Exchange Control

What is Exchange Control?

Exchange or Foreign Exchange Control is a policy where the government restricts the flow of foreign currency by private individuals or companies. 

In this policy, the foreign currency is often pooled under a single entity, which is the nation's central bank. The central bank buys these currencies from businesses and individuals at a predetermined rate. 

This exchange control aims to control foreign currency outflow and prevent a negative Balance of Payment (BoP) in the nation's trade accounts. 

There are a few ways to control foreign exchange:

1. Private individuals and businesses are banned from using & possessing foreign currency without proper licenses. 
2. The government determines the exchange rate and uses government-established entities for currency exchange.
3.  Restriction on imports and exports of goods and currency. 

Exchange control was used much more in the past when the countries used gold or silver stander for their currencies. 

This policy helped a nation prevent the outflow of precious metals and allowed the government to maintain certain reserves for essential goods. 

But after the 1990s, almost all developed countries removed all levels of exchange control to promote free trade and globalization.

Countries with a History of Exchange Controls

In the past, when all the economies used gold or silver standards, the use of exchange control was a common practice among governments. It was to prevent the gold or silver from draining out of the country.

After World War II, most European countries imposed exchange controls, but as their economies recovered, they moved towards slowly removing exchange control and encouraging a more globalized world. 

The United Kingdom removed its exchange control in October 1976. At the same time, France abolished its exchange controls in 1989. After this, most developed countries removed their exchange controls by the 1990s.

Some countries still have some level of exchange control in place. These countries are classified as Article 14 countries or transitional economies under the IMF. 

They are allowed to have exchange control because they are considered developing economies that are moving from planned economies to market economies.

A list of these economies are: 

For Example, China has two currency systems one is used for the domestic market, named the Chinese Renminbi (RMB), and one is used for international trade, named the Chinese Yuan (CNY). The country also has a stringent capital control policy to prevent capital flight. 

Objectives of Foreign Exchange Control

As a developing economy, a country has many different reasons for implementing foreign exchange control; it can range from protecting its industry to ensuring it has enough foreign currency reserves to fulfill its necessary imports. 

Some of the main objectives of implementing foreign exchange control are: 

1. Balance of payment control

It is one of the main reasons for exchange control. Developing countries primarily run a negative trade balance as they are mostly import-dependent, so the government imposes it to prevent excess currency outflow.

This limits the ability of private individuals to import goods, and the government only imports the necessary goods needed for the economy to function.     

2. To protect domestic industries

By implementing an exchange control policy, the domestic industries are incentivized to produce and fulfill the economy's needs as the imports are limited due to a lack of free access to foreign currency for imports. 

3. To maintain a desired exchange rate

In exchange control policy, the government has control over all the foreign currencies of the nation. This policy allows the government to control the exchange rate of its currency.

They can use these reserves to increase or decrease the supply of their currency or to increase or decrease the value of their currency.

4. To prevent capital outflow

In this policy, the government imposes restrictions on investment outflow to prevent foreign direct investment FDI from going out from the economy.  

For Example, the Chinese economy is known for being easy to invest in and generating good returns. Still, it is hard for investors to take that return out of the economy as the government controls all foreign exchange transactions.

Researched and authored by Kunal Raj | LinkedIn

Free Resources

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