Net ecosystem CO₂ exchange (NEE) and water fluxes of extensively managed grassland in Germany were measured in a dry year, 2003 and a normal year, 2004 using eddy covariance. Empirical descriptions of canopy capacities (light utilization efficiency and canopy capacity for maximum carboxylation) and inherent water use efficiency (IWUE*) were computed to indicate the grassland's response to environmental and management conditions. Compared with 2004, 2003 was characterized by a 2.5°C rise in summer mean temperature and an annual precipitation deficit of 286mm, which was almost one-third below the average precipitation of the normal year 2004 and the long-term annual average (1959-2005). Annual net water balance (precipitation minus evapo-transpiration) in 2003 and 2004 were 85mm and 361mm, respectively. Slightly higher IWUE* in 2003 indicates the grassland's sensitivity to drought. The grassland provided an annual gross primary production (GPP) and ecosystem respiration (R_eco) of 1022 and 728gCm^-2 respectively in 2003, as compared to their corresponding values of 1233 and 973gCm^-2 in 2004. Drought-induced biomass senescence caused GPP reduction in 2003, which in turn affected the ecosystem respiration. Light explained more than 80% of NEE variability during canopy development and as a result, annual NEE in 2003 and 2004 were -295 and -260gCm^-2, respectively. Taking into account the exported carbon by biomass harvest, we calculated net biome productivity (NBP) of -113gCm^-2yr^-1. We conclude that this managed grassland acted as a moderate carbon sink, despite the difference in environmental and management conditions.