Foreign Exchange Control: Definition, Objectives, Types and Conditions

Let us make an in-depth study of the Foreign Exchange Control:

1. Definition of Foreign exchange control 2. Objectives of Foreign Exchange Control 3. Types of Foreign Exchange Control 4. Conditions Necessitating Foreign Exchange Control.

Definition of 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.

Definition:

(1) “Foreign Exchange Control” is a method of state intervention in the imports and exports of the country, so that the adverse balance of payments may be corrected”. Here the government restricts the free play of inflow and outflow of capital and the exchange rate of currencies.

2. According to Crowther:

“When the Government of a country intervenes directly or indirectly in international payments and undertakes the authority of purchase and sale of foreign currencies it is called Foreign Exchange Control”.

3. According to Haberler:

“Foreign Exchange Control in the state regulation excluding the free play of economic forces for the Foreign Exchange Market”. The Government regulates the Foreign Exchange dealings by Consideration of national needs.

To be more clear, “Foreign Exchange Control means the monopoly of the government in the purchase and sale of foreign currencies in order to restore the balance of payments equilibrium and disregard the market forces in the decision of monetary authority”. 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.

Objectives of Foreign Exchange Control:

Important objectives of Exchange Control are as follows:

1. Correcting Balance of Payments:

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.

2. To Protect Domestic Industries:

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.

3. To Maintain an Overvalued Rate of Exchange:

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.

4. To Prevent Flight of Capital:

When the domestic capital starts flying out of the country, the Government may check its exports through exchange control.

5. Policy of Differentiation:

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.

6. Other Objectives:

Apart from the above there may be certain other objectives of exchange control.

They are:

(i) To earn revenue in the form of difference between selling and purchasing rates of foreign exchange;

(ii) To stabilise the exchange rates;

(iii) To make imports of preferable goods possible by making the necessary foreign exchange available; and

(iv) To pay off foreign liabilities with the help of available foreign exchange resources.

Types of Foreign Exchange Control:

There may be five types of Exchange Control:

1. Mild System of Exchange Control:

Under mild system of exchange control, also known as exchange pegging, the Government intervenes in maintaining the rate of exchange at a particular level. Under this system, the Government maintains on ‘Exchange Equalization Fund’ in foreign currencies.

The British Exchange Equalization Account and U.S. 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.K. Government would sell dollars for pounds and thus restrict the fall in the value of pound by increasing the supply of dollars.

2. Full Fledged System of Exchange Control:

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.e., Reserve Bank of India. 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.

3. Compensating Arrangement:

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.

4. Clearing Agreement:

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.

5. Payments Arrangements:

In a payments arrangement the usual procedure of making foreign payments through the exchange market is left intact. But each country agrees to establish a method of control whereby its citizens are forced to purchase goods and services from the other country in amounts equal to the latter’s purchase from the first country. Another type of payments agreement is one designed to collect past debts.

Conditions Necessitating Foreign Exchange Control:

The exchange control device is not effective in all cases. Only in selective cases, this measure of curbing imports is effective.

The following are conditions where exchange control can be resorted:

1. The exchange control is necessary and should be adopted to check the flight of capital. This is specially important when a country’s currency is under speculative pressure. 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.

2. 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.

3. 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.e., countries with which India had rupee-trade arrangements. Thus in above cases, the exchange control is adopted. In such cases quotas and tariffs do not help in restoring balance of payment equilibrium.