Introduction to Exchange Control

Exchange controls, like currency devaluations, form a part of expenditure-switching policy package. Because, they, too, like devaluation, aim at directing domestic spending away from foreign supplies and investment. Exchange controls try to divert domestic spending into consumption of domestically produced goods and services on the one hand and into domestic investment on the other.

Exchange controls represent the most drastic means of BOP adjustment. A full-fledged system of exchange controls establishes a complete government control over the foreign exchange market of the country. Foreign exchange earned from exports and other sources must be surrendered to the government authorities. The available supply of foreign exchange is then allocated among the various buyers (importers) according to the criterion of national needs and established priorities. From a purely BOP standpoint, the sole purpose of exchange controls, is to ration out the available supply of foreign exchange in accordance with national interests.

There are also a variety of milder forms of exchange control which merely limit certain sources of demand for foreign exchange; thereby they try to minimize their pressure on the BOP deficit. For example, a country may restrict foreign tourism or foreign study by the nationals of the country, in order to save foreign exchange. Similarly, domestic residents may restrict some of the capital transfers abroad, again to conserve scarce foreign exchange. Partial exchange controls such as these may be scrapped if a more basic improvement in the foreign exchange earnings has occurred. India at present gained confidence with bulging forex reserves  lifted several controls in recent times. The following section lists the most frequently used currency control measures. These controls are a major source of market imperfection, providing opportunities as well as risks for multinational corporations.

Typical Currency Control Measures:

  • Restriction or prohibition of certain remittance categories such as dividends or royalties.
  • Ceilings on direct foreign investment outflows.
  • Controls on overseas portfolio investments.
  • Import restrictions.
  • Required surrender of hard-currency export receipts to central bank.
  • Limitations on prepayments for imports.
  • Requirements to deposit in interest-free accounts with central bank, for a specified time, some percentages of the value of imports and/or remittances.
  • Foreign borrowings restricted to a minimum or maximum maturity.
  • Ceilings on granting of credit to foreign firms.
  • Imposition of taxes and limitations on foreign-owned bank deposits.
  • Multiple exchange rates for buying and selling foreign currencies, depending on category of goods or services each transaction falls into.

Objectives of Exchange Control:

The object of controlling exchange is to fix it at a level different from what it would be if the economic forces were permitted free interplay. The objectives of exchange control may be:-

  • To correct a serious imbalance in the economy of the country relatively to the outside world; or
  • To conserve the country‘s gold reserves which are being depleted; or
  • To correct a persistently adverse balance of payments; or
  • To prevent a flight of capital from the country; or
  • To conserve foreign exchange reserves for large payments abroad; or
  • To maintain stable exchange rate, or
  • To ensure growth with stability, and so on.

In all these circumstances, a free exchange would be either embarrassing or prejudicial to the object in view, and exchange control becomes an imperative necessity.