Foreign exchange controls – And why countries still impose foreign exchange controls

What’s common between Russia, Cuba, North Korea, India, and China? All of these countries still impose foreign exchange controls. These are measures put in place by national governments to restrict trade in their currencies. Foreign exchange controls place limitations on the buying and selling of foreign currency.

The vast majority of countries which had foreign exchange controls in the past have now removed them. Only the poorest countries really still need them. However, some of the world’s mammoth economies still choose to impose these restrictive controls.

Understanding foreign exchange controls

In a country which imposes foreign exchange controls (aka currency controls or exchange controls), people are not allowed to possess or use foreign currency. Citizens can exchange currency only at government-approved money changers. Transactions at such exchanges are subject to an upper limit. The exchange rates are all set by the government. All currency exchanges are recorded using government-issued personal identification. There are limits to how much foreign currency citizens can carry in cash, in and out of the country.

Since the Bretton Woods Conference of 1944 and subsequent discussions, most UN member countries are not allowed to have currency controls. As per articles VIII and XIV of the International Monetary Fund (IMF)’s Articles of Agreement, only certain types of economies are allowed to impose currency controls. Imposing currency controls is directly opposed to ideas of Economic liberalization and free markets, which the IMF promotes.

Benefits

Weaker economies can gain limited benefits from having currency controls in place. Imposing exchange controls is one of many ways to control exchange rate fluctuations from becoming excessive. It is a measure designed to counter the effects of extreme speculation in forex markets. One example is Iceland, which temporarily imposed exchange controls in the wake of its economy’s drastic crash following the 2008 crisis. Countries which impose currency controls claim that these contribute to financial stability. However, economists have pointed out that governments can use (and have used) currency controls as weapons to wage ‘currency wars’.

Demerits

The values of currencies are meant to rise and fall in response to natural market forces. Governments that manually control exchange rates via currency controls defeat the idea of free trade.

One negatively affected stakeholder group is international firms. Currency controls make it harder for companies to send and receive cross-border payments. For example the Russian Central Bank tightly controls Ruble exchange rates. Russian currency controls mandate every foreign sender of money to have an account with the Russian Central Bank. Moreover some of the transaction information must be filled out in Russian. These requirements greatly complicate payments to Russia, especially for smaller firms.

Currency controls also affect remittances. The world’s favorite way of sending remittances is via efficient MTOs such as Ria Money Transfer. Exchange controls have a negative effect on the cost and speed of remittances sent via all channels. This goes against the UN’s strategic goal of reducing worldwide remittance costs.

Limitations

Currency controls are imposed by governments and implemented by Central Banks. The most obvious limitation is that the banks can only monitor formal channels. Therefore currency controls can only be imposed on resident and nonresident citizens. Foreigners and operators in the grey markets are immune to the controls.

Another limitation is that companies can bypass exchange controls. There are many tactics and loopholes available in the international finance arena. Some of these allow international businesses to legally circumvent a country’s financial controls. Such tactics include the use of creative financial instruments and offshore trades.

Multi-currency ideology

Contrast the challenge of sending money to Russia with the convenience of having a multi-currency account. In such an account you can simultaneously hold several of the popular currencies including the USD, EUR, and GBP. Currencies are readily interconvertible at predictable exchange rates. Some banks impose no fees for in-account conversions. You can additionally have a multi-currency debit card to pay in local currency during your international travels. Many US, UK, and EU banks offer multi-currency accounts.

Countries that impose currency controls do not allow banks to offer multi-currency accounts. All payments, transfers, or remittances received in foreign currency are converted into the local currency, at the Central Banks’ fixed exchange rates, before being credited to recipients.

In the interest of achieving the UN’s strategic development goals, countries which still impose currency controls should abandon these and move actively toward free markets.