Currency Peg

What is a currency peg?

A currency peg is a government or central bank policy that fixes a country’s exchange rate to a foreign currency or to a basket of currencies. By anchoring the domestic currency to a more stable or widely used currency, a peg reduces exchange-rate uncertainty, encourages cross-border trade and investment, and can help stabilize inflation and economic planning.

Key takeaways

• A peg fixes the exchange rate between a national currency and a foreign currency (or basket), providing predictability for businesses and investors.
• Pegs reduce foreign exchange risk and volatility, which can promote trade and economic stability.
• Maintaining a peg often requires sizable foreign-exchange reserves and active central bank intervention.
• Poorly managed pegs can create trade imbalances, erode purchasing power, or collapse if reserves run out.

Why countries adopt currency pegs

Countries commonly peg their currencies to:
* Encourage trade and investment by removing exchange-rate risk.
Anchor monetary policy to a stable currency to control inflation.
Expand market access by aligning with a stronger or more widely used currency.
* Provide predictability for importers, exporters, and foreign investors.

Types of pegs

• Hard peg (fixed peg): The central bank maintains a strict, stable rate and intervenes to keep the rate steady.
• Soft peg (managed float or adjustable peg): The exchange rate is primarily market-driven, but the central bank intervenes when the rate moves significantly in one direction.

Advantages

• Reduces foreign-exchange risk and volatility.
• Encourages international trade and cross-border investment.
• Facilitates longer-term business planning and supply-chain stability.
• Can help stabilize inflation when anchored to a low-inflation currency.

Risks and disadvantages

• Requires large foreign-exchange reserves to defend the peg during periods of heavy capital flows.
• If pegged too low, domestic consumers lose purchasing power for foreign goods; if pegged too high, imports surge and trade deficits widen.
• A sustained imbalance can deplete reserves and force a devaluation or abandonment of the peg.
• Artificially low volatility can distort financial markets and reduce incentives to hedge currency risk.

Example: Saudi riyal pegged to the U.S. dollar

The Saudi riyal has been pegged to the U.S. dollar since 1986. The peg emerged in a context of global currency instability and regional economic shocks. Saudi authorities and the Saudi Arabian Monetary Authority maintain the peg to support economic stability, facilitate oil-denominated trade, and provide predictable costs for international transactions. The arrangement requires active reserve management to defend the fixed rate.

Currencies commonly pegged to the U.S. dollar

(As of 2024) Examples of currencies pegged to the U.S. dollar include:
* Aruban florin
* Bahamian dollar
* Bahraini dinar
* Barbadian dollar
* Belize dollar
* Bermudian dollar
* Cayman Islands dollar
* Cuban Convertible Peso
* Djiboutian franc
* East Caribbean dollar
* Salvadoran colon
* Eritrean nakfa
* Hong Kong dollar
* Jordanian dinar
* Kuwaiti dinar
* Lebanese pound
* Antillean guilder
* Omani rial
* Panamanian balboa
* Qatari riyal
* Saudi riyal
* United Arab Emirates dirham
* Venezuelan bolívar

Additionally, several currencies are pegged to the euro (for example, the Moroccan dirham and others).

Managing a peg

Central banks defend pegs by buying or selling foreign currency reserves, adjusting interest rates, and using capital-controls or fiscal measures when necessary. Effective management requires credible policy, sufficient reserves, and the ability to respond to persistent trade or capital-flow pressures.

Conclusion

A currency peg can be a powerful tool for creating exchange-rate stability, promoting trade, and anchoring monetary policy. However, it comes with trade-offs: the need for large reserves, ongoing intervention, and vulnerability to imbalances. Whether a peg is appropriate depends on a country’s economic structure, trade patterns, reserve capacity, and policy priorities.