BAJAJ BROKING
July 18, 2025
4 mins read
The exchange of foreign currencies is common in India and many other countries. However, just like the national monetary rules in a country, the exchange of foreign currency also has a set of regulations. This is known as the foreign exchange control. It is basically a set of regulations and norms decided by a country's government or its central bank.
The idea is to regulate and restrict the flow of foreign currency within a nation. It helps in stabilising the economy of a country, protects the currency reserves, and also avoids capital tussles.
The government may employ several control measures, such as restrictions on currency exchange, limitations on international transactions, and government approval requirements for foreign investment, among others. These measures are implemented to manage inflation and balance of payments, thus stabilising the economic functions of a country. Read on as we discuss India's stand on foreign exchange control and its goals.
Foreign exchange controls are regulations established by the government regarding how individuals can purchase, sell, or transfer money to other countries. These rules can help keep the country's money safe and strong. They prevent too much money from leaving the country and help keep a sufficient amount of foreign money on hand.
These steps help protect the economy and keep control over money matters. Such controls are primarily applied by developing or transitional economies and can significantly impact the way businesses and individuals engage with international markets.
Limitations on Currency Conversion: Residents can have their local currency converted into foreign currency limited.
Controlled Exchange Rates: Governments can fix exchange rates rather than letting market rates.
Import/Export Licensing: Merchants can be required to obtain official permission to conduct foreign transactions.
Limits on Capital Transfers: Capital outflows and inflows can be controlled and capped.
Forced Surrender of Foreign Earnings: Exporters may be compelled to surrender foreign exchange earnings at a fixed rate to the central bank.
Source: Investopedia
Foreign exchange controls are a macroeconomic mechanism designed to safeguard the national economy, particularly in the event of a financial crunch or a major imbalance in trade or capital flows. Governments usually implement these controls to protect themselves against excessive volatility of their currencies and possible speculative attacks on their national currencies.
Currency stabilisation: Avoid sudden depreciation of the domestic currency.
Protect foreign reserves: Set aside scarce reserves for essential imports, such as food, fuel, or medicine.
Prevent capital flight: Avoid a massive flight of domestic assets into foreign assets.
Control inflation: Control inflation through the management of money supply and exchange flows.
Balance of payments management: Maintain trade balance and prevent deficits.
Foreign exchange controls are usually imposed by countries with weak or developing economies to restrict speculation against their currencies. They also tend to issue capital controls simultaneously and restrict the level of foreign investment in the country.
Source: Investopedia
Although foreign exchange regulations can help to stabilise an economy during chaotic moments, they can also have undesired effects that include lower investor confidence and black-market currency trading. Their long–term effects usually depend on how the measures are applied and implemented.
Some Economic Effects Include:
Economic stabilisation: Appreciates when the currency gets into a shaky state (financial instability).
Controlled inflation: Checks foreign-induced inflation in the countries that depend on imported goods.
Foreign reserve protection: Allows the governments to focus on necessary imports.
Market distortion: Provides negative effects by affecting natural ways of price discovery in the FX market.
Weak foreign investment: Dissuades those who fear the blockage of the repatriation.
Black market rise: Promotes the illegal currency markets as a result of a shortage.
The parallel currency markets have grown significantly in countries like Argentina and Nigeria due to the strict foreign exchange control systems in effect. The official peso rate of Argentina stood at about 919 per USD, with key parallel rates finishing towards 1,405 per USD, highlighting a huge differentiation brought about by foreign exchange controls.
Source: Livemint
Foreign exchange control measures differ from nation to nation based on their economic requirement, level of development, and policy aspirations. Comprehensive control, partial, or even temporary controls are implemented by some nations.
China: The yuan convertibility is tightly controlled by the People's Bank of China (PBOC), and the currency is allowed to trade around a daily midpoint. There are restrictions on capital outflows through quotas and regulatory oversight.
India: The Reserve Bank of India (RBI) places limits on the amount of foreign currency that people and businesses can send abroad under the Liberalised Remittance Scheme (LRS). The businesses also require approval for some foreign investments.
Argentina: Has applied several capital controls since 2011, including dollar purchase restrictions and compulsory repatriation of export earnings.
Nigeria: The Central Bank of Nigeria prohibits the utilisation of official forex for 40+ imported services and goods, such as rice and cement, to help save reserves.
Russia: In response to the 2022 sanctions, Russia made the repatriation of export earnings compulsory in foreign currency and limited foreign exchange purchases.
Source: Livemint
Some nations have been characterised by the steady use of foreign exchange controls because of frequent economic volatility or policy preferences.
Nations that have had Exchange Controls:
Zimbabwe: Required surrender of the forex trading and having two exchange rates during hyperinflation.
Venezuela: This country tightly regulates the exchange of currencies to control inflation and shortages.
Ethiopia: Resorted to restrictions on foreign currency imports as well as activities abroad.
Foreign exchange problems, as noted in the World Bank's Migration and Development Brief, including fixed exchange rates and capital controls, have directed remittance inflows away from official channels to unofficial ones in Sub-Saharan Africa.
When the government faces macroeconomic challenges, it tends to place exchange controls. The objective of these steps is to provide short-term relief or strategic guidance in situations where markets cannot correct themselves.
The main reasons are:
Avoid devaluation of currency
Protective limited reserves
Speculative attacks prevention
Combat inflation
Become economically independent
Curb illicit outflows of finances
Government regulations on capital and exchange controls significantly contribute to shaping capital movement, particularly in periods of high inflation or political instability.
Source: Investopedia
Foreign exchange controls have both a defensive and inhibitive impact on economic development. Although they stabilise macroeconomic variables in the short term, extended controls can deter world involvement and push financial activity underground.
Can safeguard reserves and stabilise inflation.
Risk of black market expansion and inefficiency.
It may discourage foreign investors and trading partners.
Foreign direct investment (FDI) in Argentina fell considerably, with a drop from about USD 6.7 billion in 2019 to a level of about USD 4.1 billion in 2020, which is a fall of almost 38%.
Foreign exchange controls are a crucial economic instrument for addressing the national financial situation during turbulent times. When used wisely, they provide stability, save their foreign reserves, and provide protection against the impact of speculative attacks. However, abuse or excessive use may backfire, eroding investor confidence, hindering international trade, and fueling black markets in currencies.
Policy makers, therefore, need to balance the advantages they are getting and the long-term effects, and when the appropriate economic conditions are regained, they need to do phased liberalisation. Such controls are necessary, and they must achieve their intended aims without severely affecting economic growth and financial openness through their effective implementation, transparency, and regular policy reviews.
Disclaimer: This article is for informational purposes only and does not constitute investment advice. Bajaj Broking Financial Services Ltd. (BFSL) makes no recommendations to buy or sell securities
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Yes, they can stabilise a currency in the short term by controlling capital flight and speculation, but not forever.
No. Exchange controls limit the flows of currencies, whereas trade barriers (such as tariffs or quotas) restrict the movement of goods and services.
They provide temporary relief by saving foreign reserves and mitigating external vulnerabilities during financial or political unrest.
They can make it difficult to repatriate profits, raise the costs of transactions, and create uncertainty in cross-border transactions.
No. Generally, developed economies have liberalised exchange regimes in place, but some emerging and developing countries continue to impose controls.
They tend to discourage foreign investors because they limit the repatriation of capital and enhance regulatory risks.
Yes. They include macroprudential measures, flexible exchange rates that are flexible, and capital flow management instruments under IMF rules.
Common practices are such things as licensing controls, dual exchange rates, currency conversion limits, and capital transfer restrictions.
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