Currency Pegging Systems

In today's Business Standard , Arvind Subramanian, Josh Felman, and I discuss the implications of a significant shift in Reserve Bank of India (RBI)'s exchange rate policy. Although not formally announced, the RBI has effectively pegged the rupee to the dollar since late 2022. Maintaining this peg has come at a steep cost—approximately $200 billion in forex interventions over two and a half years, including $100 billion since September through spot and forward markets. Such a strategy, however, is not without risks. Exchange rate pegs tend to erode competitiveness and bind monetary policy to defending the currency rather than addressing domestic economic priorities. These vulnerabilities leave the rupee exposed. Should markets perceive it as overvalued or anticipate a shift in monetary focus, speculative pressures could mount, forcing a disruptive adjustment. The prudent course for the RBI is to allow a gradual depreciation of the rupee, bringing it closer to equilibrium value. This would free monetary policy to focus on pressing domestic needs while safeguarding India's hard-earned reputation for prudent macroeconomic management. Link to the article: https://lnkd.in/gU-uyqzR

🔍 What Does Hong Kong’s Interest Rate Gap Really Mean? (In response to Shuli Ren’s recent Bloomberg column: “Hong Kong Has All But Abandoned the Dollar Peg.”) Shuli Ren raises important questions about Hong Kong’s interest rate divergence from the U.S. But I’d like to offer a different perspective—one grounded in the actual mechanics of currency board regimes. 🇭🇰 Hong Kong’s currency board is not discretionary. It functions by maintaining a fixed exchange rate (currently 7.75–7.85 HKD/USD), backed by 100% USD reserves. The Hong Kong Monetary Authority (HKMA) does not “set” interest rates—it defends the peg through FX interventions. So, when HIBOR drops significantly below SOFR, it doesn’t signal that the peg is being abandoned. It signals: • Capital inflows into HKD assets (requiring HKMA to sell HKD and buy USD) • Excess liquidity, which pushes down local borrowing costs • Weak domestic credit demand, keeping pressure off HIBOR • A possible market consensus on USD weakness, which reduces appetite for USD carry trades 📉 Rate divergences can persist, but they are not unusual in currency boards. Arbitrage, shifts in capital flows, or changes in loan demand will eventually bring them back toward alignment—without requiring central bank intervention. 🔄 As long as the exchange rate remains within the peg band, the system is working exactly as designed. Respectfully, conflating interest rate gaps with policy abandonment risks misrepresenting a highly rules-based monetary regime. The real question isn’t whether Hong Kong is drifting from the peg—but whether global markets are recalibrating expectations around U.S. dominance. Would love to hear others’ thoughts. #HongKong #CurrencyBoard #MonetaryPolicy #FX #InterestRates #Finance #EmergingMarkets #Macroeconomics

Ever Wondered Why Most Currencies Fluctuate Daily, But Nepal’s and India’s Are So Stable? Every day, currencies around the world go up and down. The US dollar moves, the Euro moves, the Japanese Yen moves. But the Indian Rupee stays relatively stable. And the Nepali Rupee is even more stable because it is pegged to India. Nepal has pegged its currency to India since 1993, at 1 INR = 1.60 NPR. At first, it was a practical choice. Today, it looks like one of the smartest decisions for our economy. Before the peg, Nepal had frequent currency swings with India. This made trade and daily life unpredictable. Businesses struggled to plan, and prices could change quickly. To fix this, the Nepal Rastra Bank and the government decided to link the Nepali Rupee to the Indian Rupee. The goal was simple: stability and predictability. Nepal is a small country with weak industries and heavy dependence on imports. Political instability has been common. Remittances from Nepalis working abroad make up around 25% of GDP. In such conditions, a floating currency could have been risky. Prices could rise suddenly, and savings or remittance income could lose value. The peg has brought clear benefits. Prices are more predictable. Remittances retain their value. Trade with India is smoother because businesses do not face daily currency risk. Investors also gain confidence knowing the exchange rate is stable. India benefits from this arrangement too. Stable trade with Nepal reduces risk for Indian businesses. It strengthens economic ties between the countries. Indian companies operating in Nepal also benefit from predictable exchange rates. The system is not perfect. Nepal cannot adjust interest rates freely. Exports are less competitive because the currency is stronger than our productivity. Sometimes, inflation from India is “imported” when the INR weakens against the US dollar. If Nepal floated the Rupee today, the currency would likely fall. Prices for fuel, food, and imported goods would rise. Remittance value would drop. Without strong industries or foreign reserves, the economy could struggle. The peg is not just a monetary decision. It has kept Nepal afloat during decades of political and economic challenges. Until industries grow, exports diversify, and reserves strengthen, the peg remains a vital safety net for the country. #NepalEconomy #CurrencyPeg #NepaliRupee #IndianRupee #Remittances #FinancialStability #EconomicPolicy

