DEFINITION of Nonconvertible Currency
A nonconvertible currency is one that is used primarily for domestic transactions and is not openly traded on a forex market. This usually is a result of government restrictions, which prevent it from being exchanged for foreign currencies.
Because of the high restrictions, a nonconvertible currency is otherwise known as a "blocked currency."
BREAKING DOWN Nonconvertible Currency
As the name implies, it is virtually impossible to convert a nonconvertible currency into other legal tender, except in limited amounts on the black market. When a nation's currency is nonconvertible it tends to limit the country's participation in international trade as well as distort its balance of trade.
A nonconvertible currency can add as a protection to a country's economy that may be susceptible to sharp movements in the economy. If the economy hits a patch of weakness there could be a capital outflow run, which would be crippling for the economy, which is why a country will "block" its currency. Many countries with nonconvertible currencies have - in the past - experienced periods of hyperinflation.
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 have a black market currency, which is where the local currency is traded and exchanged for goods and services. For offshore investors want to trade with these nations they do business using a non-deliverable forward (NDF).
A NDF has no physical exchange in the local currency and is settled in U.S. dollars, which gets around the nonconvertible part of the currency.