What is the Procedure of Exchange Control?

For purposes of exchange control, Government designates a central control agency, usually the central bank to function as the actual buyer and seller of foreign exchange on government account. Under the most comprehensive form of exchange control, exporters and other recipients of foreign exchange are not free to dispose of their foreign exchange earning in any manner they like.

They are required to surrender all their foreign exchange for local currency. To ensure against evasion, export licences, which certify the delivery of foreign exchange to the exporters, must be presented to customs officials before shipment is permitted.

This is how the government secures its supply of foreign exchange. The central bank or control agency is in a position to ration its supply of foreign exchange for any uses that may be found desirable.

In allocating foreign exchange to various buyers (importers), the central bank takes into account the needs of the country. Relatively liberal rations of exchange will be allowed for the import of only those goods which are essential to the functioning of the economy, such as basic foodstuffs, raw materials, capital goods etc. while the control agency can flatly refuse to release exchange for luxury goods or non-essential commodities.

It should be noted that all systems of exchange control are not necessarily so rigorous. If the balance of payments pressure is not severe, controls may involve no more than general supervision of applications received for foreign exchange.

There are two ways of regulating exchange rates: (i) The monetary authorities undertake to buy and sell foreign exchange in unlimited amounts at the official exchange rates. People are free to buy any amount of foreign exchange for any purpose. The purpose of such type of exchange control is to avoid fluctuations in the exchange rate and stabilise it.

The difference between the demand for and the supply of foreign exchange at fixed exchange rates at different times is adjusted by variations in the foreign exchange reserves of the central bank.

The Exchange Equalisation Account established in April 1932 in the U.K., and the Exchange Stabilisation Fund instituted in January 1934 in U.S.A. provide examples of this method of exchange control, (ii) Another method of exchange control restricts the freedom of the people to buy foreign exchange. Under this type of control, there is a rationing of foreign exchange, and allocation is made among the importers for specific purposes only. It is the most drastic method usually employed for achieving various purposes as we have seen above.

Free Exchange Market :

When exchange control is not very rigid, together with exchange restrictions adopted by the government, a free exchange market is also allowed to operate to a limited extent.

Often the central bank releases, in addition to the official exchange in the country, a certain amount of exchange to maintain a free exchange market. All exchange earnings drawn from certain exports may be allowed to go into the free market, where they are sold to the highest bidder.

Exchange rates in the free market are invariably higher than the official rate, for the obvious reason that foreign exchange supply is less than the demand in the free market. Moreover, the exchange control agency may desire the free market rate to be higher than the official exchange rate by a certain percentage, so that importers disqualified for official exchange have to pay a premium.

It is obvious that, when exchange control exists, there is generally a black market in foreign exchange and various methods of evading the control. Foreign currencies or drafts payable in foreign currencies may be smuggled into the country.