In contrast with the free-floating currencies, restricted currencies are those subject to currency controls, that is, limits imposed by their respective governments to guarantee a certain stability on the value of that currency.
The reasons for currency restrictions
In contrast with free-floating currencies, restricted currencies are those subject to currency controls, that is, limits imposed by their respective governments to guarantee a certain amount of stability in their value. The main objective of these restrictions is to avoid currency fluctuations that would harm the country’s trade balance with potentially devastating consequences for fragile economies.
Until the late 1980s, most of the world’s currencies were restricted. In the 90s, with the emergence of free trade and globalisation, some of the world’s most developed economies embraced economic liberalisation and lifted their controls on currencies.
Detached from currency controls, the value of free-floating currencies fluctuates continuously due to monetary policy, the economic growth of the country, the value of commodities produced in the country and some other factors that have an impact on the supply and demand of that currency.
For countries with more fragile economies, however, changes in the supply and demand of their currencies could either cause a significant appreciation – damaging the competitiveness of their exports – or depreciation, in which case, the country might become unable to import basic products like food or energy. In both cases, the consequences could be catastrophic.
Some countries implement different types of currency controls to avoid these forces. These are the most common ones:
- Banning or limiting purchases of foreign currency within the country
- Banning or restricting the use of foreign currency within the country
- Setting exchange rates (instead of letting the value of the currency fluctuate according to market forces)
- Restricting currency exchange to retailers approved by the government
- Limiting the amount of money that may be imported or exported
In some cases, these restrictions give rise to “artificial” exchange rates that lead to the appearance of parallel currency exchange markets: unofficial exchange retailers that provide an exchange rate different to the official one and closer to that defined by supply and demand.
In commercial terms, restricted currencies might pose additional challenges for international companies, as the constraints enforced by the authorities often make it impossible to use financial instruments such as currency options or forward contracts to hedge FX risk.