A fixed exchange rate system, which is also known as pegged exchange rate, is when the value of a currency of one particular nation is tied to that of another nation. This type of exchange rate is favoured by many nations across the globe because it has many advantages. However, there are also some disadvantages or risks involved with fixed exchange rates which you need to know if you intend to buy forex online in India.
Pros of a fixed exchange rate
1- A fixed exchange rate is mainly employed for trade and export purposes. To make the goods more competitive in the international market, countries try to keep its exchange rate under check by controlling their domestic currency.
2-A fixed exchange rate helps ensure the stability of a nation’s currency. It gives the investors an insight into the value of a country’s currency thereby making the business environment more conducive for the foreign investors. This brings in more foreign direct investment which ultimately strengthens the economy. A fixed foreign exchange rate also provides the currency protection from fluctuations, which can have a deep impact on the economy.
3-Many economies across the world have fixed their currencies to powerful currencies like the US dollar and the Euro. This enables the nations to avoid inflation. The fixed exchange rate helps in the overall economic growth of a country and is responsible for increasing the standards of living of the citizens.
4-An unstable exchange rate is harmful for the economy of a country as it would lead to depreciation in the currency. This can be averted if the country opts for a fixed exchange rate.
Cons of a fixed exchange rate
1-One of the biggest disadvantages is the huge cost of maintaining a fixed exchange rate. To manage the value of its country, a nation requires enormous foreign exchange reserves, which makes it tough for poor countries to maintain the system.
2-A fixed exchange rate system also encourages speculation and the possibility of speculation increases if a country is experiencing a major BOP deficit.
3- There is also a possibility that fixed exchange rate may cause imbalances in the current account of a country. An exchange rate that is overvalued can cause a current account deficit.
4- Another major disadvantage of this system is the lack of flexibility. Countries which have a fixed exchange rate system find it tough to deal with situations and shocks that are temporary in nature. For e.g, in case of an increase in the price of a product such as oil, the country that is importing the oil and has a fixed exchange rate system will lack the ability to devalue the current account deficit.
Though, there are a few disadvantages of the system, but many countries prefer a fixed exchange rate because it provides a country with competitive tradition advantage and at the same time protects its economic interests.
