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

----------------------------------------------------

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