The exchange rate regime adopted by mostly underdeveloped and developed countries with weak currencies usually results in limiting citizens’ access to foreign currency, which, in turn, affects the production of local goods.
The relationship between the quantities of locally produced goods and the penalties imposed on foreign exchange buyers stands at the core of “Effects of Forex Purchases Restrictions on
Industrial Production: A Money Search Model,” a master’s thesis submitted to the American University in Cairo’s Economics Department by Mohammed Salih Grazza.
In the thesis, Grazza examines the hypothesis through a money search model.
The pegs imposed on the exchange rate in developing countries have a negative relationship with the local production of goods and services. This means that the more restrictions and penalties are imposed on the purchase of foreign currency, the lower the production of local goods and services are.
In the paper, Grazza explains the relationship by referring to the financial amount of the imposed punishment and the strictness of applying the law.
The paper, published in May 2017 under the supervision of Assistant Professor of Economics Syed S. Ali Shah, argues that producers (buyers of foreign currency) will buy less forex and produce low quantities of the local good due to the restrictions, while consumers will have more forex for buying the foreign good and less local money for buying local goods.
On another level, as importers’ profits increase, agents will either buy less of the international good or acquire more forex for buying it at its original price. As a result, they will have to either demand more of the local good or produce more of it in order to buy foreign exchange.
On the other hand, when people purchase higher amounts of foreign currency, it means that they are willing to purchase the international good more, and hence will sacrifice acquiring local money and consuming local goods.
All in all, the thesis argues that imposing a penalty on forex purchases will discourage the production and consumption of local goods.