Exchange clearing agreement is a system of bilateral settlement of mutual claims in international transactions. Under this arrangement two countries engaged in trade settle their dues through their respective central banks instead of allowing direct payments between buyers and sellers.
For example, let us assume that India enters into an exchange clearing agreement with the UK. Then the Reserve Bank of India will open an account with itself in the name of Bank of England. All imports into India, for import from UK, are required to pay the amount to the account of Bank of England with the Reserve Bank. All exports to England are paid for by the Reserve Bank from the account of Bank of England. Similarly, Bank of England would open an account of Reserve Bank of India with it which would be fed with imports into the UK from India and utilised for payments for exports from the UK into India.
Thus no foreign exchange reserves and transfers are involved in the settlement of transactions. All that is required is the passing of information of the transactions between the central banks of the two countries. The basic assumption of the arrangement is that the import and export between the countries would mutually offset and ultimately there would be no need for any payments.
In contrast to exchange restrictions which tend to restrict international trade, exchange clearing agreements encourage international trade. The trade can take place without botheration of finding scarce foreign exchange to finance them.
First, even countries which do not have exchange reserves are enabled to import as the transactions do not pass through exchange markets. However, the system has many disadvantages. It may be used by the economically stronger country to exploit the weaker country. During war Germany im-ported essential raw materials from Hungary and Rumania which had exchange clearing agreements with it and later blocked the accounts. Hungary and Rumania were thus forced to import certain unwanted items from Germany to utilise the blocked funds.
Secondly, it leads to bilateral trade at the expense of multilateral trade. It bene-fits the countries which are parties to the bilateral arrangements at the expense of other countries which are not parties to such arrangements. Bilateral trade diverts trade from natural channels reducing the benefit of international trade.
Thirdly, such arrangements result in interference with the working of foreign exchange markets. A large-scale bilateral trade will reduce the transactions in the market.