Chapter 7 Exchange Controls

Chapter 7
Exchange Controls
Exchange Controls
Exchange controls are government-imposed
limitations on the purchase and/or sale of
currencies. These controls allow countries to
better stabilize their economies by limiting in-
flows and out-flows of currency, which can
create exchange rate volatility.
Exchange controls are government-

imposed controls and restrictions on
private transactions conducted in foreign
currency. The government's major aim of
exchange control is to manage or prevent an
adverse balance of payments position on
national accounts.
Exchange control is the outgrowth of a scarcity of the
means of making foreign payments , its essence lies in
the desirability of bringing about a balance between
Nature of
the demand and supply by increasing exports and
diminishing imports.
The demand for foreign exchange comes from
Exchange
importers and others who must remit payments for
their merchandise imports as well as of those who
wish to travel abroad.
Controls
The supply on the other hand, arises out of the
government’s action in blocking or holding up the
credits due to other countries and compelling its
exporters and others who have earnings abroad to
turn their dollars to government.
Objectives of Exchange
Control
1. To maintain the exchange rate and avoid
the flight of capital
2. To assure imports of items considered
essential to the country’s well being.
3. To stimulate or discourage the production
of certain goods
4. As a Source of Revenue
1. To maintain the exchange rate and avoid the flight
of capital
With the adoption of exchange control, individuals

were not permitted to transfer funds abroad without
the permission of the government obviously intended
to prevent the flight of capital.
The flight of capital is occasioned by the demand for
foreign currency, that is, converting domestic currency
into foreign currency which is considered relatively
stable.
The Philippines had deemed it proper and necessary to
protect its interest by becoming a member of the
International Monetary Fund.
The IMF provides broad support to low-
income countries (LICs) through
surveillance and capacity-building
activities, as well as concessional financial
support to help them achieve, maintain, or
restore a stable and sustainable
macroeconomic position consistent with
strong and durable poverty reduction and
growth.
2. To assure imports of items considered essential to the
country’s well being.
The Central Bank, the institution vested by law with the

power to control and regulate the acquisition and
disposition of foreign exchange has made it a policy and
practice to classify commodities imported from abroad
under different categories for purposes of allocating the
needed foreign exchange.
Those goods which are considered highly essential either
from the point of the country’s development or the
consumer’s well being are classified as essential item.
3. To stimulate or discourage the production of certain goods
In an effort to stimulate the production of certain goods and/

or discourage the production of certain items, some
countries adopt the system of multiple exchange rates.
Not only are commodities placed under different categories
depending upon their essentiality but moreover different
rates of exchange are placed on each. Thus, the more
essential the goods to be imported are, the bigger allocation
of foreign exchange are made available and at lower rates in
order to induce and continue more production of basic
necessities in the country.
4. As a Source of Revenue
While the adoption of system of exchange

control is not actually intended for purposes
of generating income to the government,
however, in its actual operation it brings
certain gains or profits, that is the difference
between the selling rate and the buying rate.
Mechanism of
Exchange Control
Within the broad field of exchange control,
certain mechanisms may be noted such as:
Compensation clearing agreements,
payments agreements and unilateral and non
discriminatory exchange control. However,
they are not mutually exclusive but rather in
a number of instances, they are used in
combination with one another.
1. The compensation arrangement consist of
matching deals between parties in two different
countries with equivalent value being involved on
both sides. Exports of industrial goods having the
value of X peso (hypothetical) compensates for the
imports of raw materials with the equivalent value .
Thus, such transaction leaves no balance requiring
settlement in foreign exchange.
A clearing agreement maybe described simply as
agreement between two countries by which definite
trade transactions of its citizens are offset against
each country’s account, without the necessity of
passing any foreign exchange. In this manner,
importers in the first country pay the exporter in
another given country.
2. Payment agreements have been arranged
most commonly between a free exchange
and a controlled exchange country. Under
this arrangement, the controlled exchange
country agrees to allocate the foreign
exchange derived from its exports to the
other country in certain specified ways.
Unlike clearing agreements, payments
agreements do not disturb the normal
procedure of settling international accounts
in foreign exchange through the ordinary
banking channels.
3. Under unilateral and non-discriminatory
type of exchange control , the government
nations foreign exchange without formal
discrimination as between countries with the
end in view of insuring the importation of
most essential goods and services. This type
helps provide protection to domestic firms
producing goods competitive with less
essential imports
Effects of Exchange
Control
1. Exchange control contributes to a reduction of
merchandise imports. This is the most easily felt and
observed effect of the objectives of exchange control.
Without controls, the establishment of many industries in
this country within a short period of time would
doubtless not have been possible.
2. Exchange control usually has the effect of altering a
country’s terms of trade. With exports continually lagging
behind its imports then, the one sure way of arresting this
trend of unfavorable balance of trade as well as for the
purpose of reducing balance of payments difficulties is
through exchange controls.
3. With establishment of new industries protected by
exchange control, there is generated increasing
employment opportunities for members of the country’s
labor force. This is turn contributes to multiplier effect
4. On the negative side , the industries favored with the
grant of lavish amounts of foreign exchange allocations
with which to import the things they need in their
operation are insured of greater business success and
consequently of handsome profits.
5. When foreign exchange could no longer be obtained
with ease as it used to be when restrictions were totally
absent, not infrequently, the salting of foreign exchange
through smuggling as well as undervaluation of exports
and overvaluation of imports become an observed
phenomenon.

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Chapter 7 Exchange Controls

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Chapter 7

Exchange controls are government-

With the adoption of exchange control, individuals

The Central Bank, the institution vested by law with the

In an effort to stimulate the production of certain goods and/

While the adoption of system of exchange

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