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Pegging

Pegging is when a country fixes its currency exchange rate to another country's currency. For example, Nepal may peg its rupee to India's rupee so that their values move together. To maintain the peg, Nepal's central bank uses foreign reserves to buy or sell rupees on the open market if the rupee's value rises or falls against the Indian rupee. Pegging provides exchange rate stability but requires large foreign reserves that can spark inflation if not managed properly.

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Divya Chopra
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305 views7 pages

Pegging

Pegging is when a country fixes its currency exchange rate to another country's currency. For example, Nepal may peg its rupee to India's rupee so that their values move together. To maintain the peg, Nepal's central bank uses foreign reserves to buy or sell rupees on the open market if the rupee's value rises or falls against the Indian rupee. Pegging provides exchange rate stability but requires large foreign reserves that can spark inflation if not managed properly.

Uploaded by

Divya Chopra
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Pegging

• Pegging: Pegging is a method of stabilizing a


country's currency by fixing its exchange rate to that
of another country.

• A pegged exchange rate occurs when one country


fixes its currency’s value to the value of another
country’s currency.
How Currency peg works

• Suppose Nepal wants to peg its currency to India,


meaning it wants the Nepal Rupee value to move at
the same rate as the Indian Rupee.
How Currency peg works

• If the Nepal Rupee value falls relative to the Indian Rupee,


Nepal can use foreign reserves, such as euros, to buy Nepal
Rupee and remove them from the market.

• With fewer Nepal Rupee available, demand goes up, and its
value also increases.

• Nepal can sell its currency if their value rises relative to the Ind
Rupee to increase the supply of pesos until their value falls to
match.
Pegging (Pros and Cons)

• A nation with low production costs

• Another country with a stronger currency.


• A richer, nation may choose to produce its goods in a less nation A,
where production costs are smaller.

• When those nation A translate their earnings into their domestic


currencies, they make a larger profit, creating a win/win situation for
both countries.
Pegging (Pros and Cons)

• It protects a nation from volatile swings in the foreign exchange


rate.
• Low risk

• No need to hedge FX

• No Uncertainty means more trade.


Pegging (Pros and Cons)

• Disadvantages
• Large amount of reserves a central bank has to maintain to make a
pegged exchange rate work.

• Those large reserves can spark higher inflation.

• which causes prices to rise, creating problems for a country’s economic


stability.

• The central bank must also buy or sell its currency on the open market
to keep its value in line with the pegged nation’s currency.

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