What is a pegged exchange rate

Pinned exchange rate, refers to the exchange rate system in which a country maintains a fixed exchange rate between the local currency and a foreign currency or a basket of currencies. A basket of currencies is a monetary unit consisting of a number of national currencies in specific weights.

In the pegged exchange rate system, a country's currency and one of the other or a basket of currencies to maintain a relatively stable ratio between the pegged to the chosen currency. The national currency fluctuates with fluctuations in the chosen currency, but the ratio between each other is relatively fixed or fluctuates only within a small range, generally not more than 1 percent. The peg is generally the currency of a major industrialized country or the IMF's Special Drawing Rights (SDRs).

Currently, most developing countries are practicing a pegged exchange rate system. According to the different pegged currencies, the pegged exchange rate system can be divided into pegging a single currency and pegging a basket of currencies. In addition to the pegged exchange rate system other exchange rate system, including the floating exchange rate system, collectively referred to as the flexible exchange rate system.

Under a pegged exchange rate system, reserve balances will rise (or fall) strictly in line with movements in the balance of payments aggregate, i.e., offsetting net surpluses or deficits in the national currency. China's renminbi is the most important currency with a pegged exchange rate system. The country has a strong balance of payments and officially announced that its foreign exchange reserves at the end of 2004 had reached $600 billion. Diversifying the currency of the reserves would not be simple and would not only put depreciation pressure on the dollar, but would also put upward pressure on China's foreign trade surplus, thus forcing the central bank to buy more dollars. In the current better external environment, the mere revaluation of the currency or the introduction of a floating exchange rate system would enable the banks to slow down, diversify or reverse the growth of their dollar holdings.

Many in China see the current currency pressures as a reflection of buoyant foreign direct investment rather than as a result of an equilibrium rise in the basic exchange rate, citing the existence of a large unemployed labor force as evidence.

Developing countries with small and weak economies tend to prefer pegged exchange rate regimes, largely because they are less able to bear foreign exchange risk.

The current fixed exchange rate system is mainly characterized by a pegged exchange rate system. This peg is different from the Bretton Woods system under the practice of pegging the dollar, because at that time the dollar is pegged to gold, and the dollar's gold parity is fixed. After the collapse of the Bretton Woods system, the currencies pegged by a number of countries were themselves subject to floating exchange rates. Therefore the current fixed exchange rate system should essentially be a floating exchange rate system