Singapore Dollar

Exchange Rate Regime: Exchange Rate Band Monetary Authority: Monetary Authority of Singapore Symbol: S$

The Monetary Authority of Singapore

Singapore’s central bank, the Monetary Authority of Singapore (MAS), was created by the 1970 Monetary Authority of Singapore Act.
The Act tasked the MAS with a monetary policy objective of ensuring price stability:

The primary objectives of the authority shall be (1)(a) to maintain price stability conducive to sustainable growth of the economy.

- Section 4(1)(a) of the Act

Unlike the U.S. Federal Reserve, which has a dual mandate to pursue price stability and maximum employment, the only monetary policy objective laid out for the MAS in the 1970 Act is to manage the rate of increases in average prices in the Singaporean economy.
The Act does not specify an explicit inflation target for the MAS.
However, the bank has taken price stability to mean a core inflation – Singapore’s consumer price index minus the costs of accommodation and private road transfer – rate just under 2%.

Dependence on International Trade

As a small island city-state, Singapore is highly dependent on international trade, needing to import basic staples – such as food and energy – it is unable to produce domestically because of its limited size and a lack of natural resources.
And, in order to raise the funds needed to pay for these imports, it must export goods and services in sufficiently high quantities.
The result is a highly open economy: in 2017, exports were %173.35 of GDP and imports were 149.08% of GDP.
To understand just how dependent Singapore is on international trade, compare these figures with the United Kingdom, a major services exporter whose 2017 exports were 30.53% of GDP and whose imports were 31.93% of GDP.
Or consider goods exporting powerhouse Germany, whose 2017 exports and imports measured at 47.24% and 39.66% of GDP respectively.
And China, whose prolific goods exportation has aroused protectionist sentiments in the United States, had 2017 figures of 19.76% and 18.05% respectively.
In 2017, Singapore had the third highest trade share of GDP of any country in the world, measuring over 5.5 times the world average.

Top 5 countries in the world by trade share (%) of GDP. Source: World Bank.

Implications of Trade Dependence for Price Stability

Singapore’s high dependence on imports means that its rate of inflation is largely determined by the cost of imported goods.
As a result, adjustments to the exchange rate of the Singapore Dollar (S$) relative to the country’s major trading partners are an effective way to control domestic inflation: revaluation of the S$ (i.e. an increase in the exchange rates of the S$ induced by the central bank), all else equal, helps reduce imported inflation by reducing the domestic cost of foreign goods, while devaluation of the S$ has the opposite effect.
A revaluation of the S$ also reduces foreign demand for domestic products, and hence, would be expected to lead to reductions in the prices of domestic factors of production.
The result is that, for the Monetary Authority of Singapore (MAS), a policy of targeting certain S$ exchange rates is more effective at controlling domestic inflation than changing policy interest rates.

Impediments to Using Interest Rates as a Monetary Policy Tool

Moreover, the MAS’s ability to use changes to a policy interest rate as a monetary policy tool – as other central banks do - is limited by the country’s unique circumstances.
As an Asia headquarters for many multi-national corporations, the private sector of the Singaporean economy is largely comprised of companies that do not rely on domestic bond markets and banks for funding.
This reduces the capacity of the MAS to influence domestic monetary conditions by manipulation of policy interest rates.

An Exchange Rate-Centered Monetary Policy

The combination of limited effectiveness of policy interest rates as a monetary policy tool and the outsized role S$ exchange rates play in determining inflation in Singapore mean that exchange rates have a stronger influence on inflation than policy interest rates.
This led the MAS to adopt an exchange rate-centered approach to monetary policy.
Whereas other countries’ central banks (e.g. the U.S. Federal Reserve, the Bank of England) use changes in policy interest rates as the principle tool to their achieve monetary aims, the MAS achieves its goal of price stability by targeting certain exchange rates relative to the currencies of its major trading partners.

S$NEER

Because the MAS wants to target the S$’s exchange rates against several major trading partners, rather than against a single currency, the central bank constructed a sort of artificial blend of exchange rates to target called the Singapore Dollar nominal effective exchange rate or S$NEER.
The S$NEER is a trade-weighted basket of the currencies of Singapore’s major trading partners.
That is, the currencies of countries with whom Singapore trades more are weighted more heavily in the basket and currencies of countries with whom it trades less are weighted less.
This S$NEER is the target of the MAS’s policy efforts: it is around this S$NEER that the MAS maintains an exchange rate band.

