What Is a Blocked Currency?
The term blocked currency refers to a currency that can’t be converted freely on the foreign exchange or forex (FX) market because of exchange controls. A blocked currency is effectively a non-convertible or inconvertible currency. The currency is generally blocked because of government restrictions, including foreign exchange regulations, physical barriers, political sanctions, or extremely high volatility. As such, a blocked currency is mainly used for domestic transactions and does not freely trade on a forex market.
- A blocked currency can't be traded or converted in foreign exchange markets.
- Blocked currencies are also called non-convertible or inconvertible currencies.
- Exchanges may block or restrict the trade or convertibility of a particular currency, including their own.
- Some countries may preclude listing a currency pair entirely due to geopolitical purposes, physical barriers, or extreme asset volatility.
- Non-deliverable forward contracts can be used to gain access to these currency pairs.
Understanding Blocked Currencies
As noted above, blocked currencies are restricted from trading on the foreign exchange market. This means they can't be traded or converted to others. Blocked and strictly regulated currencies were fairly common in the past. But the need for freely tradable currencies became essential as global trade and international finance began to grow. Most world currencies now trade through the foreign exchange market, which exists specifically for trading and exchanging world currencies.
There are several different reasons why currencies may be blocked. A currency exchange may designate a currency as being blocked on its conversion list, or it may have limitations on the conversion quantities. For example, a nonconvertible currency may be able to be converted into only some currencies, or only in limited amounts.
A nation may block its currency to influence the domestic market or economy and control volatility. It may even take this action to monitor and influence the behavior of its citizens. So a nation with high inflation rates might limit certain currencies to try to control inflation or to prevent bad financial investments. A country would try to control and keep its currency more stable by restricting its exchange.
In other cases, a communist country may block its currency to control its citizens and how they can make purchases. The government may want to prevent individuals from capital influences and block currencies from countries it deems undesirable. China has frequently used blocked money in its financial practices. Depending on how large of a player the country blocking currency is on the global market, a blocked currency can have a widespread economic impact.
A country's central bank or government can make transactions such as buying dollars or selling euros and use these transactions to pay for imported goods or to fund projects through foreign exchange.
Having a blocked currency isn't necessarily a bad thing. And it doesn't necessarily mean that it is useless. It just means that money cannot be converted or traded on the foreign exchange market. In fact, some countries only allow limited amounts of their currency for trading.
Once blocked, it is challenging, if not impossible, to convert the currency into a freely traded one, such as the U.S. dollar. However, that does not mean it won’t happen. Blocked currencies may still swap, but only on the black market. Here, demand and availability drive the rate of exchange.
Blocked Currencies and Non-Deliverable Forward Contracts (NDFs)
Traders and investors can't trade blocked currencies because they aren't available on the forex market. Some traders end up looking for illegal ways to convert these currencies. But there are ways to exchange currencies that don't trade internationally or whose trade is severely limited or legally restricted in the domestic market legitimately.
Non-deliverable forward contracts (NDFs) are commonly used to conduct these types of trades.. NDFs are cash-settled and usually short-term forward currency contracts. They can give a trader indirect exposure to the Chinese renminbi, Indian rupee, South Korean won, new Taiwan dollar, Brazilian real, and other inconvertible currencies.
Example of Blocked Currency
Many South American countries operate a nonconvertible currency because of historic excess economic volatility. The Brazilian real, Argentinian peso, and Chilean peso are three examples. All three of these currencies have a black market currency, which is where the local currency is traded and exchanged for goods and services. Offshore investors who want to trade with these nations conduct their business using NDFs.