Currency board's resume; system's pros and cons
Currency board's resume; system's pros and cons
SINGAPORE (Reuters): Indonesia has said it is exploring the possibility of establishing a currency board to maintain the value of the rupiah.
The following is a brief resume of how a traditional currency board works and some of the pros and cons of using such a system.
A currency board
- Fixes or pegs a currency to another currency at a set rate.
- Sidelines the central bank in as much as the country establishing the board vows to hold enough of the foreign currency to which its unit is pegged to cover all local notes and coins in circulation.
- Holds low-risk bonds and other assets payable in the anchor currency.
- Pledges to exchange local currency for the peg currency at a fixed exchange rate.
- Removes interest rate control from the central bank (or the authorities). Interest rates are instead dictated by supply and demand for the local currency.
- The board earns profits from the difference between the interest it earns from anchor-currency assets and the cost of maintaining notes and coins in circulation.
Some of the pros
- The exchange rate is fixed to an anchor currency, giving predictability.
- Foreign reserves have to be a minimum of 100 percent of the local coins and notes in circulation.
- There is full convertibility.
- A currency board should be protected from political pressures.
- The board's rules are transparent.
- The local currency is effectively linked to monetary and fiscal policy of the anchor currency's country, and will benefit or suffer from the results of those policies.
Some of the cons
- If the fixed rate is set at an inappropriate level the peg will be in danger of immediate collapse because of unbalanced currency flows.
- If a futures market is established, speculators can attack the currency there, forcing up interest rates.
- Interest rates will be controlled by external forces and cannot be changed, for example, to boost domestic demand or dampen inflation.
- A black market may develop if the rate is incorrectly set and flows move against the local currency.
The following is a list of countries which have currency boards.
Country Link currency Year established
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Hong Kong U.S. dollar 1983
Argentina U.S. dollar 1991
Estonia Mark 1992
Lithuania U.S. dollar 1994
Bosnia Mark 1995
Bulgaria Mark 1997