Exchange Control Regulations, 1939

The Exchange Control Regulations, 1939 were a set of wartime financial controls introduced in British India at the outbreak of the Second World War. These regulations marked the formal beginning of exchange control in India and played a foundational role in shaping the country’s foreign exchange management framework. Their significance extends to banking, finance, and the long-term evolution of the Indian economy, influencing post-independence monetary policy and external sector regulation.

Historical Background

The Exchange Control Regulations, 1939 were promulgated under the Defence of India Rules soon after Britain declared war in September 1939. At the time, India was part of the British Empire, and its economy was closely integrated with the sterling area. The primary objective of the regulations was to conserve foreign exchange resources and prevent capital flight during wartime uncertainty.
Before 1939, India followed a relatively liberal foreign exchange regime. However, global instability, pressure on sterling reserves, and the need to finance war-related imports made unrestricted foreign exchange transactions unsustainable.

Objectives of the Regulations

The Exchange Control Regulations were designed to achieve several interrelated objectives:

• Conservation of scarce foreign exchange reserves.
• Regulation of payments and transfers to and from foreign countries.
• Prevention of speculative capital movements.
• Ensuring availability of foreign exchange for essential wartime imports.

These objectives reflected the broader shift from free-market exchange arrangements towards state-controlled external sector management.

Key Provisions and Mechanisms

Under the Exchange Control Regulations, all foreign exchange transactions required official approval. Exporters were mandated to surrender foreign exchange earnings to authorised dealers or the central authority. Import payments, remittances abroad, and foreign investments were strictly regulated.
The regulations empowered authorities to control:

• Dealings in foreign currency and gold.
• External remittances and capital transfers.
• Foreign securities transactions.

This framework effectively placed the external value of the Indian currency under administrative control rather than market forces.

Role of Banking Institutions

Banks played a central role in implementing exchange control. Authorised dealers acted as intermediaries between the public and the regulatory authorities, ensuring compliance with the rules. Commercial banks were required to report foreign exchange transactions and enforce restrictions on customers.
The establishment of the Reserve Bank of India in 1935 proved crucial, as it later became the principal authority for administering exchange control in India. The regulations strengthened the RBI’s role in managing foreign exchange and overseeing banking operations linked to international transactions.

Impact on Indian Banking and Finance

The Exchange Control Regulations, 1939 fundamentally altered the functioning of Indian banking and finance. Banks shifted from being passive facilitators of international payments to active agents of regulatory enforcement. This change enhanced institutional discipline but reduced operational flexibility.
Financial markets became inward-looking, with limited exposure to global capital flows. While this insulated the economy from external shocks, it also constrained access to foreign capital and international financial integration.

Influence on the Indian Economy

From a macroeconomic perspective, the regulations contributed to exchange rate stability during wartime but at the cost of efficiency. They encouraged import substitution and prioritisation of essential goods, shaping India’s industrial structure in subsequent decades.
The experience of exchange control during the war laid the intellectual and administrative foundation for a controlled economic regime after independence, particularly in the context of foreign trade and balance of payments management.

Continuity After Independence

Although introduced as a temporary wartime measure, exchange control continued in India long after 1947. The Exchange Control Regulations, 1939 evolved into a permanent legal framework with the enactment of the Foreign Exchange Regulation Act (FERA), 1947 and later FERA, 1973.
These laws reflected the continuation of a restrictive approach to foreign exchange, driven by chronic balance of payments constraints and development planning priorities in the post-independence period.

Relevance to Modern Indian Financial Policy

The legacy of the Exchange Control Regulations is evident in India’s cautious approach to capital account liberalisation. While India has progressively moved towards a market-oriented foreign exchange regime under the Foreign Exchange Management Act (FEMA), 1999, regulatory oversight remains a defining feature.
For students of banking and finance, the 1939 regulations represent a critical turning point in Indian monetary history, illustrating how external shocks can reshape financial institutions and policy frameworks.