Why Are Some Currencies Pegged To The Euro Exchange Rate?

Why Are Some Currencies Pegged To The Euro Exchange Rate?

Sep 19, 2014

In its short 10-year history, the euro promptly managed to become a favourite international currency for governments, which want to tie their national currency to the euro; hence, to take advantage of the stable euro exchange rate. More that a dozen countries outside the European Union have their currencies pegged to the euro and enjoy financial stability in terms of predictable exchange rate fluctuations while the euro provides shelter against unexpected drops of their national currencies.

Bulgaria, Estonia and Lithuania are among the EU member states, which have not adopted the euro, but their currencies are pegged to the single European currency, while similar countries outside the EU include Bosnia and Herzegovina, Morocco and a number of African countries that use the CFA franc, which is widespread in the former French colonies.

Different approaches are used when a country pegs its currency to the euro. Some governments allow their national currency to fluctuate within certain limits, while others have imposed strict regulations and the national currency is tied to the euro at a fixed rate i.e. the exchange rate of the particular currency follows exactly the moves of the euro exchange rate. A specific form of pegging the national currency to the euro is implemented by countries like Bulgaria; namely, pegging through a currency board, which is a specific body operating within the Bulgarian National Bank.

Other countries like Bosnia and Herzegovina and Cape Verde pegged their currencies at a fixed rate to

the German mark and the Portuguese escudo, respectively. Following the adoption of the euro as an official currency, these currencies automatically re-pegged to the new medium of exchange and the euro exchange rate. Another approach involves the pegging of a particular currency to several currencies called currency basket. Such an example is Belarus whose national currency, the rouble, is tied to the euro, the U.S. dollar and the Russian rouble at the same time. Such an approach provides some advantages for economies, which are closely tied and dependent on non-euro economies; in the case of Belarus, this is the Russian market.

The advantages of the currency peg to the euro are obvious since it serves as a safety measure against currency shocks. Critics of the currency peg emphasize some disadvantages of this method of approach, but the bulk part of analysts agree that such a policy results in better financial and business conditions in the country, which has implemented a currency peg. On the other hand, a currency, which is tied to the euro, will experience the same fluctuations as the base currency; therefore, it will not be protected against a shock decrease of the euro exchange rate. Such a scenario is rather apocalyptic, though.

The same applies to other currency pegs as well, the U.S. dollar and the British pound being the most popular examples. There are many examples of national currencies tied to the U.S. dollar all over the world, while the Falkland Islands pound, the Gibraltar pound and the Saint Helena pound are pegged to its British counterpart.

Source: www.currencysolutions.co.uk

Category: Forex

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