What Are Exchange Controls?
Exchange controls are government-imposed limitations on the purchase and sale of currencies. These controls allow countries to stabilize their economies by limiting in-flows and out-flows of money, creating exchange rate volatility. Not every nation may employ the measures, at least legitimately; the 14th article of the International Monetary Fund's Articles of Agreement allows only countries with so-called transitional economies to use exchange controls.
Understanding Exchange Controls
This tool is generally implemented to protect the economy by preventing capital flight.
Currency controls are usually seen in vulnerable countries that lack the stability and infrastructure to support the free flow of foreign exchange.
Freely convertible currencies including the U.S. dollar, euro, and Japanese yen have no controls at all.
However, almost all exotic currencies are subject to foreign exchange controls. For example:
- China, the second-largest economy globally, runs various controls over its currency, the yuan renminbi, despite it now being part of the basket of reserve currencies.
- The Brazilian real is a non-convertible currency, meaning that the money cannot leave the country. It is not traded on the foreign exchange market.
In the context of free trade, the value of currencies fluctuates continuously according to the dynamics of demand and supply. To limit the volatility of their exchange rate and provide more excellent economic stability to their countries, central banks may implement foreign exchange controls.
In the case of weaker economies, the main objective of foreign exchange controls is to avoid speculation with their currencies. Such belief could otherwise cause significant variations in the exchange rate, potentially triggering capital flows with devastating economic consequences for the country.
These are the most common currency controls:
- Banning or limiting purchases of foreign currency within the country
- Banning or restricting the use of foreign currency within the country
- Setting exchange rates (instead of letting the value of the currency fluctuate according to market forces)
- Restricting currency exchange to retailers approved by the government
- Limiting the amount of money that may be imported or exported
Currency controls are a challenge for international companies as they hinder their ability to trade in local currencies.
These restrictions often entail further processing efforts for the company and increase the costs of FX operations and cross-border payments.