The Indian Rupee has been one of Asia's worst-performing currencies. It’s down over 5% this year. Some of the reasons - US tariffs, Massive foreign investor outflow, widening trade deficit, etc. But, that's what got me thinking (and hence a new learning today). Why do some countries peg their currencies to USD (Like the UAE, Saudi Arabia), and some keep them floating (Like India, Japan, etc)? Well, the answer is fascinating. There is a concept called "Impossible Trinity" or "Trilemma" - Formalized by economists Mundell and Fleming. The idea is you can only pick two out of the three: 1.) A fixed exchange rate 2.) Free capital flows 3.) Independent monetary policy For example, 1.) If you choose, Fixed rate + Free capital = You get stability and openness, but you sacrifice a lot as you can't set your own interest rate. Like the UAE and Hong Kong 2.) If you choose, Fixed rate + independent policy = You get stability and policy control, but you must restrict capital flows. This is how China operated historically, and Malaysia during the 1998 crisis 3.) If you choose Free capital + Independent policy = you get policy flexibility + openness, but you suffer from currency volatility. Like India, the UK, etc. One thing stood out very clearly for the countries that peg their currency to the USD. They need massive reserves to defend a peg. Because in a crisis, when everyone wants to exit a local currency for a safer one (like USD), a fixed peg means the central bank has to drain its reserves; otherwise, the peg will fail. Many African and Latin American countries tried pegs and suffered massively! So, for Gulf countries: Oil sold globally -> Dollars flow IN -> Surplus of dollars -> Easy to maintain peg. So, India (Oil Importer): Oil imported -> Dollars flow OUT Electronics imported -> Dollars flow OUT Gold imported -> Dollars flow OUT Another reason I read is the Inflation differential. Countries that peg to USD have similar inflation to the US (2-3%). Floating exchange-rate currencies tend to have higher inflation (e.g., 6%-8% in India). Indian Rupee's gradual depreciation actually compensates for this inflation gap and keeps indian exports competitive. Surprisingly, India had a quasi-pegged system before 1991 (the Indian Rupee was fixed at artificial rates), and we all know how it went. Depleted reserves due to overvaluation and gold had to be pledged to avoid default! So, bringing the point back to Procurement - Map out what % of your spend is in foreign currency - Do you have hedging in place? If yes? Good. If no, there are some other methods a.) If you expect your home currency to weaken further ----> Accelerate purchases/payments b.) If you expect it to recover ---> Delay purchases/payments Do you monitor forex after you place a PO? I guess many would not! ------------------------------------ For awesome procurement content---framework, case studies, spend analysis, negotiation, and more, subscribe to my free newsletter

PEGGING & HEDGING IN CURRENCY MANAGEMENT ================================== In the context of international finance and currency risk management, “pegging” and “hedging” are two distinct strategies used to manage the impact of exchange rate fluctuations, but they serve different purposes and operate in different ways. Pegging refers to a monetary policy strategy where a country fixes its currency’s exchange rate to another major currency (such as the US Dollar) or to a basket of foreign currencies. This means that the domestic currency will maintain a constant exchange rate with the reference currency, regardless of fluctuations in the global currency market. For instance, if the Malaysian Ringgit (RM) is pegged to the US Dollar at a rate of USD 1 = RM 4.50, this rate will remain unchanged as long as the peg is maintained providing stability for trade and investment flows. In contrast, hedging is a risk management tool used by investors, businesses, or financial institutions to lock in an exchange rate today for a transaction that will occur in the future. The goal is to protect against adverse movements in exchange rates. For example, if a company plans to purchase US Dollars one month from now and enters into a hedging arrangement today at USD 1 = RM 4.50, then even if the market rate shifts to USD 1 = RM 4.60 in the following month, the agreed rate of RM 4.50 will still apply. This provides certainty and stability for budgeting and financial planning, especially in volatile currency environments. In summary, pegging is a government or central bank policy to stabilize a currency over the long term, while hedging is a commercial financial strategy used to manage short- to medium-term exchange rate risks in specific transactions. Both serve important roles in the global financial ecosystem, especially for emerging markets, international investors, and multinational businesses. Allah knows best.

I read on Bloomberg this week that “the Gulf states are buying fewer Treasuries, and that’s part of why U.S. long yields are rising.” It sounds logical, but it’s wrong. Saudi Arabia pegs the riyal to the dollar at 3.75. Under such a regime, dollar recycling is not discretionary, it’s automatic. Oil revenues that are spent locally still end up in the central bank’s hands, and those dollars must be placed somewhere, usually in Treasuries. The causality runs one way: the Fed sets rates, and Saudi Arabia imports them. Pegged countries don’t move U.S. yields; they shadow them. In my latest piece on Macro Anchor, I walk through the mechanics of currency boards and pegged regimes, from Argentina to Bulgaria, and then examine Saudi Arabia’s case. For decades the peg looked almost like a full currency board, but today its liquid backing has thinned as reserves shift into illiquid sovereign wealth fund assets. The system still holds, but it is more fragile than it appears, and far more opaque than most realize. Regards, Andre Chelhot The Macro Anchor Prague Finance Institute Zelof & Partners LLP #macroanchor #saudiarabia #bloomberg #currencypegged #currencyborad #democracy