This Bill proposes to extend the operation of the Exchange Control Act, 1954, for a further four years from 1 January 1987. The 1954 Act contains the legislative framework within which exchange controls are implemented. It was originally given a life of four years in the hope that exchange controls could eventually be dispensed with. This has not so far been found possible and the legislation has, therefore, been renewed at four-yearly intervals. I am asking the House to renew it for a further period, since to fail to do so would in effect mean the complete dismantling of our exchange control system at the end of this year. For reasons which I will indicate, this cannot be contemplated at present.
The general approach in the legislation is to prohibit a wide range of payments and other financial transactions, but to allow discretionary power to the Minister for Finance so that permissions for such transactions can be given by statutory instrument or administrative decision. In practice, general permissions have been given covering a wide range of transactions. Payments relating to trade, commercial and other current transactions are merely supervised so as to ensure that unauthorised capital transfers do not take place in the guise of current payments. Delegated authority has been given to the banks to approve most of these current transactions for their customers. General permissions have also been given for a wide range of capital transactions. For example, inflows of capital from abroad for direct investment or portfolio investment are fully permitted. Outward direct investment and investments in real estate by Irish residents within the European Community are also fully permitted.
The main restrictions remaining are on the holding of foreign currency in bank accounts or short term financial instruments and on net additional purchases of foreign currency securities. Even here, however, life assurance companies and pension funds are allowed to make substantial transfers abroad for additional purchases of foreign currency securities.
It has been, and will continue to be, the policy of the Central Bank and of my Department to keep the operation of the exchange controls under close review. There can be conflicting views on what approach we should take, that is whether we should seek to strengthen the controls of reduce capital outflows or relax them to create a more liberal investment climate. There has been a general move in the industrial countries in recent years away from the use of controls and towards the use of market-related instruments, such as interest rates, to influence monetary developments. A recent example of this is the changes introduced by France, which have brought them from being far more restrictive in many areas than Ireland to being somewhat more libreal. The general trend within the European Community is towards greater liberalisation of capital movements. The European Commission, in line with this trend, has proposed moving in stages towards complete freedom of capital movements within the Community by 1992.
In the light of these developments, I have been undertaking a comprehensive review of our exchange controls to see to what extent further relaxations may be desirable and feasible at this stage. This review of the system is currently nearing completion and I hope to present its findings to the Government shortly. I should emphasise that, since the Act provides only an overall framework, its renewal will not inhibit us from making changes. The discretionary powers given in the legislation enable changes to be made in the detailed operation of the controls as circumstances permit.
This brings me to the question of why it is necessary to renew the Act, why we cannot simply abolish exchange controls completely. The controls are intended to help maintain our official external reserves at an adequate level and increase the capital available within the State. Exchange controls are particularly important at times of exchange rate uncertainty such as we have been experiencing of late. While no one would claim that exchange controls can prevent all outflows, they do make a significant contribution to reducing disruptive currency flows. Exchange controls provide no long term substitute for appropriate domestic policies, but they can help make the pace of adjustment manageable. Such breathing space must be used effectively. To allow unlimited exports of capital, particularly short term capital, would only add to the level and volatility of pressure on the reserves. Also, while we still have a balance of payments deficit and a deficit on the public finances, there is a need to keep as much capital as possible at home to help finance these deficits and minimise domestic interest rates.
Ireland is by no means alone in feeling the need for exchange controls. Most countries in the world have them. Even within the EC, where the aim is to fully liberalise capital movements by 1992, the majority of our partners still implement controls of one type or another — some of which are more restrictive than those that we operate.
The Community recognises that the lifting of all restrictions on capital movements will require parallel action on other fronts, such as greater convergence of the Community economies and harmonisation of rules for the supervision of financial systems and the protection of users. It will be a gradual process and a difficult one for many member states. Nobody expects us to dismantle all our existing controls in one fell swoop.
The level of outflows of funds over the past year, as reflected in the balance of payments residual, has, of course, been a cause of serious concern. It is likely that most of these outflows can be attributed to temporary leading and lagging of foreign trade payments which have a very significant effect on the level of external reserves in as open an economy as Ireland's. While the underlying reason for the outflows — the weakness of sterling and the US dollar — has been outside our control, the Government have taken decisive action to remove the grounds for further speculation and to ensure that these funds return to the economy as soon as possible.
The Government have made it clear that there will be no further downward adjustment of the IR£ within the EMS. This assurance should indicate to speculators that they cannot hope to make gains by keeping funds abroad in anticipation of an adjustment of the Irish currency. The Government have also indicated their intention to take firm action to improve the public finances and have set firm targets for the year ahead.
The clarification of the Government's position in these key areas should serve to improve the prospects for economic growth and remove any uncertainty that may have existed, thereby bringing about an improvement in market sentiment and accelerating the reflow of funds from abroad. There are signs of a turn-around in the flows at this stage.
The outflows that have occurred reflect the inherent limitations of exchange controls in the case of a small open economy such as in Ireland, which is heavily dependent on foreign trade. The scope for leading and lagging which the level of this foreign trade gives is substantial and exchange controls could not stop leading and lagging without imposing unacceptable restrictions on normal commercial transactions. The exchange controls do, however, ensure that the situation is not aggravated by outflows of short term capital on a speculative basis.
As I indicated earlier, the original hope that exchange control would be only a temporary necessity has not yet been fulfilled. It is, therefore, now necessary to renew the legislation for a further period and I recommend the Bill for the approval of the House.