A country choosing an anchor currency is choosing whose monetary policy it will import, and the choice can be analysed rather than assumed. For Sao Tome and Principe the International Monetary Fund ran two methods and they disagreed: a gravity model of trade put the euro first, while a currency mapping exercise put the CFA franc first and the euro third. Both routes end at the same anchor, because the CFA francs are themselves fixed to the euro. The country adopted a conventional peg to the euro in January 2010. Fund staff had judged a hard euro peg to have a slight edge over joining a monetary union, provided institutional capacity was adequate and an agreement on external support and surveillance could be secured, and Portugal supplied such an agreement in 2009.
A country that fixes its currency to another one is choosing whose monetary policy to live under. That choice can be analysed rather than assumed, and Sao Tome and Principe is the case where the analysis was published, disagreed with itself, and still arrived somewhere.
Key Takeaways
- Picking an anchor currency is picking a source of monetary conditions, so the decision has criteria and can be modelled.
- Two International Monetary Fund methods gave different first choices for Sao Tome and Principe, and both ended at the euro anyway.
- The dobra has been on a conventional peg to the euro since January 2010, at 24.5 dobras to the euro.
- Fund staff made their recommendation conditional on external support being secured, and Portugal's contingent line is triggered by a reserves test rather than by request.
- The peg is the country's own decision, taken under its central bank's statute, with the agreement built around it rather than containing it.
What an anchor choice actually commits
Not a number. A currency peg commits the central bank's instruments to holding a rate, which means they are no longer available for anything else. Interest rates, reserve operations and the exchange rate all end up pointed at the same target, and the monetary conditions the country then experiences are largely those of the country it has anchored to.
So the question "which currency should we peg to" is really "whose policy cycle do we want to inherit". A country whose trade and borrowing run through one currency area inherits something that broadly matches its own economy; one that anchors to a currency it has little to do with inherits a cycle arriving at the wrong moments. That is why the choice is treated as an analytical question, and it is where Sao Tome and Principe becomes useful, because the analysis is on the record.
The two methods that answered the question
By two methods that gave two answers.
The International Monetary Fund published a working paper on the question in 2008, at a point when, in its own words, the authorities had recently expressed interest in reassessing the country's monetary and exchange rate arrangements. The country had had its own currency since shortly after independence in 1975, and the Fund had classified the regime as a managed float with no pre-announced path.
The first method was a gravity model of trade, applied to data from 1995 through 2006. Gravity models explain trade between two places by their size and the distance and frictions between them, and this one ranked Europe including Portugal first, on the strength of established economic ties. In 2006 Europe took over 75 per cent of the country's exports and supplied close to 65 per cent of its imports, so the result is not surprising.
The second method asks a different question. Currency mapping does not measure the ties a country already has; it asks which monetary union it would fit best if one were formed, scoring candidates on criteria drawn from optimal currency area theory. On that test the Central African union came out most preferable, making the CFA franc the preferred anchor, ahead of the West African CFA franc, the euro and the US dollar. Staff recorded that the ranking held whichever way the criteria were weighted.
| Method | What it measures | First choice | Where the euro placed |
|---|---|---|---|
| Gravity model of trade | Economic ties that already exist | Europe, including Portugal | First |
| Currency mapping | The union a country would best fit | The Central African CFA franc | Third |
Why two different answers pointed the same way
Because of what the CFA francs are.
Both are held at a fixed parity to the euro. A country joining either union would be importing euro-area monetary conditions at one remove rather than directly, so the two methods resolve to the same hard currency by different routes. The Fund made the point in terms: the gravity model emphasises established economic ties and the currency mapping attempts to account for relations that a union might create, and because both CFA francs are firmly pegged to the euro, both methods point to the same anchor.
What was left to decide was the form. Staff noted that both a hard peg and a CFA franc union can rest on international agreements covering a hard currency credit facility and firm mechanisms for monitoring domestic policy, so the choice came down to political, historical and implementation considerations, with a hard peg judged more demanding of the country's own institutional capacity. They concluded that a hard peg to the euro had a slight edge, provided that capacity was adequate and an agreement on external support and surveillance could be secured.
Note the condition. The recommendation was contingent on something the country could not supply for itself.
The facility the arrangement was built on
Somebody else's foreign currency, on terms agreed before it was needed.
The Banco de Portugal describes the arrangement it participates in. An economic cooperation agreement between Portugal and Sao Tome and Principe was signed in 2009, with the purpose of reinforcing the country's exchange rate, macroeconomic and financial stability and promoting economic relations between the two countries. Under it, Portugal makes available a limited credit facility to support the balance of payments, and Sao Tome and Principe adopts and maintains economic policy consistent with preserving macroeconomic and financial stability.
The peg took effect in January 2010, and the Fund classifies the arrangement as a conventional peg against the euro, at 24.5 dobras to the euro. Fifteen years later the Fund's assessment was that the peg continues to serve the country well in anchoring monetary policy and curbing inflation, given its small size, capacity constraints, strong ties with Europe and high exchange rate pass-through. It also recorded the strain: inflation from the start of 2022 opened a wider differential against the euro area, which put pressure on the peg and on reserves.
The credit line is where the arrangement shows its shape. The Fund describes it as a contingent credit line from Portugal which can be activated if reserves fall below three months of imports, and records that the authorities have taken advantage of it. It is a reserves test rather than a request, which makes the facility part of the country's reserve adequacy rather than an emergency measure sitting outside it. Fund staff put the optimal reserve level for the country at 3.1 months of imports, taking into account that it is a small state with an exchange rate peg and a Fund-supported programme.
