April 27, 2021(Nyamilepedia) — Exchange rate regimes are ways by which the Monetary Authority of a Nation manages the currency in relations to other foreign currency exchange markets. The policy of exchange rate is entirely related to the monetary policy of a country.
Depending on what economic objectives to pursue, Central Banks usually choose amongst the three main basic types of exchange systems to adopt. These include the Fixed / Pegged, Floating and pegged float Exchange rates.
Fixed / Pegged Exchange rate
This is a type of an exchange rate regime where the Central Bank fixes an official exchange rate of its currency at a certain value against other foreign currencies. This system has an aim of keeping the value of a currency within a narrow band. The system however, has both advantages and disadvantages.
Advantages of fixed exchange rate regime:
Maintains currency stability;
Countries that maintain a fixed exchange system are assured of currency stability against other foreign currencies. This is because the value of currency remains at a fixed rate for a certain set period of times.
Creates confidence in an economy;
While currency stability is assured in the fixed / pegged exchange rate system, this results into confidence in currency itself, prompting level of confidence in an economy.
Attracts Foreign Direct Investments (FDIs);
Fixed / pegged exchange system provides incentives for Foreign Direct Investments.
The underlying reason is that many foreign investors would prefer investing in countries that guarantee them stable currencies. The system is recommendable for economies at the ‘Take Off’ stages. And whose economic goals are to attract more investments to set it forth for economic growth and developments.
It maintains price stability;
This system maintains stability in prices of goods and services. This is because of the fact that the value of currency remains stable for a long period of time.
Keeps inflation low;
Since stability of a currency remains assured over a set period of time, it is more likely to result in minimal inflation.
Disadvantages of fixed Exchange rate regime.
Results into balance of payment deficits;
Fixed / pegged exchange regime may result in a balance of payment problem. A fixed / pegged exchange regime makes exports more expensive and imports cheaper. As a result, countries whose local productions are made expensive, may find themselves importing more than they can export. This, however, triggers a balance of payment deficit.
Results into inflation (Imported inflation);
When economies with a fixed exchange regime import more than they export, this may put an imported inflationary pressure on the country.
Requires high foreign reserves to manage;
To manage a fixed exchange rate system, the Monetary Authority must keep a high foreign reserve at disposal. Failure to do so puts pressure on the economy as demand for foreign currency may exceed supply in case of a country that depends on imports from other countries.
Expensive to manage;
Since the system requires high reserves, it becomes hardly possible to manage by countries that lack discipline in their financial systems.
It lacks flexibility;
Since the exchange rate is fixed / pegged at a certain value. It becomes hard and difficult responding to temporary shocks on the economy.
NB; Generally, the main purpose of a Fixed / Pegged exchange rate regime is to promote and encourage Foreign Direct Investments hence, providing an incentive for economic growth for the less developed countries. This system is mainly practiced in countries such as Syria, Liberia, Nigeria, Mauritania, Djibouti, Afghanistan, Cambodia, Algeria and many others.
These countries use any of the international currencies such as US Dollars, Euros and others as their exchange rate anchors. Though managing and maintaining this system puts pressure on the monetary Authorities of a country, it is highly recommendable for countries like South Sudan whose economic lifelines depend on imports from other countries.
Floating Exchange rate regime;
This is an exchange rate regime that allows the exchange rate of a currency against other foreign currencies to be determined by market forces. Depreciation and appreciation of a currency depends on forces of demands and supplies.
Advantages of a floating exchange rate regime:
Reduces balance of payment deficit;
Floating exchange rate regime makes currency cheaper. A cheaper currency makes imports more expensive and exports cheaper, as a result, it encourages exports` competitiveness of a country therefore, solving the balance of payment deficit. However, this is when a country has ‘Local Production’.
Requires less foreign reserves;
Since the exchange rate system is determined by market forces, it lessens the pressure on the government on maintaining higher foreign reserves.
It is manageable;
Many governments in some of the third world / underdeveloped countries normally enjoy `evading responsibilities’ by preferring managing `a Cheap floating rate’ over ‘an expensive fixed / pegged exchange rate system’, in the expense of the worsening economic conditions of their citizens.
Avoids inflationary pressure;
While floating exchange rate system discourages importation of expensive goods and services and encourages exports, it presents chances of getting rid of ‘an imported inflation’
Freeing internal Policy;
As countries with floating exchange systems enjoy favorable balance of payment conditions, they are able to pursue other economic goals such as full employment as well as economic growth.
Disadvantages of floating exchange rate regime.
It creates uncertainty;
Under the floating exchange rate regime, a value of currency changes day by day for the case of economies at `Take off Stages’ that lack local productive capacity. This creates uncertainty in an economy.
Discourages Foreign Direct Investments (FDIs);
As a result of uncertainty created by the unstable value of a currency, Foreign Direct Investments are discouraged from taking up investments in those countries. This generally affects macroeconomic outputs of a country.
The day-day fluctuation in the exchange rate system presents dangers in speculation. This may encourage movement of hot money from country to country hence causing more exchange rate fluctuation.
Basis for inflation;
As currency changes value over and over again, the chances are high that an economy can enter into inflationary pressure
Basis for economic instability;
The overall economic status of a nation may likely be plunged into instability. This is for the case of economically less developed countries that may not afterwards export anything though floating their exchange rate regimes. These countries will suffer from economic shocks resulting into economic recessions, depressions and downturns.
NB; The overall objective of this system mainly focuses on improving the balance of payment problems of a country. As countries produce more goods and services but find it difficult to compete in an international market, due to expensiveness of goods and services as a result of expensive / over valued currencies, these countries are highly recommendable for floating exchange regimes. Adopting a floating exchange rate regime by these countries will make its imports more expensive and exports cheaper thus discouraging imports while encouraging exports.
However, this system becomes detrimental when wrongly copied and pasted by less developed countries which will not any point export as a result of their low or no economic productivity. The overall economic lifelines of these countries depend on imports from other countries. Some countries practising this exchange rate regime inlcude the USA, Australia, Canada, Netherlands, Japan, China and many more.
Pegged float exchange rate regime;
This is an exchange rate system where the Monetary Authority of a nation sets the exchange rate of a currency at a certain value against other foreign currencies, but still allows fluctuation within a defined limit / value. The merits and demerits of this are more likely those of floating exchange rate systems..
While the Transitional government of the Republic of South Sudan works into restoring political stability, the Monetary Authority (Bank of South Sudan), should closely in later and spirit, adopts a ‘Fixed Exchange Rate Regime’. Adopting this system will create confidence in the South Sudanese Pounds, reduce uncertainty / negative speculation in our currency / economy system hence promoting economic activities in the long run.
While I am aware of the current positive efforts being exerted by Bank South Sudan through the sales of foreign currency into an economy, who knows what will happen once again, to the strengths of South Sudanese Pounds when the Bank of South Sudan reaches limit sales of the foreign currency being auctioned out, while exchange rates of SSP against other foreign currencies remain floated?
Follow me on my next Article on “Impacts and Analysis of currency devaluations on Economies”
The Author is a Graduate Student at The University of Juba, Pursuing a Master Degree of Arts, Economic Development and Policy Analysis.
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