In recent years, currency pegs have gained popularity in the forex world. Nearly one-fourth of all the countries in world at present have already pegged their currencies to some other major currencies, such as the dollar and the euro. In this article, we will discuss the benefits that countries get from currency pegs.
Stable Planning Basis
Currency pegs offer an excellent basis for the government’s financial planning processes. These governments need to buy important commodities such as oil and food grains from the international market. To accomplish that, the government need to use a foreign currency to pay for the goods. The US dollar is the most common denomination of these goods since the greenback is the world’s reserve currency. But the euro and some other major currencies are also accepted.
Nevertheless, the government still has to convert its own local currency to another currency at the forex market. If the rates constantly fluctuate, the government won’t anticipate how much of its own currency it needs to convert to foreign currency and meet the demand.
On the other hand, currency pegs fix the rate and give a stable basis for governments to plan their revenues and expenses in local currencies without any worries about the volatility of the forex market.
Credible and Streamlined Monetary Policy
Currency pegs are popular among third world countries, which have used currency pegs in the past. This is because such countries are also quite strict with their local monetary policies. Therefore such countries aim to outsource their monetary policy to a more developed nation where the policymakers would take more responsible decisions.
This only partly offsets the threat of sabotage from local authorities. This is because the politicians can still order printing of money and cause inflation. On the other hand, they won’t be able to diminish interest rates and cause a bubble in the economy in general when a currency peg is being followed.
Aside from the local governments, the local businesses and companies also benefit from the advantages that are possible thanks to currency pegs. The local businesses can predict the way their goods will be priced in the international market.
When they are already aware of the exact pricing, they will also able to foresee or predict more accurately the quantities that will be in demand at that level of price. And because this is the system, they won’t be facing much volatility. They will also be able to insulate themselves from foreign exchange losses in the process.
This puts them a huge advantage when you compare them to their other rivals and competitors who are required by necessity to face such downsides or risks. And because of that, they will be compelled to add a risk premium for the same products in their prices.
These are the top advantage of currency pegs, which are very useful for many market participants in the foreign exchange market. However, it is also important to note that there are downsides to this system. Those include higher level of foreign influence, speculative attacks, and a tough time in automatic adjustments.