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Exchange Control Regulation

Exchange control is one of the important devices to control international trade and
payments. It aims at equilibrating foreign receipts and payments. Exchange control
refers to the control by the Govt. or by the centralized agency of the transactions
involving foreign exchange. The meaning of Exchange Control could be well
understood with the help of following definitions:
Haberler: Exchange control refers to the state regulation excluding the free play
of economic forces in the foreign exchange market.
P.T. Ellsworth: Exchange control means dealing with the balance of payments
difficulties, disregards market forces and substitutes for them the arbitrary
decisions of Govt. officials. Import and other international payments are no longer
determined by the international price comparisons, but the considerations of
national needs.
From the above definitions, it is clear that Exchange Control implies Govt.
intervention in the matter of Foreign Exchange and Exchange Rates.

Objectives of Exchange Control


1. Conservation of foreign exchange.
2. Prevention of capital flight.
3. Correcting disequilibrium in BOPs.
4. Stabilization of exchange rates.
5. Protecting the interest of home producers.
6. Redemption of exchange debts.
7. Effective economic planning.
8. Maintaining overvalue of home currency.
9. Generating public revenue.
10.Prevent spread of depression.

Methods of Exchange Control

Direct Method:
Method
In direct Exchange control, certain measures are adopted which effectuate
immediate direct restrictions on foreign exchange from all sides-its
sides its quantum, use
and allocation. The method includes those devices which are adopted by the Govt.
to have an effective control over the exchange rates. In
In general, direct exchange
control includes following measures:
1. Intervention- It refers to the Govt. intervention or interference in the free
working of the foreign exchange market with a view to overvalue or
undervalue the countrys currency in terms of foreign
foreign money. This method is
also known as Pegging Exchange Rate. When Govt. fixes the exchange
rate above the normal rate it is known as Pegging Up and on the contrary,
when the Govt. fixes it below the normal market rate, it is known as
Pegging Down.
2. Exchange RestrictionsRestrictions It refers to the policy or measures adopted by the
Govt. which restricts or compulsorily reduces the flow of home currency in
foreign exchange market. It can be of 3 types:types:

i.
ii.
iii.

Govt. may centralize all trading in foreign exchange with itself or the
centralized authority.
Govt. may prevent the exchange of local currencies against foreign
currencies without its permission.
Govt. may order all foreign exchange transactions to be made through
its agency.

Exchange restrictions may take various forms, the most common of them
being: a) Rationing of Foreign Exchange; b) Blocked A/c & c) Multiple
Exchange Rates.
3. Exchange Clearing Agreement- It is a system of bilateral settlement of
mutual claims on international transactions. Under this agreement, 2
countries agree to establish an A/c in their respective Central Bank through
which all payments for exports and imports are cleared. Therefore, exchange
clearing device is helpful to a country which has little or no foreign
exchange reserves and which is more interested in selling than buying.
4. Payment Agreements- Under this method, 2 countries establish mutual
credit facilities where payment to the exporter is made through specially
opened Non-Resident A/c for this purpose. Under this scheme, exporter gets
payment immediately as the importers Central Bank receives the
information that the importer has discharged all his obligations.
5. Gold Policy- Through a suitable gold policy, the country can bring the
desired exchange control. For this, the country may resort to the
manipulation of the buying and selling prices of gold which affect the
exchange rate of the countrys currency.

Indirect Method:

As the name suggests, under this method, control measures do not effectuate
immediate direct restriction on foreign exchange.
Here exchange rates are controlled indirectly by regulating international movement
of goods.

1. Changes in Interest Rates: It tends to influence indirectly the foreign


exchange rate. A rise in interest rate of a country attracts liquid capital and
banking funds of foreigners. This tends to keep their funds in their own
country. All this tend to increase the demand of local currency and
consequently the exchange rate moves in its favor.
2. Tariff Duties & Import Quotas: Import duty reduces imports and with it rise
the value of home currency relative to foreign currency. Similarly, export
duty restricts exports; as a result, the value of home currency falls relative to
foreign currency.
3. Export Bounties: Export bounties or subsidies increase exports, as such the
external value of the currency of the subsidy giving country rises.

Exchange Control Regulation Act


Foreign exchange control is one of the regulatory role of the Govt. in building its
economic environment. The RBI exercises control over foreign exchange
transactions in accordance with the general policy laid down by the Union Govt.
Foreign exchange transactions were regulated in India by the FERA, 1973. This
Act also sought to regulate certain aspects of the conduct of business outside the
country by Indian Cos. and in India by Foreign Cos.
The main objective of FERA, framed against the background of severe foreign
exchange problem and the controlled economic regime, was conversation and
proper utilization of the foreign exchange resources of the country.
There was a lot of demand for substantial modification of FERA in the light of the
ongoing economic liberalization and improving foreign exchange reserves
position. Accordingly, a new Act, the FEMA, 1999 replaced the FERA.
The FEMA came into effect from Jan.1, 2000, which extends to the whole of India
and also applies to all branches, office and agencies outside India, owned or
controlled by a person.

The objectives of FEMA are:


1. To facilitate external trade and payments.
2. To promote the orderly development and maintenance of foreign exchange
market.

Main Provisions of FEMA


Dealing in Foreign Exchange: FEMA empowers the Central Govt. to
impose restrictions on dealing in foreign exchange and foreign security and
payments to and receipts from any person outside India.
Holding of Foreign Exchange: Act imposes restrictions on persons
resident in India on acquiring, holding or owing forex, foreign security and
immovable property abroad on transfer of forex or security abroad.
Current A/c Transactions: FEMA permits dealing in forex through
authorized persons for current A/c transactions.
Capital A/c Transactions: Any person may sell or draw forex to or from
an authorized person for a capital a/c transaction.
Export of Goods and Services: For the purpose of ensuring that export
value of the goods is received without any delay, the RBI may direct any
exporter to comply with such requirements as it deems fit.
Administration of the Act: the rules, regulations and norms pertaining tio
several sections of the Act are to be laid down by the RBI, in consultation
with the Central Govt.