Definition of Pegging of Currency

Pegging of Currency

Normally, a developing country pegs its currency to a strong currency or to a currency with which it has a very large part of its trade. Pegging involves fixed exchange rate with the result that the trade payments are stable. But in case of trading with other countries, stability cannot be guaranteed. This is why pegging to a single currency is not advised if the country’s trade is diversified. In such cases, pegging to a basket of currency is advised.

But if the basket is very large, multi-currency intervention may prove costly. Pegging to SDR is not different insofar as the value of SDR itself is pegged to a basket of five currencies. Ugo Sacchetti (1979) observes that many countries did not relish pegging to SDR in view of its declining value. Sometimes pegging is a legislative commitment which is often known as the currency board arrangement. Again, it is a fact that the exchange rate is fixed in case of pegging, yet it fluctuates within a narrow margin of at most + 1.0 percent around the central rate. On the contrary, in some countries, the fluctuation band is wider and this arrangement is known as “pegged exchange rates within horizontal bands”.