Methods and mechanism of exchange control
Answers
Apparently, buying foreign exchange at a rate above the equilibrium rate amounts to subsidisation of exports, while selling foreign exchange at a rate above the equilibirum rate amounts to a tariff on imports.
Another merit of the system is that it enables the government to yield revenue by buying foreign exchange at low prices in domestic money from exporters and then selling it at higher prices to importers.
However, the system has the following drawbacks:
(i) Instead of correcting the balance of payments, it adversely affects the growth of international trade and the maximisation of world output and welfare.
(ii) It puts too much arbitrary powers into the hands of the government to influence foreign trade.
(iii) It creates undue complexities in calculation, due to different exchange rates for different imports and exports which may be changed from time to time, resulting in uncertainty in foreign trade.
(iv) The system has a formidable administrative problem of effective control. Utmost vigilance has to be maintained against the undervaluation of export invoices and overvaluation of import invoices and care should be taken to see that exporters do not sell their proceeds of foreign exchange in the black-market and importers do make specific and proper use of the allotted foreign exchange. Further, the system is also likely to breed corruption.
We may thus, conclude with Ellsworth that exchange control by the system of multiple exchange rates is only a partial solution to devaluation, and introduces uncertainties and distortions of its own.
Exchange Clearing Agreements :
European countries had adopted this form of exchange control in the Thirties. It was a system for the direct bilateral bartering of goods on a national scale. Under this device, two countries engaged in trade pay to their respective central banks the amounts payable to their respective foreign creditors.
These central banks then use the money in offsetting the corresponding claims after fixing the value of the currencies by mutual agreement. And, importers have to deposit their payment with the central bank can use such money to pay the domestic exporters.
This economises exchange needs for trade. 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. However, this system is essentially one of offsetting each other's payments, and the basic assumption is that countries entering into such an agreement should try to equalise their imports and exports so that, there will be no necessity for either making or receiving payments from the other countries.
Following are the drawbacks of exchange clearing agreements:
(i) There is a possibility of exploitation of an economically weaker country by a stronger country.
(ii) The exchange clearing agreements involve bilateral transactions in foreign trade, which cause a diversion of normal trade pattern and endanger the promotion of world trade.
(iii) This device also reduces the volume of international trade. Besides, it attempts to do away with the foreign exchange market.
(iv) The scheme requires that all payments have to be centralised.
Payment Agreements :
To overcome the difficulties of the problems of waiting and centralisation of payments observed in clearing agreements, the device is formed as payment agreements. Under this scheme, a creditor is paid as soon as informants.
Under this scheme, a creditor is paid as soon as information is received by the central bank of the debtor country from the creditor country's central bank that its debtor has discharged his obligation and vice versa. By designing the arrangement for mutual credit facilities, thus, possibilities of delay are ruled out. Payment Agreements have the advantage that direct relation between exporters and importers are maintained.
However, payment agreements suffer from two defects:
(i) The agreement accounts could only be debited or credited for licensed payments.
(ii) The balances in the accounts could only be used for payment from one partner to another.
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 country's currency. In 1936, for instance, the U.K., France and U.S.A. signed the Tripartite Agreement in this regard for fixing a suitable purchase and sale price of gold.