime to impede an imminent "balance of payments"1 crisis. This crisis arises due to a sudden drop in foreign investment and a surge in outbound capital flow, as exchange rate expectations deteriorate and the confidence in the nation’s financial stability decreases. In conjunction with stringent capital controls, this has resulted in the flourishing of a black market for currency with free market exchange rates. Such a market operates outside regulatory oversight in unlicensed facilities, such as "exchange kiosks," and has become more accessible and appealing to currency holders. In the face of these challenging economic conditions, it is understandable that the NBU has sought to employ a pegged exchange rate regime to address both inflation and the issue of a widening black market premium. To slow down the rise in the black market premium over the official rate, the NBU has implemented an "adjustment-pegged" regime, where the official exchange rate adjusts to a black market rate once the premium reaches 20%. Thus, the NBU has two primary objectives: maintaining low inflation (its main goal) and keeping the exchange rate low while simultaneously controlling the black market exchange rate premium. The efficacy and stability of this policy must be evaluated to ensure that the stated goals are achieved. This work will outline a model that explains the existence of the black market.