Blocked Currency

What Is a Blocked Currency?

A blocked currency is a currency that can’t freely be converted to other currencies on the foreign exchange (FX) market as a result of exchange controls. It is mainly used for domestic transactions and does not freely trade on a forex market, usually due to government restrictions.

A blocked currency is effectively a non-convertible or inconvertible currency. These are several reasons for making money blocked, including foreign exchange regulations, government restrictions, physical barriers, political sanctions or extremely high volatility.

Understanding Blocked Currency

At one time, blocked and strictly regulated currencies were commonplace. However, with the growth of global trade and international finance, the need to have currencies that trade freely is essential. Most world currencies now trade through the foreign exchange market, which exists specifically for trading and exchanging world currencies. Moreover, through forex, 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.

An 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 might block their currency as a way to influence the market or economy of their country, or even monitor and influence their citizens’ behaviors. For example, a nation with high inflation rates might limit certain currencies to try to control the rates of inflation or to prevent bad financial investments. By restricting the exchange of one money to an outside currency, a country would try to control and keep its currency more stable.

In other instances, a currency might be blocked by a country under communist control as a way to control its citizens and how they can make purchases. A communist country may want to prevent citizens from capital influences, for instance, and block currencies from nations they deem 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.

Trading Blocked Currencies Through NDFs

There are ways to trade in foreign currencies which do not exchange internationally or whose trade is severely limited or legally restricted in the domestic market. Non-deliverable forward contracts (NDFs) can give a trader, for instance, indirect exposure to the Chinese renminbi, Indian rupee, South Korean won, new Taiwan dollar, and Brazilian real and other inconvertible currencies.

NDFs are cash-settled and usually short-term forward currency contract. 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 NDFs.

Special Considerations

Blocked currency most often refers to money that cannot convert or trade on the foreign exchange market known as the forex (FX). In some cases, only limited amounts of the currency are allowed 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.