Methods of Exchange Control

1. Influencing Exchange Rate.

Exchange control is exercised either by regulating international movements of goods through various devices or by the purchase and sale of foreign currency at specified rates in order to maintain a particular range of exchange fluctuations. Exchange control can be exercised by influencing demand for, and supply of, currencies in the exchange market. This can be done indirectly by devices like tariffs, quotas, bounties, changes in interest rates, etc. Imposition of import duties and of import quotas will reduce imports, cut down the demand for foreign currency, lower its value or raise the value of the domestic currency. Export duties, which are not so common, will have the opposite effect. Bounties affect the other way about. Export bounty will raise and import bounty (which exists nowhere) will lower the value of the home currency. A rise in the interest rates attracts funds from abroad, increases demand for domestic currency and raises its value, and vice versa.

But these are the ways in which exchange is influenced and not controlled. The effect of such devices can be offset by similar devices adopted by rival nations. These measures are not necessarily adopted for controlling exchange and are not sufficiently strong to bring rates of exchange under effective control. Hence, more direct methods have to be adopted.

2. Controlling Exchange Rate.

There are two methods generally adopted for controlling exchange:

  • Intervention: In this case, the government enters the exchange market either to purchase or to sell foreign exchange in order to bring the rate up or down to the desired level. This method has been called intervention and leads to ‘exchange pegging’.
  • Restriction: In this case, the government can prevent the existing demand for, or supply of, the country, in which they are interested, from reaching the exchange market. This method has been called restriction. The second method has been more popular because intervention proved a weak weapon and was also expensive.

3. Exchange Control Proper.

Exchange restriction is exchange control proper. For this three things are done: (a) all foreign dealings are centralised, usually in the central bank; (b) the national currency cannot be offered for exchange without previous permission, and (c) it is made a criminal offence to enter into an unauthorised foreign exchange transaction.

The usual procedure is to order all exporters to surrender claims on foreign currency to the central bank and ratio the foreign exchange made so available among the licensed importers. Exchange, control thus involves import control. Up to 1939, Germany was a pioneer in the method of exchange control although exchange control was adopted in several other European countries also during the Great Depression (1929-33).