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What is Currency Pegging?

Currency pegging is fixing the exchange rate of a currencyby matching its value to the value of another singlecurrency or to a basket of other currencies, or to anothermeasure of value, such as gold or silver.

CHARACTERISTICS

Pegging is characterized by having a fixed exchange rate.

Stabilizing the value of a currency.

Timely or frequent Government intervention.

A country can have control of its currency by trading it inthe world exchange market

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HISTORYOF PEGGING1870 -1914 - There was a global fixed exchange rate.

1940 - Bretton Woods conference

Establishment of International Monetary Fund (IMF)

1970s - Major governments adopted a floating

system, and all attempts to move back to a global

peg were eventually abandoned in 1985

HISTORYOFINDIANRUPPEE

1898-1966 PEGGEDAGAINST POUND

1966-1971 PEGGEDAGAINSTUSDOLLAR

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EXCHANGE RATES

NOMINAL EXCHANGE RATE

REAL EXCHANGE RATE

BILATERAL EXCHANGE RATE

MULTILATERAL EXCHANGE RATE

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EXCHAN

GERAT

ER

EGIM

ES

Exchange rate regimesExchange rate regimes

FREE FLOATING EXCHANGE RATE

FIXED EXCHANGE RATE

CRAWLING PEGOR EXCHANGE RATE

MANAGED FLOATING EXCHANGE RATE REGIME

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Countries With Pegged Currency HaveUnsophisticated CapitalMarket And Weak

Regulating Institution

To Achieve Lower Inflation

StimulationOf Growth

Risk Free Trade

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Loss of IndependentMonetary Policy

Transmission of Shocks from the AnchorCountry

Speculative Attacks

Possibility of financial fragility

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1994- 2005. Chinese Yuan was pegged againstU.S. dollar. 1$ = 8.28 Yuan.

Currency not fully convertible in internationalmarket.

China has tight restriction and full control overcapital market.

China has moved from fix float to managed float.

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Not trying to promote export over import.

Abandoning the peg could lead to economiccrisis and damage export industry

MAIN REASONS FOR PEGGING

To capture the major global export market

Devaluating currency attracts foreign investorswhich strength foreign reserve.

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MAIN EFFECTS

U.S. wants Yuan to appreciate leading toreleasing pressure of debt.

Low domestic demand of US products andincrease in demand of Chinese products.

Impact on Exporters and Import-Competitors

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EFF

ECT:-A domestic imbalance between saving and

investment.

Americans save little, foreigners will use their

saving to finance profitable investmentopportunities in the U.S.; the trade deficit isthe result

The increase in U.S. imports (and hence, therisingU.S. trade deficit with China) is largelythe result of China becoming a productionplatform

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CHIN

A APPRECIATE RENM

IN

BI

U.S. STOP SELLING BONDS TO CHINA

CHINA SELLS USD INOPENMARKET

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The approach that can be taken is this thatChina should allow Yuan to appreciate slowlyotherwise it will lead to high inflation andrecession in US economy

US should stop providing subsidies and otherbenefits to US households but governmentshould try to increase the investment part in

the economy becauseUS economy consumesa lot and saves very less.

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