Restricted Currency

A restricted currency is a currency that cannot be freely exchanged for other currencies or moved across borders because the issuing country applies exchange controls. The restrictions may limit who can buy or sell the currency, for what purpose, in what amounts and where it can be held. Foreign exchange and payments firms use the term to separate these currencies from freely traded ones such as the US dollar, euro or pound.

Restriction is a matter of degree. Few currencies are completely inconvertible. Most restricted currencies can be exchanged for trade and other everyday transactions, with documents, but face limits on investment flows or on trading outside the country. The term overlaps with exotic currency, which refers to thin trading and wide spreads, though a currency can be exotic without being restricted.

Controls are normally a tool of economic management. A government may wish to keep a fixed or managed exchange rate, protect scarce foreign exchange reserves, prevent sudden outflows of capital in a crisis, or keep domestic savings invested at home. Economic theory holds that a country cannot have a fixed exchange rate, an independent monetary policy and free movement of capital all at once, and capital controls are one way to resolve that conflict.

A common distinction is between current account and capital account transactions. Most members of the International Monetary Fund have accepted an obligation not to restrict payments for current transactions such as trade in goods and services. Restrictions on the capital account, covering loans, investments and transfers of wealth, are permitted and remain widespread.

• Documentary requirements. Banks may convert or remit only against evidence of an underlying transaction, such as an invoice, contract or tax certificate.
• Limits on offshore holding. Non-residents may be barred from holding accounts in the currency abroad, or the currency may not be deliverable outside the country at all.
• Quotas. Individuals or companies may be allowed to buy only a fixed amount of foreign currency each year.
• Surrender rules. Exporters may have to bring earnings home and sell some or all of them to the central bank or to authorized banks, known as foreign exchange surrender.
• Licensed dealing. Only authorized banks and dealers may trade the currency, sometimes at an officially set rate.

The Chinese renminbi is the most traded restricted currency. It is convertible for trade but controlled for capital flows, which has produced two markets: onshore RMB traded within mainland China and offshore RMB traded in centers such as Hong Kong, with slightly different exchange rates. The Indian rupee, the Brazilian real and the South Korean won are large currencies that have historically not been freely deliverable offshore.

Stricter regimes are found where foreign currency is scarce. Countries such as Nigeria, Egypt and Argentina have at various times rationed foreign exchange, which leads to a backlog of unpaid import bills and a gap between the official rate and the parallel market rate. Regimes change, sometimes quickly, so the status of any particular currency should be checked at the time of a transaction.

A payment company cannot treat a restricted currency like a major one. It usually cannot hold the currency in an account outside the country and send it in by wire. Instead it pays a local bank or licensed partner in dollars or another hard currency, and the partner converts and makes a local payout through the domestic payment system. The partner may need information on the sender, recipient and purpose of each payment in order to satisfy the local regulator.

Collecting money is harder than paying it out. A foreign business that sells to local customers can take payment through local currency collection, but converting the proceeds and sending them abroad requires approval or documentation and may be delayed when foreign currency is short. Multinationals describe balances that cannot be moved as trapped cash, and cash repatriation from restricted markets is a standing concern for corporate treasurers.

Because many restricted currencies cannot be delivered outside their home country, ordinary forward contracts are often unavailable to foreign businesses. The usual substitute is the non-deliverable forward, a contract that fixes an exchange rate for a future date and is settled by paying the difference in dollars, with no exchange of the restricted currency. These contracts trade in international financial centers beyond the direct reach of the home regulator.

Offshore prices can diverge from official onshore rates, particularly when a devaluation is expected. Thin FX liquidity also means wider spreads and higher costs for conversion.

The main risks are that rules tighten without warning, that conversion is delayed for weeks or months, and that a sharp devaluation occurs while funds are waiting to be converted. Using unofficial channels to get around controls can breach local law and anti-money laundering rules. Firms that operate in restricted markets therefore limit the balances they leave onshore, price in the cost of delay and keep records to support every conversion.

• International Monetary Fund