Exchange controls are policies and procedures that are implemented to control the type of currencies traded in a particular market. In most situations, those restrictions apply to both domestic and foreign currencies. The main purpose of exchange controls is to maintain a greater degree of economic stability within a given nation, making controls of this type helpful when that national economy is somewhat weak.
In some instances, exchange controls are aimed at regulating the use of foreign currencies within a country. When this is the case, the controls tend to lean toward restricting the use of anything other than domestic currency, except is specifically identified trading situations. Along with limiting the use of any non-domestic currency, the national government may require a set rate of exchange between its currency and currencies issued in other nations. This helps to at least internally keep the domestic currency stable.
At times, more stringent exchange controls are put in place that totally prevent the utilization of foreign currency in any manner. In these extreme situations, the use of anything other than domestic currency is expressly banned, and may be subject to fines or other legal action. Citizens may be banned from even possessing foreign currency, even if there are no plans to use that currency for purposes of trading. If any currency exchange is allowed to take place at all, it is managed through a select number of exchangers who are authorized by the government. Even then, those approvals may be subject to review, making it possible to revoke those trading privileges when and as necessary.
Nonresidents who are living in a nation that currently makes use of exchange controls are usually bound by those same controls as citizens. Should those nonresidents choose to engage in activities that are considered in violation of those controls, it is not unusual for some type of punitive action to take place. This may range from imposing a fine to spending some time in the custody of law officials or even deportation.
Typically, the use of exchange controls is intended to aid a nation that is experiencing some sort of transition in the economy. Specific provisions prepared by the International Money Fund and supported by most nations make it possible for nations to implement these controls for limited periods of time, with the duration of those controls determined by the movement of the economy within a given nation. Exchange controls are usually not desirable or necessary in nations where the economy is considered stable.