EXCHANGE RATE REGIMES

By: PAAVNI SHARMA ROLL NO. 15069

An exchange rate is the value of one currency in terms of another. Example : If the U.S. exchange rate for the Canadian Dollar is $1.60, this means that 1 American Dollar can be exchanged for 1.6 Canadian dollars. Units of home currency for one unit of foreign currency or units of foreign currency for one unit of home currency.

EXCHANGE RATE REGIME

Exchange rate regime is defined as the mechanism, procedures and institutional framework for determining exchange rates at a point in time and changes in them over time , including factors which induce the changes. Factors affecting exchange rate: Inflation Interest rates Speculation Change in competitiveness Relative strength of other currencies Government debt Government Intervention Economic growth/recession Balance of payments

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CATEGORIES OF EXCHANGE RATE ARRANGEMENTS

EXCHANGE RATE ARRANGEMENTS

HARD PEGS

SOFT PEGS

FLOATING REGIMES

OTHER MANAGED

Exchange rate regime Conventional fixed pegged with no separate tender Pegged with horizontal bands Currency board Crawling Peg Arrangement

Floating Free floating

EXCHANGE RATE REGIMES(NUMBER OF COUNTRIES)

Source : Annual report on Exchange Arrangements and Exchange Restrictions 2013,IMF

Free floating, 30 Floating, 35

No separate legal tender, 13

Currency board, 12

Conventional peg, 45

Other managed arrangement, 19

Crawl-like arrangement, 15

Stabilised arrangement, 19

Pegged with horizontal bands, 1

Crawling peg, 2

1. EXCHANGE ARRANGEMENTS WITH NO SEPARATE LEGAL TENDER

A country either adopts the currency of another country as its legal tender or a group of countries share a common currency. A country adopting such a regime cannot have cannot have an independent monetary policy. Examples: a) Ecuador and Panama have adopted the US dollar as their legal tender. b) European Union has Euro as its currency c) Countries belonging to the Eastern Caribbean Union(ECCU) East Caribbean dollar which in turn is pegged to the US dollar in a currency board arrangement

2. CURRENCY BOARD ARRANGEMENTS

Legislative commitment to exchange the domestic currency against a specified foreign currency at a fixed exchange rate coupled with restrictions on the monetary authority to ensure that this commitment will be honoured.

The domestic currency is usually fully backed by foreign assets

Example: The Hong Kong Monetary Authority (HKMA).The Hong Kong dollar is linked to the U.S. dollar at US$1=HK$7.78 since 1983 and US$1=HK$7.75 since 1998.

3. CONVENTIONAL FIXED PEG ARRANGEMENTS

The country (formally or de facto) pegs its currency at a fixed rate to another currency or a basket of currencies The basket is formed from the currencies of major trading or financial partners and weights reflect the geographical distribution of trade, services, or capital flows. The exchange rate may fluctuate within narrow margins of less than 1% around a central rate-or the maximum and minimum value of the exchange rate may remain within a narrow margin of 2 %-for at least six months.

Flexibility of monetary policy The monetary authority maintains the fixed parity through 2 ways: Direct intervention (i.e., via sale/purchase of foreign exchange in the market) Indirect intervention (e.g., via aggressive use of interest rate policy, imposition of foreign exchange regulations, exercise of moral suasion that constrains foreign exchange activity, or through intervention by other public institutions).

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4. PEGGED EXCHANGE RATES WITHIN HORIZONTAL BANDS

There is a peg but variation is permitted within wider bands. The value of the currency is maintained within certain margins of fluctuation of atleast 1% around a central rate-or a margin between the maximum and minimum value of the exchange rate that exceeds2 % Example: Tonga

5. CRAWLING PEG

The country (formally or de facto) pegs its currency to another currency or a basket of currencies but the peg is periodically adjusted. The adjustments may be pre announced and according to a well specified criterion or discretionary in response to changes in selective quantitative indicators such as inflation and other market factors. Example: Nicaragua and Botswana

The main key advantages under the crawling peg system as opposed to conventional exchange rate regimes are: Avoid economic instability as a result of infrequent and discrete adjustments (fixed exchange rate) Minimize the rate of uncertainty and volatility since the fluctuation in the exchange rate is kept minimal (floating exchange regime)

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6. FLOATING REGIME

A floating rate is largely market determined, without an ascertainable or predictable path for the rate. Foreign exchange market intervention may be direct or indirect and serves to moderate the rate of change and prevent undue fluctuations in the exchange rate. Policies targeting a specific level of the exchange rate are incompatible with floating Example: India, Pakistan, Afghanistan , Mexico

7. FREE FLOATING

If intervention occurs only exceptionally and aims to address disorderly market conditions. Authorities have provided information or data confirmation that intervention has been limited to at most three instances in the previous six months , each lasting no more than three business days. Example: Australia, Canada, Japan, US,UK

QUIZ

1.

Which of the following best describes the following exchange-rate regime? The currency of another country circulates as the sole legal tender or the member belongs to a monetary or currency union in which the members of the union share the same legal tender.

a. currency board arrangements b. pegged exchange rates within horizontal bands c. crawling pegs d. exchange arrangements with no separate legal tender

2. A monetary regime based on an implicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure the fulfilment of its legal obligation is best described as: a. currency board arrangements. b. exchange arrangements with no separate legal tender. c. pegged exchange rates within horizontal bands. d. independent floating.

3. Which of the following best describes the following exchange-rate regime? The value of the currency is maintained within margins of fluctuation around a formal or de factor fixed peg that are wider than +/- 1% around a central rate. a. exchange arrangements with no separate legal tender b. pegged exchange rates within horizontal bands c. currency board arrangements d. crawling pegs

4. In which of the following types of exchange-rate regimes is the currency adjusted periodically in small amounts at a fixed, preannounced rate or in response to changes in selective quantitative indicators?

a. exchange arrangements with no separate legal tender b. currency board arrangements c. crawling pegs d. pegged exchange rates within horizontal bands

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