Exchange Controls: What They Are and How Companies Respond

What are exchange controls?

Exchange controls are government-imposed limits on the purchase, sale, transfer, or possession of foreign—and sometimes domestic—currency. Governments use them to restrict capital flows, stabilize exchange rates, and limit speculation against their currency. International agreements have historically restricted their use; for example, the IMF’s Articles of Agreement have placed limits on when countries may apply such measures.

Why governments use exchange controls

• Stabilize volatile exchange rates during crises or when capital is highly mobile.
• Prevent capital flight that can deplete foreign-exchange reserves.
• Manage balance-of-payments problems in weak or developing economies.
• Limit foreign investment or the export/import of currency for political or macroeconomic reasons.

Historical note

Many Western European countries imposed exchange controls after World War II and gradually removed them as economies recovered (the U.K. eliminated its final restrictions in 1979). Today, exchange controls are most common in countries with weaker or transitional economies.

Common ways exchange controls are enforced

• Banning possession or use of a particular foreign currency.
• Imposing fixed or pegged exchange rates to reduce speculative pressure.
• Requiring all foreign-exchange transactions to go through government-approved exchangers.
• Limiting how much currency can be imported or exported.
• Restricting or prohibiting forward and derivative contracts denominated in the local currency.

How companies and market participants try to get around controls

Because exchange controls can block normal hedging and settlement, firms use various tactics to manage currency risk or access restricted currencies:

• Forward contracts with settlement in a major convertible currency: Parties agree on an exchange rate for a future date, but settle gains and losses in a convertible currency rather than the restricted one.
• Non-deliverable forwards (NDFs): Cash-settled forwards traded offshore that reference a restricted onshore currency but settle in a convertible currency. NDF markets often develop where onshore forwards are restricted. Countries with active offshore NDF markets have included China, the Philippines, South Korea, and Argentina.
• Offshore vehicles and routing: Corporates and investors use foreign affiliates and offshore markets to execute FX transactions outside the jurisdiction of local controls.

Limitations to these tactics

Many countries explicitly prohibit certain hedging techniques or limit them to specific residents or purposes (e.g., essential imports). Enforcement can reduce the availability of legal hedges and push more activity to offshore markets or informal channels.

Case study: Iceland (2008 crisis and aftermath)

• Crisis context: Iceland’s banking sector grew to roughly 14 times the country’s GDP before the 2008 financial crisis. When the crisis hit, rapid capital outflows caused the krona to plunge and the banking system to collapse.
• Controls in practice: During the crisis, exchange controls prevented investors from repatriating offshore krona deposits and blocked normal cross-border currency movements.
• Exit and follow-up measures: In March 2017 the Central Bank of Iceland lifted most exchange controls, restoring cross-border currency movement. At the same time the bank imposed new reserve requirements and revised FX rules to limit speculative “hot money” inflows. To resolve outstanding disputes, the authorities offered to buy foreign-held krona assets at a discounted rate (roughly 20% below market), and required foreign holders of krona government bonds to sell them back at a discount or accept profits locked in low-interest accounts.

Implications and trade-offs

• Benefits: Exchange controls can provide short-term stability in balance-of-payments crises and give authorities time to implement structural reforms.
• Costs: Controls can deter foreign investment, create distortions and black markets, limit firms’ ability to hedge, and impose losses on foreign creditors. They may also complicate diplomatic and investor relations.
• Workarounds: When formal hedges are unavailable onshore, offshore instruments (NDFs) and alternative transaction structures tend to proliferate, shifting activity to less-regulated venues.

Key takeaways

• Exchange controls restrict currency transactions to manage macroeconomic or financial stress.
• Enforcement can take many forms (bans, fixed rates, approved exchangers, limits on trade).
• Corporates often use forward contracts and offshore non-deliverable forwards to hedge or transfer exposure when onshore markets are restricted.
• Controls carry both benefits (stability in crisis) and costs (market distortion, reduced investment, and proliferation of offshore workarounds).