Question

In order to prevent capital flight, and maintain the stability of the bolivar (Venezuela's currency), the Chávez administration in January 2003, made it more difficult for investors to exchange bolivars for dollars. This is an example of

Question 5 options:

	Indirect intervention
	Capital Controls
	Foreign Direct Investment
	Direct intervention

Answer 1

The correct option is Capital Control.

Explanation:-

From the economic history of Venezuala, we find out that in January 2003, the Chavez regime implemented strict currency controls which made it more difficult for investors to exchange bolivars for dollars. This decision of their currency controls and exchange rate fixing acted became the final component to the collapse of the Venezuelan economy. At that time, the government created CADIVI which is a currency control board charged with handling foreign exchange procedures. At the same time, the Venezuelan government suspended trading of the bolivar as it continuously plummeted in value with respect to dollar. This was an attempt by the Chavez regime to protect Venezuela’s foreign reserves by setting a fixed rate for the dollar, to prevent capital flight, and maintain the stability of the bolivar after several oil strikes and as a result of this govt. act, there were a series of devaluations disrupting the macroeconomic stability of the country. A direct result of this economic policy is that the Venezuelan government will have direct say over who gets U.S. dollars and who doesn’t.

Currency controls, foreign exchange controls or currency exchange controls are a set of restrictions applied by some governments to ban or limit the sale or purchase of foreign currencies by nationals and the sale or purchase of local currency by foreigners.

The most common foreign exchange controls are as follows:-

• Banning or limiting purchases of foreign currency within the country
• Banning or restricting the use of foreign currency within the country
• Setting exchange rates (instead of letting the value of the currency fluctuate according to market forces )
• Restricting currency exchange to retailers approved by the government
• Limiting the amount of money that may be imported or exported
• These currency controls often pose additional challenges to companies working at an international level, either by hindering cash transactions or by making it impossible to use financial instruments such as currency options or forward contracts to hedge Forex risk.

Capital controls are when the governments of nations restrict the inflow and outflow of capital into the economy. When countries want to ensure that their economies stay relatively stable in the long run, they impose some form of capital controls.

Types of Capital Controls :-

1) Minimum Stay Requirements: When countries have a sort of lock in period with respect to capital investments. This means that they allow free movement of capital in and out of the country. However, there should be a certain time gap between the inward movement and the outward movement. This is called as a lock in period or as a minimum stay requirement.

2) Limit the Currency Trading: Some countries want to limit the amount of foreign currency that is available for trading in the Forex market at any given point of time. This is because they want to maintain currency pegs i.e. fixed exchange rates. This helps them plan their economic activity better especially if they are an export oriented economy. Changing forex rates means that their competitiveness in the international market changes every minute. Capital controls are an effective way to avoid this issue.

Hence, we can conclude that currecny control is a type of capital control policy.