Currency basket

[9] Baskets of currencies are ideal for small countries with less diversified production, which are well integrated with the global economy and thus more vulnerable to external disturbances.

[8] The authorities should regularly review the relative currency weights in the basket and adjust them based on current economic situation.

[8] Choice of the averaging method is made based on currency characteristics that are deemed desirable.

A geometric average method should be used when authorities’ policy objective is maintaining predetermined currency weights.

A harmonic average method has a built-in appreciation (anti-inflation) bias and thus is optimal for price stability.

An arithmetic average is best for maintaining the real effective exchange rate with its bias towards nominal depreciation.

They include how often to quote the exchange rate, whether or not to disclose the basket composition and how wide of a currency band margin to maintain.

[8] In theory, to adhere strictly to a basket peg rule under given conditions, the authorities must continuously calculate and quote the exchange rate against the intervention currency and must always be ready to sell or buy whatever amount of the intervention currency is necessary to support that rate.

This deviation makes the basket-pegged currencies more vulnerable to speculation as foreign exchange dealers may short-sell or short-buy them more often.

They may also adjust basket’s value or composition to offset a loss of competitiveness or to accommodate a change in a structure of the country’s trade.

[8] Excessive use of the interventions may, however, lead to a loss of monetary discipline and credibility which are key for proper functioning of the basket peg valuation system.