Where the commitment sits
The country does, and it is worth being precise about that, because an arrangement supported from outside is easy to mistake for one imposed from outside.
The Banco de Portugal's description separates the two halves. The agreement provides the credit facility and the policy undertaking. Stability then rests on the adoption, by Sao Tome and Principe, of a fixed parity regime with the euro. The Fund's account of the exchange system points the same way from the legal side: the organic law of the central bank is what authorises it to make decisions regarding exchange rate policy.
So the peg is a national decision that an international agreement is built around, rather than a term of that agreement. That distinction decides who is able to change the rate, and the answer here is the country whose currency it is.
The arrangement is run through machinery more elaborate than a credit line usually warrants: commissions of representatives from both finance ministries, both foreign ministries and both central banks, with technical units for macroeconomic monitoring underneath them. A facility drawn on a reserves test needs somebody watching the policies that decide whether the test is met.
The arrangement at the counter
The rules reach further down than the parity does.
The Fund's description of the exchange system records that the commission on foreign exchange sales by banks may not exceed 2 per cent for the euro, while the spread on other currencies may not exceed 4 per cent, and that purchases of euro by banks must be done at the rate the central bank publishes with no commission allowed on them at all.
The anchor currency is treated differently from every other currency at each of those points, which is what a peg looks like once it stops being a headline number and becomes a rulebook. Anyone converting from Australia is dealing with a currency whose relationship to the euro is administered and whose relationship to everything else, the Australian dollar included, follows from wherever the euro happens to be. The Sao Tome and Principe dobra pair moves with the Australian dollar against the euro and very little else.
Where to look next
what it means to import another country's monetary policy covers the case where the anchor currency circulates alongside the local one, and how a currency board defends a peg covers the strictest form the commitment can take. For the live figures, see the AUD to STN page.
Sources
- International Monetary Fund, The Choice of Monetary and Exchange Rate Arrangements for a Small, Open, Low-Income Economy: The Case of Sao Tome and Principe, Working Paper WP/08/118 - the authorities' interest in reassessing the arrangements, the currency dating from shortly after independence in 1975, the December 2007 classification as a managed float, Europe taking over 75 per cent of exports and supplying close to 65 per cent of imports in 2006, the gravity model run on 1995 to 2006 data ranking Europe first, the currency mapping ranking the Central African CFA franc first and the euro third, the robustness of that ranking to weighting, and the conclusion that a hard euro peg had a slight edge provided capacity was adequate and external support could be secured
- International Monetary Fund, Democratic Republic of Sao Tome and Principe: 2025 Article IV Consultation and First Review Under the Extended Credit Facility Arrangement, Country Report No. 25/228 - the conventional peg against the euro since January 2010 at 24.5 dobras to the euro, the peg continuing to serve the country well given its size, capacity constraints, ties with Europe and pass-through, the wider inflation differential since 2022, the contingent credit line from Portugal activated if reserves fall below three months of imports and the record that the authorities have used it, the optimal reserve level of 3.1 months, the organic law authorising exchange rate policy decisions, and the commission caps of 2 per cent on euro sales and 4 per cent on other currencies with no commission on euro purchases
- Banco de Portugal, Cooperacao - the 2009 economic cooperation agreement, its purpose, the limited credit facility for the balance of payments, the policy undertaking, the statement that stability rests on Sao Tome and Principe adopting a fixed parity regime with the euro, and the commissions and macroeconomic monitoring units staffed by both countries' finance ministries, foreign ministries and central banks
- Banco Central de Sao Tome e Principe - the issuing institution
General information about exchange rate arrangements and how anchor currencies are chosen. Not financial advice, and not a recommendation of any product or institution. Reviewed by the Tradergy editorial team, September 2026.
Common questions
What is an anchor currency?
The currency another country fixes its own to. Once the rate is fixed, the anchor country's monetary conditions pass through to the pegging country, because holding the rate is what the pegging central bank has committed its instruments to doing. Choosing an anchor is therefore choosing whose policy to import, which is why it is a decision countries analyse rather than settle by habit.
How did the International Monetary Fund analyse the choice for Sao Tome and Principe?
With two methods that answered different questions. A gravity model of trade, run on data from 1995 to 2006, ranked Europe including Portugal first on established economic ties. A currency mapping exercise, which asks instead which monetary union a country would best fit into, put the Central African CFA franc first, the West African CFA franc second, the euro third and the US dollar fourth. Fund staff noted the ranking held whichever weighting was applied to the criteria.
Why did two disagreeing methods point at the same anchor?
Because both CFA francs are themselves firmly pegged to the euro. A country joining either union would be importing euro-area monetary conditions at one remove, so the gravity model's direct answer and the currency mapping's indirect one resolve to the same hard currency. Fund staff made that point explicitly, and judged that a hard peg to the euro had a slight edge provided institutional capacity was adequate and external support could be secured.
What condition did Fund staff attach to recommending the peg?
External support. Staff concluded that a hard peg to the euro had a slight edge over joining a monetary union, provided that domestic institutional capacity was adequate and that an international agreement on external support and effective surveillance of domestic policies could be secured. Sao Tome and Principe has a contingent credit line from Portugal that can be activated if reserves fall below three months of imports, and the Fund records that the authorities have used it.
Who can change the dobra's parity?
Sao Tome and Principe. The Banco de Portugal describes the 2009 agreement as providing a credit facility and a policy undertaking, with stability resting on the adoption, by Sao Tome and Principe, of a fixed parity regime with the euro. The International Monetary Fund records that the central bank's own organic law authorises it to make decisions on exchange rate policy. The commitment sits with the country; the agreement is built around it.