Exchange Rate Control: Objectives and Limitations

In this article we will discuss about:- 1. Meaning of Exchange Rate Control 2. Objectives of Exchange Rate Control 3. Utility 4. Limitations.

Meaning of Exchange Rate Control:

Exchange control involves a complete control over all transactions relating to foreign payments and foreign receipts. It occurs when the inhabitants of the country are compelled to surrender their all foreign receipts to the exchange control authorities (namely, the central bank of a country) and are permitted to obtain foreign currency only after the application to the central bank.

The main features of a developed system of exchange control are as follows:

(a) Centralisation of all foreign exchange operations:

There is a centrali­sation of all foreign exchange operations in a single institution, either the central bank or some specially instituted exchange control authority.

(b) Delivery of all foreign proceeds to the central authority:

Exchange control requires the delivery to the central authority of all proceeds from international transactions carried on by the residents of the country.

(c) Fulfillment of demand for foreign currencies from the common pool:

Under the exchange control system, all demands for foreign currencies must be met from the central pool; subject to the discretion of the central authority.

(d) Official monopoly in all exchange dealing:

The basis for exchange control is to be found in the official monopoly in all foreign exchange dealings, and control is effective only to the degree to which this monopoly power is exercised.

Exchange control in varying degrees is now in operation in most of the countries of the world, including India where it is administered by the Reserve Bank of India under the Foreign Exchange Management Act, (FEMA).

Such controls are usually adopted through the methods like, intervention in the rates of exchange by the exchange control authorities, restriction on the sale of foreign currencies and on the remittances of funds to the foreign countries, agreements relating to trade, clearing and payments between the countries, and multiple exchange rates.

Objectives of Exchange Rate Control:

The main objectives of exchange control are divided into two parts — primary and secondary:

The primary objectives are:

(a) To deal with a particular phenomenon (i.e., the prevention of the flight of capital from the country),

(b) To regulate trade with regard to allocation of foreign currencies among different commodities and services, firms, as also among countries, 

(c) To protect the newly started industries of the less developed countries and

(d) To restrict the demand for foreign exchange within the limit of present availability.

The secondary objectives are

(a) To provide the government with an easy access to foreign exchange in times of emergency; and

(b) To retaliate against other countries which have imposed trade restrictions.

Utility of Exchange Rate Control:

Exchange control serves the following purposes:

(a) Prevention of exces­sive fluctuations in the rate of foreign exchange,

(b) Proper allocation and use of scarce foreign currencies for imports in the developing countries,

(c) Prevention of the undesirable flight of financial capital from the country,

(d) Proper regulation of import trade and proper direction of export trade in the overall interest of the country,

(e) Mitigation of the temporary balance of payments pressure,

(f) Establishment of the government’s control over the exchange dealings to remove unofficial foreign exchange dealings, and

(g) Imports of essential goods and materials for implementing development plans and programmes.

Limitations of Exchange Rate Control:

But the actual operation of the exchange control system gives rise to:

(a) Fall in the volume of international trade,

(b) Black-marketing in forcing ex­change in the unofficial markets, and

(c) Smuggling of foreign exchange and export of capital even under strict.

Conclusion:

Exchange control as a short-term and transitory measure may be beneficial to a country suffering from the balance of payments crisis. But it should not be allowed to continue for a long time in the broader interest of multilateral trade. This is why the WTO is against it.