Methods of Exchange Control and its Objectives

To know exactly what methods of exchange control are? First we should try to understand that what exchange control is? Exchange control refers to the policy of the government through which it controls or intervenes in the foreign exchange market. In other simple words, government puts restrictions on the sale and purchase of foreign currencies and refers a measure which influences the foreign exchange rate and closing free movements of foreign exchange in the country.

In a free market economy, there are no restrictions on the movements of foreign currencies from inside to outside, but in a planned economy, there are restrictions and control of the government on the movements of currencies, for which different devices and methods are adopted. Exporter and other investors are directed by the government to surrender and deposit the foreign currencies held by them with the monetary authorities for whom they are paid in home currency at the prevailing rates of conversion.

Methods of Exchange Control

In order to achieve goals of exchange control, two main methods are applied which are as under:-

• Unilateral methods
• Bilateral methods

1. Unilateral Methods

In unilateral methods of exchange control, a government applies exchange control without consultation with other governments. These methods are discussed are as under;

1. Exchange Pegging

It is the method of exchange control. Exchange pegging refers to the policy of fixing the exchange value of the current according to some desired rate. When it is fixed higher than market rate, it is “Pegging up”. but if fixed lower than market rate, it is known as “pegging down”.

2. Clearing Agreement

Another method of exchange control is clearing agreement. It is an undertaking between two countries to exchange goods and services in accordance with a predetermined or specified rate of exchange. This method is applied to check fluctuation in exchange rate and to maintain equilibrium in balance of payments.

3. Standstill Agreement

In this agreement the relationship between two countries in terms of capital movements remains unchanged. Debtor country is allowed to repay her loan in installments or the short term loan is converted into long term loan.

4. Compensation Agreement

According to this agreement, goods of just equal value are exported and imported from each other country. Hence, no balance is left and no foreign exchange is involved.

5. Payment Agreement

In this method, creditor country will export more and more to Creditor County and the creditor country will import less and less from debtor country to settle the accounts.

6. Foreign Exchange Rationing

Government has the right to direct all the exports and other investors to surrender all foreign exchange with the central banks. Foreign exchange, so collected can be rationed by fixing quota of amount and rate of foreign exchange.

7. Blocking of Foreigner Accounts

During emergency, a country may block or restrict the foreigners to transfer their funds in their home accounts. But rarely this step is taken by the countries.

2. Bilateral Methods

In bilateral methods of exchange control, a government applies exchange control with mutual understanding and consultation of the other government. These methods are discussed are as under;

1. Clearing Agreement

When two countries agree to settle their accounts in their home currencies, through their central banks, this method is known as clearing agreement.

2. Moratorium Application

A legal authorization to debtor to stop payment is known as Moratorium. To solve temporary problems of payment, a country can stop to make payment for imports and interest on capital.

Objectives of Exchange Control

Exchange control is adopted by the government to achieve following objectives;

1. Correction of Unfavorable Balance of Payments

This objective is achieved by curtailing unnecessary imports by putting the restrictions.

2. Protection of Home Industries

In order to protect the home industries from foreign competition, policy of “protection” is implemented for this purpose; government will not allow the imports of those goods produced by the home industries.

3. Stabilization of Exchange Rate

The fluctuations in the exchange rate of a country are not favorable for the economy. It is very necessary to stabilize this rate to create confidence in the economy.

4. Conservation of Foreign Exchange

Foreign exchange reserves are very important for a country, which is conductive for all economic development process as it enables the government to import essential goods for production and defense of the country.

5. Restrictions on Injurious and Harmful Goods

Governments though exchange control restricts the import of injurious and harmful goods in the country.

6. Helpful in Proper Planning

Government can plan her developing policies and other objectives according to the available foreign exchange resources and can use them accordingly.

7. Source of Revenue

Exchange controls also may result as a source of revenue for government, it purchases foreign exchange at a lower rate and sells at a higher rate and then the difference will naturally generate revenue.

8. Policy of Discriminations

Though exchange control policy of discrimination is adopted, that is, either to favor or disfavor a country, some better concessions are granted or some more restrictions are imposed.