Exchange Rate Band

The MAS uses an exchange rate band system, placing a floor below and a ceiling above the S$NEER exchange rate.
The MAS allows the S$NEER to float freely within these defined levels.
This exchange rate band system, with boundaries wider than a conventional peg, minimizes the need for direct intervention in the foreign exchange markets by the MAS, in contrast to a hard currency peg system with tight boundaries which can necessitate frequent interventions.
If the S$NEER breaches these established outer bounds, the central bank intervenes in the S$ forex markets to push the S$NEER back into the acceptable range.
To clarify the relationship between the S$NEER and the S$ consider the following hypothetical scenario.
Suppose that the S$ depreciates relative to the US Dollar (US$), one of the constituent exchange rates of the S$NEER currency basket.
And suppose that this depreciation is large enough to push the S$NEER rate targeted by the MAS out of the exchange rate bands it has established.
Then the MAS would intervene in the S$/US$ forex market to cause an appreciation of the Singapore Dollar relative to the US Dollar, and thus, cause an appreciation of the S$NEER back into the acceptable range.
The MAS does not reveal to the public where it has set its S$NEER bands at any given time.
The MAS does, however, publish historical data on the movement of the S$NEER.
As a result, bank analysts are able to formulate their own estimates of the S$NEER bands which are relatively close to the actual bands.
This helps increase arbitrage and reduces the need for direct intervention in the forex markets by the MAS.
Bank analysts can also infer when the MAS has intervened in the forex market by observing the behavior of Singapore Dollar exchange rates when their S$NEER models detect that the targeted exchange rate is close to their estimated bounds of the band.
For example, if bank analysts’ models suggest that the S$NEER is nearing one of the estimated exchange rate bands and the analysts then observe an unusually large move in a particular constituent S$ exchange rate, it can be inferred that the MAS intervened in the forex markets to keep the S$NEER within its target range.

Exchange Rate Crawl

In addition to the exchange rate band, there is also a “crawl” or “slope” component to the MAS’s exchange rate policy.
The slope of the exchange rate band refers to the rate of appreciation of the exchange rate over time that the MAS finds acceptable.
The slope component of the MAS’s exchange rate policy serves a similar purpose as the U.S. Federal Reserve’s anticipated Federal Funds interest rate trajectory.
If the Fed wishes to gradually tighten monetary conditions, it progressively increases its policy interest rate over a period of time.
Likewise, if the MAS aims to gradually tighten monetary conditions over time, it sets the slope of its exchange rate band at a positive number, allowing the S$NEER’s floor and ceiling to gradually appreciate over time.
For example, in its October 2018 monetary policy statement, the MAS announced that it had slightly increased the slope of the S$NEER.
The MAS can also hypothetically set a negative slope for its exchange rate band if it wants to ease monetary conditions over time. However, it has never done so to date.
The slope of the policy band is not disclosed to the public.
The MAS thus has three ways of intervening in the forex markets:

1. It can directly intervene in the forex markets (via spot or forward purchases).

2. It can adjust the exchange rate band, tightening or widening it, and moving it up or down as necessary.

3. It can change the slope of the S$NEER bands.

Graphical depiction of Singapore’s exchange rate band.

Loss of Interest Rate Autonomy

Because Singapore’s monetary policy centers around maintaining the S$NEER exchange rate between certain levels and the government has opted to allow capital to flow freely in and out of the country, Singapore gives up control over its domestic interest rates.
That is whereas, for example, the Bank of England changes its policy interest rates based on considerations within the domestic U.K. economy, the Singapore monetary authority cannot target interest rates that are not broadly in line with international monetary developments.
Singapore’s domestic interest rates are thus largely determined by foreign interest rates.
International economists refer to this tradeoff as the “international trilemma” of open economy macroeconomics.
The trilemma states that a country can choose only two of the following three options simultaneously: free movement of capital, a pegged/managed exchange rate, and interest rate autonomy.
Singapore has chosen to give up its interest rate autonomy in exchange for free movement of capital and an exchange rate band.
To understand why it must make this tradeoff, consider the following simplified scenario.
Assume the SMA tries to simultaneously pursue all three options: free movement of capital, an exchange rate band, and monetary policy autonomy.
Now suppose that the U.S. Federal Reserve raises its policy interest rate.
The policy of allowing capital to move freely in and out of Singapore means that money will flow out of Singapore and into the U.S. to take advantage of higher interest rates there.
This would be expected to cause the U.S. Dollar to appreciate relative to the Singapore Dollar: as capital flows out of Singapore, Singapore Dollars are sold for U.S. Dollars that can earn a higher interest rate.
The depreciation of the Singapore Dollar relative to the U.S. Dollar, if it is sufficiently large, would cause the S$NEER to fall below the lower end of the exchange rate band.
But the SMA has a policy of maintaining this exchange rate band.
So Singapore could restrict the free movement of capital in and out of the country. This would prevent the flow of capital out of Singapore that results from the interest rate differential between the two countries.
But it has opted to serve as a regional financial capital and allow free movement of capital.
Alternatively, it could abandon its exchange rate band. But the band is the focal point of its efforts to achieve domestic price stability.
Given that it insists on free movement of capital and maintaining an exchange rate band, Singapore is left with only one option: the SMA must increase its policy interest rate in line with the increase in the U.S. to prevent the flow of capital out of the country, and thus, prevent the depreciation of the S$ that results in the S$NEER breaching its lower band.
The SMA thus cedes control over its interest rate policy to international developments: it cannot target interest rates that are significantly out of line with international interest rates.

