What it means
Between a rigid peg (a fixed rate against another currency) and a completely free float lies a spectrum of arrangements, and a managed currency sits in the middle. The exchange rate moves with supply and demand, but the central bank intervenes when it thinks movements are too large or heading in an unwelcome direction.
This is why the approach is sometimes called a managed float or a dirty float. The tools are fairly straightforward.
A central bank can sell foreign currency from its reserves to support its own currency, buy foreign currency to weaken it, move its policy interest rate, or announce a target band within which it wants the rate to stay. Some countries publish their band and others keep their intentions private.
For businesses, a managed currency changes how currency risk is measured. Exchange rates tend to be steadier than under a free float, which makes budgeting and pricing easier.
However, steadiness can be deceptive, because if market pressure builds beyond what the central bank can withstand, the rate may jump when the policy changes. Exporters, importers and lenders to companies in these countries should keep an eye on the central bank's reserves, inflation and trade balance.
Thin reserves or a persistent trade deficit suggest that the current rate may be hard to defend. Hedging instruments such as forward contracts are still worth using, because a managed rate can be reset with little notice.
Managed currencies are common among emerging economies and in countries that depend on a few export products. Each has its own rules, so a reader should always check how the specific currency is described by the central bank and by the International Monetary Fund.
In practice
Real-world examples.
Example
An electronics importer buys components priced in dollars and sells them in a country with a managed currency. Because the central bank keeps the exchange rate within a narrow band, the importer can set prices for six months at a time with little fear of sudden cost increases.
Example
A commodity exporter earns most of its revenue in dollars but pays wages in a managed local currency. The finance team watches central bank reserves closely, as a drop in reserves could signal that the currency will be allowed to weaken.
Example
A bank lending to a hotel group in an emerging market asks the borrower to hedge its dollar-denominated debt. The bank knows that managed rates can shift suddenly if the authorities change course, so it wants protection in place beforehand.
Formula
Calculation
Upper limit = Central rate x (1 + Band width)
Lower limit = Central rate x (1 - Band width)
Suppose a country targets a central rate of 3.60 local currency units to $1, with a permitted band of 2% either side. The upper limit is 3.60 x 1.02 = 3.672 units to $1, and the lower limit is 3.60 x 0.98 = 3.528 units to $1. If market pressure pushes the rate to 3.68, which is above the upper limit, the central bank would be expected to sell dollars from its reserves and buy its own currency to pull the rate back inside the band.Case study
Seen in the real world.
Marlow Textiles is an illustrative, fictional manufacturer that sells garments to customers abroad and buys cotton in dollars. Its home country runs a managed currency with a published 2% band around a central rate, and the company's finance director built the annual budget on the central rate.
For three years the rate stayed inside the band and the budget held. In year four, falling export income drained the central bank's reserves, and the authorities announced a new central rate that was 10% weaker.
Marlow's imported cotton suddenly cost 10% more in local currency terms, and its margins narrowed. In this illustrative story, the company learned to hedge a share of its dollar purchases forward and to test its budget against a wider range of exchange rates.
Watch out
Common mistakes.
- Assuming a managed currency is as safe as a fixed peg, when the central bank can change the target or band with little notice.
- Ignoring the central bank's reserves, which are the main indicator of whether the current rate can be defended.
- Skipping hedging because recent volatility has been low, when low volatility under management can end abruptly.
Questions
People also ask.
How is a managed currency different from a floating currency?
In a free float the market alone sets the rate, while in a managed currency the central bank intervenes to guide the rate within limits.
Does the central bank always succeed?
No, because its reserves are finite, and a determined market move can overwhelm the target.
Why do countries choose this approach?
It offers more stability than a free float while giving more flexibility than a rigid peg.
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