Topic#3 Exchange control

Exchange control? Restrictions on conversion of a country's currency for another, imposed by its government in an attempt to improve its balance of payments position. controls imposed by a government on the purchase/sale of foreign currencies by residents or on the purchase/sale of local currency by nonresidents.

Common foreign exchange controls include: Banning the use of foreign currency within the country Banning locals from possessing foreign currency Restricting currency exchange to government-approved exchangers Fixed exchange rates Restrictions on the amount of currency that may be imported or exported

Objectives of exchange control To conserve foreign exchange To correct balance of payments To maintain exchange value To prevent the flight of capital To protect domestic industry To encourage essential imports

Objectives of exchange control(cont..) To discourage conspicuous consumptions To enable the government to repay foreign loans

Methods of exchange controls Unilateral methods Bilateral methods

unilateral methods

Foreign exchange rationing Foreign exchange rationing: all the peoples within its jurisdiction are required to buy from and sell to a special agency, such as central bank or exchange control board To pay for essential imports To meet external debts To prevent flight of capital

Foreign exchange rationing(cont..) depending upon the severity of balance of payments system of rationing may be partial or complete if position is severe then system will be more centralized and proceeds of all international transactions be sold to one central agency

Foreign exchange rationing(cont..) if position is moderate then it may require that only certain percentage or the proceeds of defined classes of transactions are sold to any one or more specific agencies in partial rationing system both controlled market and free market operated side by side

Regulating bank rate Is the bench mark which brings change in all other rates of interest change in interest rate affects the flow of foreign capital when internal interest rates rise, the inward flow of foreign capital increases which further bring increase in the demand of domestic currency and ultimately leads to appreciation in the value of domestic currency

Regulating bank rate(cont…) when bank rates are lowered it produces the opposite results

Regulating foreign trade biggest source of earning and spending foreign exchange by discouraging imports and encouraging exports the demand and supply of currency can be channelize, which will lead to appreciation or devaluation of currency value

Multiple exchange rates country fixes different rates of exchange for the trade of different commodities or for transactions with different countries

Exchange pegging establishment of official rates at which the central agency will buy and sell the foreign currencies the rates so fixed, may be below or above the normal market rate pegging up Pegging down normally pegging is done when there is violent fluctuations in exchange rates

Blocked accounts these are bank deposits, securities and other assets held in controlling country by the people of other countries foreign holders of such accounts would very much like to convert them into the currency of their own countries, but if they are permitted to do so if they are permitted this it could cause severe problem of balance of payment for controlling country

Blocked accounts(cont…) therefore the balances held in blocked accounts regulated in number of ways Interests and dividends in blocked accounts have been permitted for investment in new long term securities balances in blocked accounts are permitted for investment in other kinds of property within the blocking countries

Blocked accounts(cont…) some countries permit the use of blocked accounts for partial payment of goods exported holders of blocked accounts generally authorized to use them in meeting expenses while travelling as tourist into the blocking country or to sell them to others who plan to use them for tourist expenditure there

Exchange stabilization fund This fund is to stabilize the exchange rate of national currency through the sale and purchase of foreign currencies

Bilateral/multilateral methods

Payment agreement Agreement between a debtor country and creditor country for the repayment of principal and interest by the debtor to the creditor Creditor country commits to refrain from imposing restrictions on imports from debtor country so as to enable the debtor country to increase its exports to the creditor

Payment agreement(cont…) Debtor country takes necessary steps to encourage exports and discourage imports from creditor country

Clearing agreement Device for direct bilateral exchange of goods on national scale Under this agreement importers make payments in domestic currency to the clearing account and exporters obtain payment in domestic currency from the clearing fund

In such way the need for foreign exchange does not arise except at the time of settling the net balance between the trading countries Each country stipulated about the quantity of buying and selling In advance within a given period of time

An official exchange rate is also settled between two which could be different with other trading countries

Private compensation agreement Closely resemble barter A business firm in one country is required to equalize its exports to the other country with imports from that country So that at the end neither deficit nor surplus on both sides

Standstill agreement Facilitating debtor country to pay for imports at later date During the moratorium period importer and debtor both make payments in home currency to an authorized bank