Question

Explain the problems with exchange rate controls

Answer 1

This is a measure, used by central authority of any country to stabilizing economy by controlling inflow and outflow of foreign currency by imposing limitation on sale and purchase of foreign currency like euro and dollar. Thus control exchange rate volatility.

The main purpose of exchange control are:

(i) balance of payments equilibrium, economic planning and rapid economic growth, to conserve foreign currency, stabilizing exchange rate, to protect domestic Industry and market and as a measure to prevent country from depression etc.

Disadvantage or problems

1. It may create black marketing of foreign currency, as unavailability of fully convertiblity of local currency into foreign currency.

2. If any any country impose restrictions on inflow and outflow of foreign currency then it is harmful and distorating for Export and import or free inefftrade.

3. It may lead to Industrial inefficiency because it restricts convertiblity of capital account, thus inflow of new technology and capital.

4. Undervaluation of currency is a tool of control exchange rate. It leads increase in arbitration related to currency war, lead to Trade war, like situation when undervaluation of currency (USA and China trade war) is export distorting tend toward dumping of goods.

5. Thus, these control also create problems in foreign relationship and reduce trust in that country's currency. For example China renmimbi undervaluaction against dollar and dumping of China's cheaper products in South east asia and India. It is harmful for their industry and market.

Other problems are red tapism, inequality of wealth and income and it may set a wrong trend of currency manipulation.