Multiple Exchange Rates in Forex
It is not appropriate to divide all exports into a few categories and apply a single exchange rate to each category containing goods of varying nature and importance.
If the number of categories, into which the exports and imports are divided, is increased, the simplicity of multiple exchange rates decreases. In the limiting case, where each good forms a separate category, multiple exchange rates system is transformed into a full-fledged exchange control system.
Taxes and subsidies have the advantage that these can be adjusted according to the nature and importance of each commodity. The affected countries, Fund and GATT consider fiscal devices (i.e., taxes, subsidies, license fees etc.) as less objectionable than the multiple exchange rates.
Multiple exchange rates require a cumbersome administrative machinery to collect foreign exchange proceeds from exporters, to allocate the same among importers to see that the foreign exchange is spent on the products for which it has been sanctioned and there are no arbitrage dealings (buying foreign exchange in the cheap market in order to sell it in dear market). Fiscal devices do not require so heavy administrative machinery.
Fiscal devices, however, have the disadvantage that it is very difficult to tax some of the invisible items in the balance of payments. Tourists' expenditure, for instance, can be taxed only if the exact amount spent abroad is known. This can be known better if there exists strict exchange control and the money to be spent abroad has got to be sanctioned by the exchange control authority.
Moreover, fiscal devices are generally, administered by legislature and are thus inflexible whereas multiple exchange rates, administered by the monetary authority, are more flexible and can be adjusted easily and quickly to changed conditions. This will adversely affect the countries exporting products similar to its imports and exports to which unfavorable and favorable exchange rates have been applied respectively.
If the deficit is cured by depreciation, the expansion of exports and the contraction of imports will be spread over many commodities and thus over many countries. Even if the spread is not uniform and hits some countries more severely, it will not arouse protest from these countries because the discrimination is not intentional.
Multiple exchange rates lead to arbitration (buying foreign exchange in the cheap market for selling it in the dear market) and thus encourage corruption and black marketing. If the favored import rate for a particular commodity is less than the export rate, re-export of the imported goods either in the original form or after slight processing will be encouraged. Such re-export trade will he carried on a large scale if the difference between the two rates is fairly wide.
Fixation of multiple exchange rates for the import and export of different commodities for achieving certain objectives assumes knowledge of the elasticities of demand for and supply of the import and export of all commodities. In the absence of this ki1owl~dge, the penalty rates might be fixed at a level that restricts imports by more or less than that required for the achievement of the particular objectives.
Moreover, the desired results might not be achieved immediately (as in case of quotas) because the market takes some time to adjust according to changed circumstances. This method, therefore, might not be useful in the short-run for countries possessing insufficient reserves of gold or of other acceptable currencies.