It seems a bit unfair to punish the kids for the teacher's dishonesty. If you pass the course it seems reasonable you should be able to go to the next level. If you pass the course but not the test then either the teacher has been inflating the grade or the has been teaching and assessing the wrong stuff - not the students fault.
The entire point of it is to keep them honest and it seems to work well. As I mentioned it isn't happening often. The students get a second chance at the exam before the next year begins. For the most part our teachers are grading hard not inflated. My oldest dc had it happen years ago that he tanked the exit exam. He retook it and passed. Why he tanked I don't know, but he knew the material and had a solid grade. Just a bad day for him, I guess. I actually like the system because I do think it keeps the teachers from passing off kids that don't know the material. They won't have a job if a bunch of A/B students can't pass the exit exam. The kids that most often fail it are the kids hovering on the passing line the begin with in class. They don't retain younger kids, but they use it as a guide for grouping the following year. They older kids have to meet a minium level to move on.
I appreciate it the system. I really don't want my dc moving on if they have not master material. My ds 13 has done 3 years in the last year. Each one of the those exit exams was an added measure for me that he did indeed master the material before moving on.