An exchange rate which ordinarily remains fixed, but which can be adjusted as and when required, is termed an adjustable or moving peg exchange rate.
Depending upon the frequency and extent of exchange rate revisions, it may also be labeled as a ‘crawling peg’, or a ‘trotting peg’, etc.
This arrangement is expected to reap the advantages of both fixed and floating exchange rates and minimise the risk of disturbing the domestic economy.
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Devaluation:
An important and frequently discussed version of the adjustable peg is that of devaluation of the home currency. We are taking it up for detailed discussion.
Meaning:
Devaluation means a reduction, as a matter of deliberate policy action, in the external value of the home currency. It is expected to be used only occasionally and infrequently.
Measurement:
It means that, after devaluation, a given sum of rupees buys 20% less dollars, or an importer who is to pay for American goods in dollars, gets 20% less of imports from America for a given sum of Indian rupees.
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In contrast, a dollar holder, by spending same amount of dollars, can get 25% more rupees, or buy 25% of more of Indian goods (prices quoted in rupees).
For the devaluing country, the immediate effect of devaluation is that it increases the prices of all imports by a given proportion, and reduces the external prices of all its exports by another given proportion.
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This often leads to subsequent changes in the quantities of imports and exports depending upon several factors including their elasticities of demand and supply.
Extent:
It is expected that the decision of authorities regarding the extent of devaluation would be based upon several relevant considerations including, for example, (i) the estimated demand and supply elasticities of the country’s imports and exports; (ii) the targets of reduction in import bill and increase in export earnings; (iii) the possibility of a retaliatory action by the country’s competitors and trading partners; and (iv) the extent to which “follow up actions” can be taken by the devaluing country.