What is Currency Pegging?

Something strange is happening in India’s external economic relations. The rupee value has gone down to a new low level against US dollar and other major currencies. It seems likely to depreciate further. I have explained in my old article about the reason for rupee value decline and how it impacts your daily needs. Making rupee stronger is equivalent to improving our external relations to other countries via increasing the exports. This steep decline has resulted in lot of negative sign on India, like increase in the petrol price.

I have noticed in one of my previous article about the currency value depreciation, few readers have posted a query about the currency pegging mechanism in different countries and whether India is following that strategy to maintain the rupee value. This article speaks about the currency pegging, what are the countries misused the currency pegging and how India stands on the currency pegging strategy to balance rupee value.  If you have any more doubts on the rupee value and other macro economic factors, please post it in the comments section.

What is Currency Pegging?

Currency Pegging is also called as the Fixed Exchange Rate. In simple words, currency pegging is a concept of fixing the standard rate of one currency against the another or group of currencies. In example, rupee against dollar is traded at Rs. 56 today, our central bank (RBI) can use the currency pegging to make Rs. 56 is the standard rate against dollar and maintain it to same rate to avoid the volatility in the exchange rate. Currency Pegging is useful if a country depends on another country for the external trade. A frequent change in the currency value might affect the trades, in order to keep less volatile, countries tries to maintain the same exchange rate. It is the simple definition, but making it work is not easy.

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How to implement Currency Pegging?

But, how currency pegging is achieved by a country. I hope you understand when a currency value is increased or decreased. If you are not familiar in that subject, please read reason for rupee value decline. In a normal case, when one currency’s value increased or decreased based on the imports and exports against a particular currency. If the exports are higher then the imports, currency value will increase, if the imports are much higher then the exports, the value will decrease (which is happening in India).

Every country and company has the foreign currency reserve to trade with other countries. Indian govt. , banks, companies, etc. have billions of dollars as the reserve to trade with the other countries. If India is buying more dollars in the market, rupee against dollar will decrease because we are in need of more dollar, so we are selling the rupee to the market and buying the dollar currencies.

When there is a more than expected depreciation in the rupee value (or any other currency), if RBI wants to stop the further decline, it urges the banks and companies to sell their Forex reserve on dollars and buy the rupee. It will increase the rupee value. But, this is can be done only for temporary if the decline is less manageable. I hope now you have understood how we can artificially maintain the currency value.

Yuan vs Dollar Controversy

Do you know who are the major manipulators of the currency. It is Chinese  govt. who maintain their currency value lower to get the benefit of the exports. A country which heavily depends on the exports has lot of benefit if their currency is lower in the value. China is the single largest exporter to USA, they want to maintain their currency value lower amid the lot of pressure from the USA. It is difficult situation for USA because they are losing if they are importing for more price. It has been a hot topic once, in the recent days china has agreed to smoother the relations.

What is India’s stands on Currency Pegging?

India has the very minimal interference with the currency manipulation. Rupee value is always market traded value. We never tried for the fixed exchange rate. In some occasions, RBI has tried to control the value. In the recent days, rupee value is out of control from the RBI’s hand and it is expected to decline further and might touch the new historical low at Rs. 60 against the dollar.

Summary

The idea of pegging against gold started in the late 17th century when a new gold coinage was introduced in Great Britan. So, the idea is very old it has been used in the monetary world from the ancient time. In the olden days, it is used against the Gold and Silver commodities. Currency Pegging is not a good practice for the country. But, the world is more competitive and want to gain the maximum profit from the exports. Nowadays currency pegging is normal and it is used for stabilizing the currency value.