Macroprudential Oversight

As discussed above, the MAS’s monetary policy centers on targeting certain levels of exchange rates rather than targeting certain levels of a policy interest rate.
We have also established that, because the MAS uses an exchange rate-centered monetary policy and the government has opted for free movement of capital, Singapore loses control of domestic interest rates.
An important consequence is that changes in policy interest rates cannot be used to manage domestic financial conditions.
Whereas other central banks may increase policy interest rates to tighten credit conditions when they believe banks have been lending too freely, this option does not exist for the MAS.
Moreover, a policy monograph published by the MAS in January 2019, argued that monetary policy was too blunt of an instrument to engage in such counter-cyclical measures anyway.
To see why it believes this, consider the following.
Suppose a central bank is worried about a rapid appreciation home prices fueled by easy lending conditions.
A central bank that chooses to use its policy interest rate as a counter-cyclical tool would increase its policy interest rate, which in turn would make taking out a mortgage more expensive, slow home buying, and cause inflation in home prices to slow or turn negative.
But tightening the policy interest rate to slow appreciation in the cost of housing would also tighten credit conditions for every other sector of the economy, including sectors that are not at risk of overheating or perhaps even need looser credit conditions.
So, rather than try to manage domestic financial conditions by manipulating a policy interest rate – which it cannot do anyway because of the above mentioned international trilemma - Singapore compliments its exchange rate-centered monetary policy with macroprudential oversight.
Macroprudential oversight refers to a holistic set of policies which monitor the health of the financial system as a whole rather than focusing narrowly on the health of individual firms and banks (microprudential oversight).
In addition to being Singapore’s central bank, the MAS is also Singapore’s top financial regulator.

The primary objectives of the authority shall be (1)(b) to foster a sound and reputable financial centre and to promote financial stability.

- Section 4(1)(b) of the 1970 Monetary Authority of Singapore Act

It is in this second role that the MAS implements macroprudential policies to manage credit conditions in Singapore.
The MAS uses macroprudential measures such as increasing and decreasing the cap on loan-to-value ratios to control credit creation.
(Loan-to-value ratio (LTV) refers to the ratio of the size of a loan extended by a lender relative to the price of the asset the borrower will purchase using the loan.
For example, if a borrower receives S$800,000 from a bank to purchase a home that costs S$1,000,000 than the loan-to-value ratio is 0.8. By reducing the cap on the LTV, the MAS forces the borrower to pay for a greater share of the cost of the asset without credit, thus reducing leverage-driven asset inflation and the risk that borrowers will take on a debts they cannot manage.)
In acting as the nation’s top financial regulator, the MAS is aided by its close cooperation with the government’s finance and national development ministries.
The trio of agencies has established an inter-agency working group which works to ensure policy coordination and the sharing of relevant information.
The Ministry of National Development, which oversees sales of government land, increases or decreases the rate of those sales to meet demand for land to build private residences and a means of controlling home price inflation.
And the Ministry of Finance implements fiscal measures – such has implementing stamp duties on property sales - to slow the rate of sales and borrowing.
In recent years, concerns over rapid rises in the cost of housing have forced the MAS to put macroprudential policies into action.
As the effects of 2008 global financial crisis abated, residential property prices in Singapore soared.
This prompted the above-mentioned trio of organizations to implement a host of macroprudential measures from 2009-2013.
This included moves like reducing the cap on the loan-to-value ratio of mortgages extended by banks.
Another macroprudential measure the MAS enacted was requiring financial institutions to consider all of a prospective borrower’s outstanding debts (e.g. credit cards, mortgages, etc.) across all financial institutions before extending the individual certain forms of new credit.
The measures helped trigger a decline in the cost private residential properties from the 3rd quarter of 2013 to the 1stt quarter of 2017.

Singapore’s Private Residential Property Price Index

Domestic Demand-led Inflation

Macroprudential policies which help control the rate of inflation in housing costs also help offset a drawback of an exchange rate-centered monetary policy: while it is effective at taming imported inflation, it is less effective at taming inflation that results from domestic demand-led inflation (e.g. inflation in the cost of housing driven by limited supply of residential properties on offer in a small densely populated city state).
Changing the exchange rate does not significantly influence the cost to Singaporeans’ of purchasing or renting a home in the densely populated city-state.
But macroprudential policies aimed at managing credit creation and domestic asset prices do help reduce inflation in the cost of residences.

Written By: Aiden Singh Published: May 17, 2020 Sources

Singapore Dollar

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