Hard Currency

A hard currency is a currency that is widely accepted in international payments, can be freely exchanged for other currencies, and is expected to keep its value over time. The US dollar, the euro, the Japanese yen, the pound sterling and the Swiss franc are the usual examples. Foreign suppliers, lenders and investors generally want to be paid or repaid in one of them, which is why access to hard currency is a constant concern for importers and governments in many emerging economies.

The opposite is a soft currency: one that is not readily accepted abroad, may be subject to exchange restrictions, and is prone to sharp depreciation. The term is informal and has no legal definition; a currency's hardness is a matter of market confidence rather than official designation.

No single test makes a currency hard, but the currencies usually described that way share several features:

• Full convertibility: residents and non-residents can exchange it for other currencies for both trade and investment purposes without significant capital controls.
• Deep and liquid markets: it trades in large volumes in the foreign exchange market, with narrow spreads in its major currency pairs.
• Stable value: a record of relatively low inflation and a credible central bank.
• Institutional strength: rule of law, political stability and well-developed financial markets in the issuing country or currency area.

The currencies that most clearly meet these criteria are also the main reserve currencies. The International Monetary Fund's Special Drawing Right is valued against a basket of five currencies: the US dollar, euro, Chinese renminbi, Japanese yen and pound sterling. The renminbi was added in 2016, although it remains subject to capital controls and is not usually described as fully hard.

Most international trade in commodities and many manufactured goods is invoiced in a small number of currencies, above all the US dollar. A country whose own currency is not accepted abroad must earn hard currency through exports, remittances, tourism or borrowing in order to pay for imports and service foreign debt. Its foreign exchange reserves, held largely in hard currencies, are its buffer, and import cover measures how many months of imports those reserves could pay for.

When hard currency is scarce, governments may ration it through official allocations, require exporters to convert earnings under export proceeds repatriation rules, or impose capital controls. Such measures often give rise to a parallel market rate at which dollars trade above the official price.

Households and firms in countries with soft currencies often save in hard currency to protect against depreciation. In extreme cases, such as episodes of hyperinflation, prices and contracts move into dollars or euros and the economy moves toward dollarization. The dynamic follows Thiers' Law: when people are free to choose, they prefer the stronger money.

Governments and companies in emerging markets frequently borrow in hard currency because foreign lenders will not accept the local one. This creates a currency mismatch: if the local currency falls, the debt burden rises in local terms. Economists have called the inability to borrow abroad in one's own currency "original sin".

For payment companies and banks, hard currencies are the settlement backbone of payment corridors. A remittance from the Gulf to South Asia, for example, typically converts the sending currency into US dollars and then into the receiving currency, with dollar balances held in correspondent accounts. Payment providers serving markets with scarce hard currency face delays in obtaining dollars, multiple exchange rates and the risk of capital flight-driven policy changes, and they price that risk into their spreads.

Exotic and frontier currencies, by contrast, usually trade against a hard currency rather than against each other, so a conversion between two soft currencies is normally carried out through the dollar or the euro.