Understanding Currency Pegging: The Case of Bhutanese and Indian Rupees
When we compare the currencies of Bhutan and India, one might find the only commonality to be their equivalent exchange rate. However, this similarity does not tell the whole story. Behind the scenes, there lies a complex yet simple concept known as currency pegging, which is notably used by Bhutan.
Bhutanese Currency: Nu (Ngultrum)
Bhutan, a small nation nestled in the Himalayas, has adopted a system called “currency pegging.” Its official currency, the Nu (Ngultrum), has been intricately linked with the Indian Rupee (INR) due to significant support from India in various projects and initiatives.
What is Currency Pegging?
Currency pegging is a financial arrangement where a country fixes the exchange rate of its national currency to another fixed foreign currency, a basket of currencies, or even a fixed value of gold. This system is akin to setting a home price for your currency, thereby providing stability and predictability in the market.
The concept of a fixed exchange rate can be applied in various ways. It could be pegged to another major currency, such as the US Dollar, or to a basket of currencies, reflecting a broader economic strategy. Currency pegging is a strategic monetary policy choice that benefits both the pegged and pegging countries in different ways.
Why Do Countries Use the Pegging System?
Currency pegging can be particularly advantageous for smaller countries like Bhutan. Here are the key reasons why countries adopt this system:
Stability for an Unstable Currency
One of the primary reasons for currency pegging is to provide stability to an unstable currency. Bhutan, with its relatively small economy, finds it advantageous to link its currency with a more stable and larger economy like India. This not only helps in reducing exchange rate volatility but also brings confidence to international investors.
Simplified Trade
When two currencies are pegged to each other, it simplifies trade between the two countries. For instance, when Bhutan and India engage in trade, they no longer need to constantly monitor exchange rate fluctuations. This makes international trade more predictable and easier to manage.
Control Over Currency Behavior
Another benefit of currency pegging is the control it offers over the behavior of the currency. By fixing the exchange rate, countries can control inflation, stabilize their economy, and maintain competitiveness in global markets.
Increased Credibility
Currency pegging also increases the credibility of the central bank of small nations. A stable and predictable exchange rate instills confidence in domestic and foreign investors, which can be crucial for attracting foreign investment and sustaining economic growth.
For Bhutan, the pegging of its currency with the Indian Rupee has brought numerous advantages. By adopting currency pegging, Bhutan has not only stabilized its exchange rate but has also simplified trade relationships and improved economic credibility.
Conclusion
The story of Bhutanese and Indian currencies sharing a common exchange rate is more than just a numerical coincidence. It reflects a strategic financial arrangement known as currency pegging. This system has been instrumental in bringing stability, simplifying trade, and enhancing economic credibility for Bhutan, reaffirming the value and importance of currency pegging in today's global economy.