Exchange restriction refers to the policy of the government whereby the supply of domestic currency in the exchange market is restricted. The exchange value of the domestic currency is maintained by restricting its supply. Exchange restriction has three main features.
First, all trading in foreign exchange is centralised with government or a central monetary authority. Secondly, public have to obtain prior permission of the government to exchange national currency for foreign currencies. Thirdly, all foreign exchange transactions are routed through the government or the government agency. Exchange restrictions may take the form of blocked accounts or multiple exchange rates.
(a) Blocked accounts. All payments to a foreign country will not be made directly but paid to the central bank of the country imposing the restriction. The central bank will keep the amount in an account with it in the name of the foreign creditor. This amount is not available to the foreign creditor in the currency of his country but can be used by him to make purchases from the country blocking the accounts.
This system is known as ‘blocking of accounts’ because the bank accounts and other assets of the foreigners are denied conversion into their own currencies. The system of blocked accounts causes great hardships to the foreign creditors who cannot use the amount in any other currency for any purpose. Further blocked accounts reduce international trade since other countries would not like to export to the country and get their funds blocked. The blocking of accounts also results in black marketing in foreign exchange. The foreign creditors whose accounts are blocked would like to sell it to others at lower rates.
(b) Multiple exchange rates. Multiple exchange rates refer to the policy of employing different rates of exchange for transactions involving different commodities and also for different currencies. The aim is to encourage exports and discourage imports to the extent possible. By quoting an unfavourable rate for imports, imports are discouraged. When the government wants to restrict imports of a particular commodity, a different rate may be prescribed for imports of such commodity. Thus, multiple rates of exchange substitute direct methods like im-ports quantity control and quota system and tries to achieve the same results by increasing the cost of imports.
Different rates may be fixed for different currencies. For example, when the dollar/sterling rate of exchange is $ 2 per £ 1, the rupee rate may be fixed at Rs. 50 per £ 1 and Rs. 17 per $1. The purpose may be to control the direction of trade of the country. in the present case rupee is overvalued in terms of dollar relatively to pound-sterling. This may result in more imports from dollar countries and more exports to sterling countries.
Another variation of multiple rate is adoption of different rates for commer-cial and capital transactions. The aim is to prevent flight of capital from the country.
The advantage of multiple rates is that they encourage exports and discourage imports and thus help improve the balance of payments position of the country. However, it is a complex and confusing system. There is a tendency for the number rates to get multiplied. The rates are purely arbitrary and keep on changing. This creates uncertainty.
Further, multiple rates result in inefficient use of domestic resources. It is discriminatory affecting only a few of the competitors. The multiple rate system is disapproved by the IMF and its members are urged to adopt a single rate of exchange.