Few policy decisions shape a developing country's trajectory as profoundly as how it manages its currency. Yet exchange rate policy rarely gets the attention it deserves in development conversations — overshadowed by debates about trade agreements, industrial policy, or foreign aid.

The choice between pegging a currency, letting it float, or adopting some hybrid arrangement is not merely a technical matter for central bankers. It determines whether exporters can compete internationally, whether inflation stays manageable, and whether governments retain the flexibility to respond to economic shocks. Get it wrong, and decades of development gains can unravel in a single crisis.

What makes this question especially tricky is that the right answer changes depending on a country's institutions, its stage of development, and the global environment it faces. There is no universal prescription. Understanding the trade-offs — and how successful developers have navigated them — is essential for anyone working in emerging market policy or strategy.

At its most fundamental level, the exchange rate determines how much a country's goods cost relative to the rest of the world. An overvalued currency makes imports cheap and exports expensive — a combination that can feel comfortable in the short run but often devastates domestic manufacturing and agricultural exports over time.

This matters enormously for structural transformation. Countries that successfully shifted from agriculture to manufacturing — the classic development story — almost universally maintained competitive exchange rates during their transition periods. When your currency is priced so that your labor-intensive goods can compete in global markets, firms invest in export capacity, workers gain skills, and the economy diversifies. When it's overvalued, those same firms never get off the ground.

The mechanism works through what development economists call the tradable sector bias. A competitive exchange rate effectively acts as a subsidy to all export-oriented and import-competing industries simultaneously, without requiring the government to pick winners. It creates broad-based incentives for the sectors that drive learning, technology absorption, and productivity growth — the sectors that matter most for long-run development.

But there's a catch. Maintaining a deliberately undervalued currency requires accumulating foreign reserves, which has costs. It can also generate inflationary pressure domestically and invite accusations of currency manipulation from trading partners. The political economy is real: cheap imports benefit urban consumers and powerful importers, while a competitive exchange rate benefits dispersed exporters and workers who may lack political voice. Many developing countries have stumbled not because policymakers didn't understand the economics, but because the political incentives pointed toward overvaluation.

Takeaway

A competitive exchange rate acts like an economy-wide industrial policy — it doesn't pick winners, but it tilts the playing field toward the tradable sectors that drive structural transformation and learning.

The textbook debate frames the choice as fixed versus flexible. A fixed exchange rate — pegging your currency to the dollar, euro, or a basket — provides predictability for traders and investors. It can anchor inflation expectations in countries where central banks lack credibility. And it simplifies economic planning in small, open economies heavily dependent on a single trading partner.

The cost is profound, however. A fixed rate means surrendering independent monetary policy. When your economy needs lower interest rates to fight a recession, you can't cut them if your peg demands otherwise. And if the peg becomes misaligned with economic fundamentals — as inevitably happens over time — the eventual adjustment can be catastrophic. The Asian financial crisis of 1997, Argentina's collapse in 2001, and numerous African currency crises share a common thread: rigid pegs that were defended too long.

A flexible exchange rate avoids these dramatic blowups by adjusting continuously. It gives policymakers room to respond to domestic conditions and acts as a natural shock absorber — when commodity prices fall, the currency depreciates, automatically helping exporters adjust. But floating requires institutional infrastructure that many developing countries lack: a credible central bank, deep foreign exchange markets, hedging instruments for firms, and the capacity to manage the volatility that comes with a market-determined rate.

This is why the real world is dominated by neither pure floats nor hard pegs, but by managed arrangements. Most developing countries intervene in currency markets, maintain reserves, and use capital flow management tools. The honest question isn't fixed or flexible — it's how much management, with what tools, targeting what objectives, and backed by what institutional capacity.

Takeaway

The fixed-versus-flexible debate is largely a false binary. What matters is whether a country has the institutional depth to manage whichever regime it chooses — and the willingness to adjust when circumstances change.

The East Asian development successes offer the most instructive — and most debated — examples. South Korea, Taiwan, and China all maintained actively managed exchange rates during their high-growth periods, keeping currencies competitive while gradually building institutional capacity. They didn't simply peg or float; they intervened strategically, accumulated reserves as insurance, and adjusted their approaches as their economies matured.

China's experience is particularly revealing. Its managed depreciation in the 1990s and subsequent stable-but-competitive rate through the 2000s supported an unprecedented export manufacturing boom. But as the economy grew more complex and financial markets deepened, maintaining a tightly managed rate became increasingly costly and distortionary. China's gradual shift toward greater flexibility reflects a pattern seen across successful developers: the regime that works at one stage of development may become a constraint at the next.

Contrast this with many resource-rich African and Latin American economies, where currency overvaluation driven by commodity booms — the so-called Dutch Disease — has repeatedly undermined manufacturing development. Nigeria, Venezuela, and others have seen their non-oil sectors hollowed out precisely because exchange rate management failed to insulate the broader economy from resource revenue surges.

The lesson is not that one approach is universally superior, but that exchange rate policy must be embedded in a broader development strategy. Countries that treated their currency as a strategic tool — adjusting the regime as institutions strengthened and the economy evolved — fared better than those that adopted rigid ideological positions. Pragmatism, institutional awareness, and a willingness to change course when the evidence demanded it: these are the common threads among successful developers.

Takeaway

Successful developers didn't commit to a single exchange rate philosophy — they treated currency management as an evolving strategy, adjusting the regime as their economies and institutions matured.

Exchange rate policy is never just about the currency. It is a window into a country's institutional capacity, its development priorities, and its willingness to make difficult trade-offs between short-term comfort and long-term transformation.

The evidence from decades of comparative development experience points not toward a single best regime, but toward a strategic mindset: keep the rate competitive when building export capacity, invest in the institutions that enable greater flexibility over time, and resist the political temptations of overvaluation.

For practitioners and analysts working in emerging markets, the question to ask isn't which regime is best — it's whether the current regime fits the country's stage of development, and whether the institutions exist to manage what comes next.