Case Study I.
Emily Barr and Danny Purvis
Exchange Rate Policy at the Monetary Authority of Singapore
Basic Information
• Currency: Singapore Dollar (S$ or SGD)
• US $1.00 = S$ 1.2780
• One of the highest per capita GDP
• Exports provide main source of revenue
• Electronics, chemicals, service
• Port of Singapore: • Busiest port in the world• (Total Shipping Tonnage)
Exchange Rate Systems
Fixed Exchange Rate Advantages
Minimizes International Trade/Investment Risk
Elimination of Destabilizing Speculation
Requires Discipline in Economic Management
Disadvantages Large holdings of foreign
reserves are required Fixed rates can also be
unstable (devalue/revalue) Loss of Freedom in terms of
Internal Policy (interest rates) Countries are vulnerable (and
dependent) on the economic conditions of other countries
Floating Exchange Rate Advantages
Countries are more protected from the economic conditions of foreign countries
Central Bank interventions are not needed
Freedom in internal operations
Disadvantages Promotes currency speculation Exchange Rate Risk
Investors and MNCs must spend considerable resources to protect against
Inflation
Trends in Exchange Rate Systems
Overall Shift…Fixed Exchange Rates Freely Floating
In 1975, approximately 87 percent of developing countries had some type of fixed exchange rate.
By 1996, that percentage had dipped well below 50 percent.
Spurred by dissolution of the Bretton Woods Era
History of Singapore’s Foreign Exchange Policy
Prior to 1970: SGD pegged to Pound
1972: Pound came under speculative attack SGD briefly floated, than switched to US$ peg
1973: Major devaluation of the U.S.$ Collapse of Bretton Woods, SGD floated again
1974-1981: Shift of exchange rate policy towards money market operations and monetary policy for control
1981-2001: Managed Float
Current Exchange Rate System: Managed Float
SGD managed against a basket of currencies based on major trading partners/competitors
Managed Float Trade-weighted exchange rate
is allowed to fluctuate within undisclosed policy band
Periodically Reviewed Typically every 3 mo. Ensure currency valuation is aligned
with fundamentals of economy
Choice of Exchange Rate for Target of Monetary Policy Implies that Singapore gives up
control over domestic interest rates (and thus money supply)
“Unholy Trinity”
Since 1981, Singapore has focused on management of the Exchange Rate
Monetary Authority of Singapore (MAS)
Mission: Promote sustained, non-inflationary growth and a sound and progressive financial center
MAS is the central bank of Singapore Has the authority to regulate all elements of
monetary, banking, and financial aspects within the country of Singapore
Vision for Singapore: Be a World Class Financial Center
Full service provide in capital and money markets
Regional hub for retail and wholesale financial services
The “Unholy Trinity”
The “Unholy Trinity”
Illustrates various tools a country can use when determining monetary policy
A country can exercise 2 out of the 3, but cannot utilize all 3 concurrently (“tri-lemma”)
(1) Monetary Independence Ability to control the supply of money in circulation (and thus
influencing the interest rates)
(2) Exchange Rate Stability Altering the exchange rate by various methods in order to
depreciate/appreciate and maintain a stable ER
(3) Financial Integration The free and continuous conversion of currency for FDI and
changes in the holdings of stocks, bonds, loans, bank accounts, currencies, etc
The “Unholy Trinity”: Singapore’s Trade-Off
Trade (in terms of exports/imports) is the cornerstone to Singaporean Economy Imports and Exports consistently > GDP
Because of this, it is essential that Singapore maintain an open capital account
Interest Rate Control vs. Exchange Rate Control Historically, larger economies are more responsive to changes in interest
rates because they have an expansive domestic banking industry Changes in Exchange Rates: yielded much quicker results
Since trade was imperative to everyday life
Nominal Exchange Rates
The nominal exchange rate is the value of a country’s currency in relation to other currencies without the adjustment for inflation.
The nominal exchange rate measured the ratio at which Singapore dollars were traded for other dollars on the spot market.
