Exchange controls are government rules that restrict the buying, selling or holding of foreign currency, and the transfer of money into or out of a country. They can limit who may obtain foreign exchange, how much, at what rate and for what purpose, and they usually require residents to hand over foreign earnings to the central bank or to licensed banks. Governments use them to protect scarce reserves, defend a fixed rate or stop money leaving in a crisis.
Exchange controls overlap with capital controls but are not the same thing. Capital controls target investment and lending flows on the capital account; exchange controls work through the currency itself and can also restrict ordinary payments for imports, travel or dividends on the current account. Many countries have used both at once. Exchange controls are often administered by a central bank or a body such as China's State Administration of Foreign Exchange (SAFE).
Exchange controls in plain terms
Think of a country's supply of foreign money as water in a reservoir during a drought. When rain is plentiful, anyone can draw as much as they like. When the level drops, the authorities post a guard at the tap, ask each person why they need water, and hand out a fixed ration. Farmers growing food get priority; someone filling a swimming pool waits.
Exchange controls are that guard. People who earn dollars or euros abroad must pour them back into the reservoir, and anyone who wants foreign money must explain what it is for and accept a set amount. The system keeps the reservoir from running dry, but it also creates queues, paperwork and a temptation to buy water from a backstreet seller instead.
Common forms
- Surrender rules. Exporters must sell foreign earnings to the central bank or an authorised bank within a set time, a practice described under FX surrender and export proceeds repatriation.
- Licensing and approval. Only authorised banks or a licensed dealer in foreign exchange may trade currency, and some payments need prior approval.
- Quotas and allowances. Individuals receive an annual limit; China, for example, sets a USD 50,000 yearly quota for individual purchases of foreign currency.
- Multiple rates. Different transactions are given different official prices, as in a dual exchange rate.
- Limits on accounts and cash. Residents may be barred from holding foreign accounts, and cash taken across the border may be capped.
History
Modern exchange controls spread in the 1930s, when the gold standard collapsed and countries such as Germany rationed foreign currency to protect their reserves. The Second World War made them nearly universal. The United Kingdom introduced controls at the outbreak of war in 1939 under the Defence (Finance) Regulations and placed them on a permanent footing with the Exchange Control Act 1947. In the following decades British residents faced limits on investing abroad and, from 1966, a travel allowance of £50 per person for journeys outside the sterling area. The Conservative government abolished all remaining UK controls in October 1979, a decision announced by Chancellor Geoffrey Howe.
Under the Bretton Woods system, controls on capital were accepted as normal, while controls on current payments were meant to be temporary. Western European currencies became convertible for current transactions in 1958, and most advanced economies removed their remaining controls during the 1980s and early 1990s. India's Foreign Exchange Management Act of 1999 replaced the stricter Foreign Exchange Regulation Act of 1973, and Malaysia reintroduced controls and pegged the ringgit in September 1998 during the Asian financial crisis.
The IMF framework
The International Monetary Fund distinguishes the two sides of the balance of payments. Under Article VIII of its Articles of Agreement, members that accept its obligations may not restrict payments and transfers for current international transactions, or use discriminatory currency arrangements and multiple currency practices, without the Fund's approval. Article XIV lets members keep such restrictions during a transitional period, while Article VI allows members to control capital movements. A currency free of current-account restrictions is said to have currency convertibility for current purposes.
Effects and criticism
Supporters argue that controls can buy time in a crisis, slow capital flight and let a government keep interest rates lower than markets would allow. Critics point to their costs:
- They tend to create a parallel market rate and illegal dealing.
- They encourage misinvoicing of imports and exports and push payments into informal channels.
- They discourage foreign investment, because investors fear their money will become trapped capital.
- They require a large administrative apparatus and invite favouritism in who receives foreign currency.
For businesses that move money across borders, controls show up as documentation requirements, delays and limits on remittances, and they shape how cross-border payment companies operate in each market.
When controls are lifted, the usual sequence is to free current payments first and capital flows later, with adequate foreign exchange reserves in place beforehand. A sudden rush of residents moving savings abroad is a common risk in the months after liberalisation, which is why many countries remove controls in stages rather than in one step.