Indirect Methods of Exchange Control
There are several indirect methods of regulating the rates of exchange. The most important indirect method is the use of tariff duties and quotas and other quantitative restrictions on the volume of international trade. Restriction of imports by the use of tariffs leads to the decline of the demand for foreign currency and if exports are increased, the rate of exchange will go up in favor of the country imposing import restrictions. In this sense, import duties and other quantitative restrictions may have an effect on the rate of exchange but an import duty, imposed specifically to protect local industries against foreign competition cannot be properly called a method of exchange control since the main objective is to restrict imports.
Another method of indirect exchange control is the rate of interest. The rate of exchange is the result of demand and supply of each other's currencies arising out of trade or capital movements. A change in the rate of interest in a country will lead to the movement of capital. For instance, a high rate of interest in a country, says England, will attract short-term capital from other countries like the U.S.A., Germany, etc. This will lead to greater demand for the pound sterling and a higher exchange rate for the pounds in terms of other currencies. A lowering of the rate of interest will have the opposite effect.
Objectives of Exchange Control
The chief objective of exchange control is to restore equilibrium in its payments. If a country finds that its balance of trade has been persistently unfavorable, then it must do something to set it right. The balance of payments must ultimately be made to balance.
There are several ways of doing it, viz., devaluation of currency or its depreciation or deflation. But it may not be considered desirable to adopt any of these methods. Devaluation is supposed to damage the prestige of the country. Depreciation may lead to counter-depreciation by the rival countries. Deflation brings disaster in its wake in the form of depression and unemployment. In these circumstances exchange control is considered to be the best.
The system of exchange control is adopted not merely with a view to correcting the adverse balance of payments. Its further objects are the protection of home industry from unfettered competition from abroad and also to conserve foreign reserves of the country. This system was used by Great Britain during and after World War II to conserve its dollar resources.