The Difference Between Real and Nominal Exchange Rates
Real Exchange Rates
The real exchange rate is the actual exchange rate for the two currencies of concern adjusted for inflation.
The real exchange rate measured the ratio at which Singapore dollars were equivalent to other currencies in terms of purchasing power.
The Difference Between Real and Nominal Exchange Rates
Singapore’s Exchange Rates Prior to 2001
From 1981 to 2001 the Singapore dollar had been on an appreciating trend against the main global currencies, including the United States.
During this time, Singapore experienced rapid economic development, high productivity growth, and a high savings rate.
The S$ nominal exchange rate appreciated by 74% while the S$ real exchange rate appreciated by 92% from 1981 to 2001.
How Pegged Currencies Led to the Asian Financial Crisis
(1997-98)
Some Asian countries pegged their currencies to the US dollar from 1995 to 1997
For most countries that were impacted, it began from a belief that domestic debt denominated in foreign currency would no longer be serviceable if the currencies were allowed to float.
Many of the Asian currencies were not able to support the peg because of weak economic conditions and the depreciation of their currencies against the US dollar.
In July 1997 the Thai Baht collapsed and this spread to the rest of the region.
What started out as a currency crisis quickly spread to the wider economy and led to economic downturns in several countries.
How Pegged Currencies Led to the Asian Financial Crisis
continued
Overall Impact: The Financial Crisis and Asian
Countries
Many foreign investors began to panic, and lost confidence in the currencies of those countries and their overall economies.
In the countries that were most affected by the crisis, such as Thailand, banks and other companies collapsed or had to be rescued.
This resulted in massive unemployment
Asian Financial Crisis: The Impact on Singapore
Singapore was not directly hit by the crisis, but still suffered from the effects of the economic slowdown of its neighbors.
As a result, Singapore fell into a recession during the second half of 1998.
Overall, the Singapore economy declined by 1.4% in 1998 in terms of real gross domestic product.
Singapore vs. Thailand: The Varying Affects of the Crisis
Singapore engaged in several positive financial policies
The MAS signaled a willingness to allow the nominal exchange rate to depreciate somewhat, but in an orderly manner.
The MAS widened the band within which the exchange rate would be allowed to fluctuate.
Fiscal policy was adjusted by implementing significant cost-cutting budgetary measures
Employer contribution rates to the Central Provident Fund were reduced, which lowered the effective cost of labor.
The Singapore government also aimed to further reduce costs to businesses by implementing a 10% corporate tax rebate
Singapore vs. Thailand: The Varying Effects from the
Crisiscontinued
Recovery from the Financial Crisis
During the crisis, Singapore still experienced a healthy inflation rate between 0-3%
By the beginning of 1999 the Singapore economy had already experienced a positive growth, powered by a strong rebound in the manufacturing sector
The recovery sustained through the year and overall GDP for the year increased by 7.2%
Recommendation
Our Recommendation: Maintain the Managed Float Freely Floating Rate would introduce too much volatility and
likely result in investors/MNCs re-evaluating trade/investment decisions
Fixed Rate would provide stability, but may skew the actual value of the currency Hong Kong example
Managed float allows Singapore with flexibility to deal with sudden changes in the global economy while simultaneously preserving the purchasing power of the Singapore dollar.
Recommendation continued
Historically, Singapore has been famous for low inflation rates. A freely floating exchange rate system would go against the
primary goals of MAS Freely floating system may actually encourage inflation since it
allows the cost of imports to rise while the exchange rate falls
The country can attribute much of its success to the managed float that they have maintained and perfected over the decades As of August 2010, Singapore has the fastest growing
economy in the world with an estimated 17.9 percent increase in GDP for the first half of the year
Recommendation continued
Singapore is still relatively small. Because of this, coordinated monetary and fiscal policy
actions are possible Primary advantage of having a freely floating exchange
rate system is to have the ability to pursue an independent monetary policy
Which at this point in time is not a feasible strategy for Singapore.
Conclusion: altering the exchange rate system would be detrimental to Singapore’s economy as a whole, since the economy is almost entirely based on a stable currency that promotes international trade and investment
Thank You!