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Concept
Currency basket
Summary
A currency basket is a portfolio of selected currencies with different weightings. A currency basket is commonly used by investors to minimize the risk of currency fluctuations and also governments when setting the market value of a country’s currency.
An example of a currency basket is the European Currency Unit that was used by the European Community member states as the unit of account before being replaced by the euro. Another example is the special drawing rights of the International Monetary Fund.
A well-known measure is the U.S. dollar index, which is used by Forex traders. There are six currencies forming the index: five major currencies – Euro, Japanese yen, British pound, Canadian dollar, and Swiss franc – and the Swedish krona.
After major world currencies began to float in 1973, small countries in reaction decided to peg their currencies to one of the major currencies (e.g. U.S. Dollar, Pound Sterling). This led to a greater fluctuation against other major currencies and soon, some of the countries elected to manage the currency movements using more currencies, important for the given country, i.e. started to use currency baskets.
In following years, greater diversification in international trade led to greater use of the currency baskets and by 1985, according to IMF data, 63 countries had tried the currency basket policy and 43 of them were using it at the time.
In the following decades, the number of countries that anchored their exchange rate to a currency composite declined and in 2019, there were only eight of them. Three tracked the special drawing rights (SDR) as the sole currency basket or as a component of a broader reference basket (Botswana, Libya, Syria). Morocco tracked the euro and the U.S. dollar basket, and the remaining four countries did not disclose the composition of their reference currency baskets (Fiji, Kuwait, Singapore, Vietnam).
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.
Official source
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