Understanding corporate finance: foreign exchange: exchange controls
How exchange rates are determined: exchange controls
Governments may sometimes want to restrict the movements of foreign and domestic currencies in or out of the country. This often happens in wartime, when it is vital that a country’s trade and payments are controlled. The UK, for example, introduced exchange and trade control provisions in the Emergency Powers (Defence Act) of 1939. This was repealed in 1947, but replaced by the Exchange Control Act, which imposed fresh, although looser, controls. Exchange controls were not finally abolished in the UK until 1979.
Developing countries also frequently impose exchange controls. Countries with high levels of foreign debt want to earmark sparse foreign currency receipts for servicing those debts and for ‘essential’ imports. Such countries may find it impossible to function economically without rigid control of foreign exchange.
Exchange controls take many different forms. Governments will generally control the outflow of foreign currency by restricting the amount of foreign currency which individuals and companies can buy, and by requiring importers to buy currency from the central bank at an official rate. They may also require exporters to sell foreign currency receipts to the central bank at a specified rate. There are often regulations restricting the payment of dividends, interest, or rents to non-residents.