Various methods of exchange control
Meaning and Definitions of Exchange Control
Exchange control was first of all used by Germany after first world war (1914-18), when, due to war there was a considerable fall in the exchange rate of Mark against all currencies. By following the methods for exchange control, Germany tried to improve the value of its currency. Subsequent to this, after 1931, almost all European countries tried to control the fluctuations in their exchange rates.
The considerable destruction during the Second World War (1939 1945) further forced the countries to control fluctuations in exchange rate using different methods of exchange control. In today’s world, because of the prevalence of paper based currency exchange control is exercised by every country.
According to Prof. Evilt, “Any form of government intervention in transactions related to foreign exchange is referred to as exchange control.”
According to G. N. Halms, “By exchange control we refer to measures which replace part of the equilibrating functions of foreign exchange market by regulation alien to the pricing process.”
According to Haberler, “Exchange control refers to the state regulation excluding the free play of economic forces in the foreign exchange market.”
Characteristics of Exchange Control
The following are the characteristics of exchange control:
(1) Centralisation of Exchange Transactions-All transactions related to foreign exchange are routed through the Central Bank of the country or it’s representative. Also for all transactions related to foreign exchange, the permission of Central Bank is required.
(2) Deposting Foreign Exchange with Central Bank- The public is not allowed to keep foreign exchange. They are required to deposit it with the Central Bank.
(3) Foreign Exchange for Specific Purpose-Foreign exchange can be obtained from the Central Bank for certain specific purpose.
(4) Favourable Balance of Payments by Control on Imports- By exchange control, imports are kept at a minimum, so that a favourable BOP can be achieved.
(5) Monopoly of Government- Exchange control ensures government monopoly over foreign exchange.
(6) Payments through the Central Bank- The importers obtain the required foreign exchange from the Central Bank to make payments abroad.
Objects of Exchange Control
The various objects of exchange control are explained below:
(1) Balancing the Balance of Payment- With the help of exchange control, it is tried to control the flow of foreign exchange so that a favourable BOP can be maintained.
(2) Making Foreign Exchange Reserves- It is tried that receipts in foreign exchange exceed the payments in foreign exchange so that foreign exchange reserves can be maintained.
(3) Stability in Exchange Rate- A currency based on paper standard is subjected to constant fluctuations, which adversely affects the economy in short-run, as well as, long-run. With the help of exchange control, these unfavourable fluctuations can be controlled.
(4) Check on Outflow of Capital- Outflow of capital is harmful for a country. Exchange control prevents, sale of foreign currency so that the outflow of currency is checked.
(5) Making Commercial Differention Possible-By initializing different degrees of exchange control measures on different countries, a country can maintain different commercial relations with them.
(6) Protection-By adopting exchange control measures a country aims to protect its domestic industries.
(7) Restriction on Trade-The objective of exchange control can relate to restrict export or import of certain items.
(8) Income to the Government- Central Government can also earn income by exercising exchange control.
(9) Check on Depression-Exchange control can help a country to fight depression.
Methods of Exchange Control
The methods of exchange control can be categorized as direct or unilateral and indirect or multilateral. These methods are explained below:
(A) Direct Methods/Unilateral Methods
These methods aim to affect the demand and supply of foreign exchange directly.
The various techniques of this method are as follows:
(1) Rationing of Foreign Exchange- Under this method, the right to purchase and sell foreign exchange rests solely with the government. The government purchases the whole of the foreign exchange and the government imports only those items which are needed by the country on the basis of availability of foreign exchange.
(2) Exchange Pegging- It refers to the process of government intervention in the foreign exchange market so that the exchange rate is maintained at a specific point. To achieve this objective, the Central Bank buys or sells foreign exchange. Exchange pegging can take the following two forms:
(a) Pegging up- Pegging up means that the currency will be revalued at a higher rate and efforts are made to maintain this rate.
(b) Pegging down- It means that the currency will be devalued and efforts are made to maintain that rate.
(3) Blocked Accounts- This system was introduced by Prof. Schacht. Under this method, during times of economic crisis, the government discourages the payments to be made by its citizens abroad in the form of repayment of loans, interest payments, payments for imports etc. The amount is required to be deposited in the account of foreigners but is not remitted to them in their currency.
(4) Multiple Exchange Rates- This system was developed in Germany during the Great Repression. Under this system, different rates are declared for importing and exporting different categories of items.
(B) Indirect Methods/Multilateral Methods-The different indirect methods of exchange control are as follows:
(i) Change in interest rate- Interest rate does not affect the exchange rate directly but indirectly it affects the exchange rate and exchange control. If the interest rate is high then this will ensure inflow of foreign exchange in the country for the purpose of investment.
(ii) Tariff-With the help of tariff, a government can control the quantity of exports and imports. If a high tariff is imposed on imports, then it will discourage imports.
(iii) Import Quota-By declaring import quota on different goods, imports are controlled within a limit and outflow of foreign exchange is checked.
(iv) Export Subsidy- By declaring subsidy on exports, exports are encourages and inflow of foreign exchange is checked.
