Definition of Foreign exchange control 2. Objectives of Foreign Exchange Control 3. Types of Foreign Exchange Control 4. Conditions Necessitating Foreign Exchange Control. In modern times various devices have been adopted to control international trade and regulate international indebtedness arising out of international workings and dealings. The spirit of economic nationalism induces every country to look primarily to its own economic interests.
Foreign Exchange control is one of the devices adopted for the purpose. Foreign Exchange control is a system in which the government of the country intervenes not only to maintain a rate of exchange which is quite different from what would have prevailed without such control and to require the home buyers and sellers of foreign currencies to dispose of their foreign funds in particular ways.
Here the government restricts the free play of inflow and outflow of capital and the exchange rate of currencies. The Government regulates the Foreign Exchange dealings by Consideration of national needs. When tariffs and quotas do not help in correcting the adverse balance of trade and balance of payments the system of Foreign Exchange Control is restored to by Governments. The main purpose of exchange control is to restore the balance of payments equilibrium, by allowing the imports only when they are necessary in the interest of the country and thus limiting the demands for foreign exchange up to the available resources.
Sometimes the country devalues its currency so that it may export more to get more foreign currency. The Government in order to protect the domestic trade and industries from foreign competitions, resort to exchange control.
It induces the domestic industries to produce and export more with a view to restrict imports of goods. This is the principal object of exchange control. When the Government feels that the rate of exchange is not at a particular level, it intervenes in maintaining the rate of exchange at that level.
For this purpose the Government maintains a fund, may be called Exchange Equalization Fund to peg the rate of exchange when the rate of particular currency goes up, the Government start selling that particular currency in the open market and thus the rate of that currency falls because of increased supply.
On the other hand, the Government may overvalue or undervalue its currency on the basis of economic forces. In over valuing, the Government increases the rate of its currency in the value of other currencies and in under-valuing; the rate of its over-currency is fixed at a lower level. When the domestic capital starts flying out of the country, the Government may check its exports through exchange control. The Government may adopt the policy of differentiation by exercising exchange control.
If the Government may allow international trade with some countries by releasing the required foreign currency the Government may restrict the trade import and exports with some other countries by not releasing the foreign currency. Under mild system of exchange control, also known as exchange pegging, the Government intervenes in maintaining the rate of exchange at a particular level.
Exchange Stabilisation Fund were two examples of mild control. In case the demand for dollar goes up and as a result the value of pound falls, the U. Government would sell dollars for pounds and thus restrict the fall in the value of pound by increasing the supply of dollars. Under this system, the Government does not only Peg the Rate of Exchange but have complete control over the entire foreign exchange transactions.
All receipts from exports and other transactions are surrendered to the control authority i. The available supply of foreign exchange is then allocated to different buyers of foreign exchanges on the basis of certain pre-determined criteria.
In this way the Government is the sole dealer in foreign exchange. A compensating arrangement per-takes of the character of the old-fashioned barter deal. An example would be the sale by India of cotton goods of a particular value to Pakistan, the latter agreeing to supply raw cotton of the same value to India at a mutually agreed exchange rate. Imports thus compensate for exports, leaving no balance requiring settlement in foreign exchange. A clearing agreement consists of an understanding by two or more countries to buy and sell goods and services to each other, at mutually agreed exchange rates against payments made by buyers entirely in their own currency.
The balance of outstanding claims are settled as between the central banks at the end of stipulated periods either by transfers of gold or of an acceptable third currency, or the balance might be allowed to accumulate for another period, pending an arrangement whereby the creditor country works of the balance by extra purchases from the other country.
In a payments arrangement the usual procedure of making foreign payments through the exchange market is left intact. Another type of payments agreement is one designed to collect past debts. The exchange control device is not effective in all cases. Only in selective cases, this measure of curbing imports is effective.
The exchange control is necessary and should be adopted to check the flight of capital. In such cases tariffs and quotas would not be effective. Exchange control being direct method would successfully present the flight of capital of hot money. Exchange control is effective only when the balance of payment is disturbed due to some temporary reasons such as fear of war, failure of crops or some other reasons.
But if there are some other underlying reasons, exchange control device would not be fruitful. Exchange Control is necessary when the country wants to discriminate between various sources of supply. Country may allow foreign exchange liberally for imports from soft currency area and imports from hard currency areas will be subject to light import control.
This practice was adopted after Second World War due to acute dollar shortage. Even in India, many import licenses were given for use in rupee currency areas only, i. Thus in above cases, the exchange control is adopted. In such cases quotas and tariffs do not help in restoring balance of payment equilibrium. How are Payments made in International Trade? Special Drawing Rights S. History and Uses I.More...