What do you understand by Pegging of currency and describe its various arrangements.

Pegging of currency refers to a method of stabilizing a country's currency by fixing its exchange rate to that of another country. Different countries follow different methods for pegging of their currencies. The foreign exchange value is established according to the practice being followed by a country. If the country follows a fixed rate of parity between its currency and a foreign currency, then the changes in parity value of that currency shall determine changes in the value of domestic currency vis-a-vis other foreign currencies. Thus, in that situation, performance of the domestic economy is not reflected in the valuation of its currency. This is one extreme side of absolute rigidity in fixation of exchange rate. The other extreme is allowing the exchange value of the national currency to float independently according to market forces without any intervention from the Central Bank. In between these two extremes, there are many intermediate arrangements for determination of exchange values. These arrangements are being listed below: (1) Domestic currency pegged to one foreign currency Under this arrangement, the exchange rate of one currency is pegged to a dominant foreign currency, usually the U.S. dollar. (2) A currency pegged to a basket of currencies The currency of a country may be pegged to a basket of currencies. The basket is generally formed by the currencies of major trading parties to make the pegged currency more stable than if a single currency peg is used. Trade, services and major capital flows may be used as currency weights while calculating the basket. (3) Flexibility limited in terms of a single currency In this system, the value of the currency is maintained within certain margins of the peg. (4) Pegged to some indicators Under this arrangement, the currencies adjust more or less automatically to changes in the selected indicators. (5) Managed Float Central Bank of a country decides the exchange rate in this system. The rates are revised from time to time depending on forex reserves, developments in parallel exchange markets, the real effective exchange rate etc. (6) Independent float In this system market forces determine the exchange rate. Most of the developed countries follow this system of exchange rate.