Foreign Exchange
Senior 6 · Economics
Foreign Exchange
Lesson 3 of 4
25 min
The chart shows how much the Rwandan franc lost against the US dollar in each year to December, as reported by the BNR. The table gives the BNR's end-of-June rate for six years.
| End of June | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 |
|---|---|---|---|---|---|---|
| Frw per US$1 | 937.1 | 987.1 | 1,024.5 | 1,164.6 | 1,311.1 | 1,433.0 |
Read the data. (1) In which year did the franc fall fastest? (2) Has it ever risen against the dollar in these years? (3) Unit 2 showed a wider current account deficit in 2023. How are the two linked?
Definition
Floating (flexible) exchange rate: an exchange rate determined by the demand for and supply of the currency in the foreign exchange market, without a target set by the central bank.
Depreciation: a fall in the value of a floating currency against another; appreciation: a rise.
Example: from end-June 2024 to end-June 2025 the price of a dollar rose from Frw 1,311.1 to Frw 1,433.0: the franc depreciated.
Definition
Managed float (dirty float): a floating rate in which the central bank intervenes, buying or selling foreign currency and adjusting interest rates, to smooth sharp movements, without defending a fixed value.
Intervention: the central bank buying or selling foreign currency in the market to influence the exchange rate. Selling dollars supports the home currency; buying dollars weakens it and adds to reserves.
Worked example
Worked example 1: measuring the franc's fall (BNR end-June rates)
(a) One year, June 2024 to June 2025: the price of a dollar rose by
(b) Five years, June 2020 to June 2025: the price of a dollar rose by
but the dollar value of one franc fell by
Both describe the same change; they differ because they are measured from different bases.
Worked example 2: what depreciation does to an importer
A Kigali firm imports a vehicle priced at US$30,000. At the end-June 2024 rate of Frw 1,311.13 it costs
at the end-June 2025 rate of Frw 1,433.02 it costs
Frw 3,656,700 more for the same vehicle, before any change in its dollar price. This is how depreciation feeds imported inflation.
Suppose Rwanda's imports rise, so demand for dollars shifts from D1 to D2. In a free float, the price of the dollar rises from e1 to e2. In a managed float, the central bank sells some dollars from its reserves, so supply shifts from S1 to S2 and the rate rises only to e3. The franc still falls, because the market pressure is real, but more gradually.
On 6 March 1995 the BNR stopped announcing official exchange rates. Since then commercial banks and licensed forex bureaus have set their own rates, and the BNR publishes a daily average market rate for reference; the IMF described the new system as a managed float with no predetermined path for the rate (IMF, 2007). The BNR's reserve management plans set aside a tranche for foreign-exchange interventions (BNR Annual Report 2024–2025), and in its March 2026 statement it credited foreign-exchange market reforms, among other factors, for the slower depreciation of 2025.
Definition
Nominal effective exchange rate (NEER): a weighted average of the home currency's exchange rates against its main trading partners' currencies.
Real effective exchange rate (REER): the NEER adjusted for differences in inflation, so it measures changes in competitiveness.
Example: in 2025 the franc's NEER depreciated by 11.7% but its REER by only 5.9%, because prices in Rwanda rose faster than in its partners, cancelling part of the competitive gain (BNR).
| Fixed | Free float | Managed float | |
|---|---|---|---|
| Who sets the rate? | The central bank, at an official value | The market | The market, with central bank smoothing |
| Reserves needed | Large | Small | Moderate |
| Certainty for traders | High (while the peg holds) | Low | Moderate |
| Automatic correction of a deficit | No: needs devaluation or deflation | Yes: the currency depreciates | Partly |
| Independent monetary policy | No | Yes | Mostly |
| Main risk | Speculative attack; loss of reserves | Volatility; imported inflation | Using up reserves by fighting the trend |
Merits: the balance of payments tends to correct itself; the central bank needs fewer reserves; monetary policy can target inflation at home; no black market for foreign currency. Demerits: uncertainty for traders and investors; sudden falls raise the price of imported fuel and food; a weaker currency raises the burden of foreign-currency debt; speculation can push the rate further than the fundamentals justify.
Warning
A managed float cannot stop a trend. Intervention can smooth day-to-day swings, but if the demand for dollars keeps outrunning the supply (a persistent current account deficit), selling reserves only delays the fall and uses up the reserves. The lasting cure is on the supply side: more exports, more tourism, fewer imports that can be made at home.
Tip
Draw it, then say it. For any exchange-rate question: draw the market for the foreign currency, shift the right curve (imports and payments abroad move demand; exports, tourism, remittances and investment move supply), then state what happens to the franc in words.
Important
Discuss. The franc fell by 18.05% against the dollar in 2023 but by only 4.40% in 2025. Using the balance of payments data from Unit 2 and the idea of a managed float, explain the difference. Should the BNR have used more of its reserves in 2023 to slow the fall?
EconplusDal, "Managed Exchange Rates" (about 5 minutes). How a central bank lets the market set the rate but steps in to limit swings, and the advantages and disadvantages of doing so.
Practice
Sources and credits
Written by Ganzaa: the chart, the diagram, the tables, the worked examples and the practice items.
