Merits and demerits of multiple exchange rates system
multiple exchange rate system
What is multiple exchange rates system?
It is a system under which a country adopts different rate of exchange for import and export of different commodities. A country may adopt controlled rate of exchange with some countries and free exchange rate with others. The exchange rates do not fluctuate but several fixed exchange rate and their categories may exist. Completely free and floating exchange rates may also be possible for certain transaction with some countries. The objective of multiple exchange rates is to obtain the maximum foreign exchange by maximizing exports and minimizing imports to correct the balance of payment deficit.
Merits of multiple exchange rate system:
The main merits of multiple exchange rates system are as follows:
1. Promotion of exports.
Even though devaluation may also be used for promoting exports but it makes imports costly and export cheaper. But under the multiple exchange rate system, the best rates can be obtained for different exports and imports. The country can obtain full advantage of elasticity’s of demand and supply which are favorable to it. Thus this system is more effective than devaluation.
2. Imports profitable.
A developing country has little to export but it has to import capital goods, raw material, technical knowhow and even consumption goods on a large scale. Its imports have an inelastic demand. So it wants to enlarge the import of above goods and restricts that of luxury and other consumer goods to raise its development potentials.
3. Correcting balance of payment deficit.
The above discussion makes it obvious that under the multiple exchange rates system maximum foreign exchange may be earned from exports and minimum possible payment can be made for import. Thus the balance of payment deficit can be corrected.
4. For particular country.
Especially in a situation where a country has a balance of payment surplus but deficit with particular country, the deficit can be controlled by lowering the exchange rate of commodities exported to and imported from that particular country. Thus the problem of deficit or surplus in balance of payments can be solved through the multiple exchange rate system.
5. Capital formation.
Capital goods and necessary inputs can be imported at cheaper rates through the system of multiple exchange rates. On the other hand, high export earnings may also be utilized for capital formation.
6. Capital flow.
Multiple exchange rates may be very helpful to achieve to higher capital inflow from one country and to restrict capital outflow to another country. In such a case, a higher rate of exchange would be applicable to the former and a lower exchange rate to the latter. It may also be used for channelizing foreign capital into favorable lines of production.
7. Helpful for weak industries.
Weak or declining industries can be lifted with the help of multiple exchange rate system. They may get protection or export subsidies and import capital goods, raw materials and technical knowhow at some preferential and favorable rates of exchange under thus system.
8. Diversifying the economy.
They system encourages the diversification of industries through favorable exchange rate. it provides protection to weak industries from foreign competition. It can help in developing new export goods industries, processing and defense industries. Commodities of mass consumption can also be produced. Thus it can diversify the economy and raise output, employment and income in the economy.
9. Maximizing revenue.
The multiple exchange rate system enables the government to earn more revenue. Since this system encourages the expansion and diversification of industries, and increase output, employment and income, the government earns larger revenues from excise duties, sale tax, corporation tax, personal taxes etc.
10. Favorable terms of trade.
A country may secure more favorable terms of trade under this system. That is why it can be used for keeping prices of exports goods at a higher level and prices of import articles at a lower level.
11. Improvement of standard of living.
Since the import of capital goods, raw materials, etc. can be obtained at low prices under this system; their cost of production is low. Similarly, essential consumer goods of mass consumption are imported cheap. These tend to reduce the cost of living and raise the standard of living of the people.
Demerit of multiple exchange rates system:
The multiple exchange rates system has the following demerits;
1. Administrative difficulties.
In this system, large number of different exchange rate exists for variety of goods and for different countries. To administer them requires large administrative machinery. This involves a complex exchange control system which leads to administrative inefficiencies, red- tapism and corruption.
2. Discriminatory.
This system is discriminatory because it discriminates between commodities, industries, sectors, regions and countries. The same commodity may be exported to a country at a different rate than to another country. This is likely to leads to retaliation by the other country and so adversely affects their trade and political relations.
3. Harmful for domestic industries.
A country may import commodities at cheap rates from abroad which may harm the domestic industries as they cannot face foreign competition.
4. Not helpful for export.
If the demand for exports is elastic or if exports have inelastic supply in the market or foreign importers from a monophony or oligopoly exchange rates will be of no help to the country in increasing its exports.
5. Black marketing.
This system leads to
black marketing of foreign exchange. Importers buy foreign exchange at lower
rates because the exchange rate for essential imports is low. But they sell
foreign exchange at high rates in the foreign exchange market.
6. Limits to different rates.
It is not possible for the monetary authority to fix different exchange rates for a large number of exportable and importable commodities. So they are classified in small categories or groups. Their classification may be arbitrary and lead to corruption for every exporter or importer would like to have his commodity in the favorable exchange rate category.
7. Less effective in BOP.
The multiple exchange rates system is less effective than quantitative restriction like export and import license, exchange controls, etc. in reducing balance of payment deficit.
8. Accumulation of inventories.
This system leads to accumulation of inventories, when exporters do not export their goods in anticipation of more favorable exchange rates being announced by the monetary authority, it leads to stock piling of goods in god owns. This adversely affects production and leads to losses.
9. Not a sufficient system.
The multiple exchange rates system is not sufficient for economic development of less developed countries. In such countries, the demand for essentials imports is inelastic so the exchange rates for their imports cannot be lowered. On the other hand, their capacity to export is limited. So they cannot increase the exchange rates for their exports. That is why such countries suffer from shortage of foreign exchange.
Conclusion:
On the whole, the multiple exchange rates system leads to allocation of resources, reduces economic efficiency and gains from trade of the country adopting it. That is why; this system is no longer in use
Also read:
causes of changes in exchange rates system
Meaning of foreign exchange rate
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