Forex Lesson 3 : Explaining Singapore's Managed FX Policy System
I explained to my father AGAIN last night how Singapore’s exchange rate policy works because he did not get it the last time, I suppose. And for me, I do not expect many Singaporeans care.
For the few who understand the exchange rate policy, there are even fewer “Singaporeans, I do not think there are more than a handful or maybe hundred, including past and present money market dealers who understand how SIBOR works or what SIBOR is.” https://tradehaven.net/market/are-your-loans-feeling-heavier/
But that is story for another time, or you can read the link above.
Let’s clarify a few things and perhaps address some misconceptions in the country about our Foreign Exchange Rate Based Monetary Policy and I will do this in as few words as I can because I have written over a dozen articles in the past 2 years that I have been told, surprise, are “too technical”.
FACTS
- Singapore’s managed foreign exchange mechanism is UNIQUE in the world because no other country is using purely foreign exchange without other forms of monetary policy.
- Since 1981 when it was implemented, the brainchild of the late Dr Goh, I believe, the SGD has appreciated 42.41% against the USD (and about 66.83% against the MYR).
- We are not entering a CURRENCY WAR. MAS merely decided that the path of appreciation will be slowed down. It means that the SGD will continue to allowed to appreciate between 0.5 to 1.5% (market guess) to the basket of currencies that make up the SGD NEER ( Nominal Effective Exchange Rate) basket. https://tradehaven.net/market/putting-the-funky-sgd-policy-to-the-test/
Estimated NEER
- Yesterday’s move by MAS is the second ever on record that they have surprised markets with an sudden announcement outside their semi annual Monetary Policy Statement dates (April and October coinciding with GDP release).
Business Times published this last year.
https://tradehaven.net/market/fx/post-mps-the-silent-sgd-on-a-full-moon-eclipse-night/
Why do we use the Foreign Exchange Rate Based Monetary Policy ?
- Legacy because it worked. By keeping the currency on an appreciation stance as long as we have inflation, we shall enjoy investment inflows into the country that has greatly helped in economic development in the 80’s that was bolstered by a stable government.
https://tradehaven.net/market/fx/singapore-blast-from-the-past-and-the-oct-mps/ - Money can come in but cannot go out. There is a section 757 where a foreigner or foreign entity is prohibited from borrowing more than 5 million SGD onshore unless it’s for the purpose of buying a local asset.
- Singapore will always be inflationary because she has limited resources and almost everything has to be imported including labour and raw materials. Thus keeping a strong currency ensures that imported inflation will be kept in check .
A recent study in 2012 in the semi annual Macroeconomic Review has vindicated that the mechanism works best . http://www.mas.gov.sg/~/media/resource/publications/macro_review/2012/MRApr12.pdf (page 91) - Dispenses away with headache of monetary policy and rate setting.
Why does lower inflation lead to higher interest rates and not the other way like other countries ?
- There is no central authority to set SIBOR. MAS can influence the amount of liquidity in the system to an extent in their daily money market operations but cannot directly influence the SIBOR rate.
- When expectations are for the SGD to weaken, the USDSGD forward points would rise. Taking those forward points and deriving the Swap Offered Rate (SOR) with a “known” Libor, higher forward points would result in a higher SOR.
- SOR can be seen to be correlated to SIBOR but cannot replace SIBOR because it is an off balance sheet item (derivative) while SIBOR is a balance sheet item (lending). *note it is possible to derive SIBOR from SOR by stripping out LIBOR and factoring out the cost of funds charges etc
Limits to the Foreign Exchange Rate Based Monetary Policy
- 2013 : There is a limit to how far Singapore can use the exchange- rate policy to contain inflation, central bank Managing Director Ravi Menon said in July. Still, the measure remains the broadest and most effective tool
“We need to avoid competitive currency devaluations.” Ravi Menon, managing director of Singapore’s central bank, said today. Past episodes of currency friction “have only led to more misery and further downward spirals,” he said. https://tradehaven.net/market/some-thoughts-on-mas-monetary-policy-statement/ - After the world (US) turned to the Zero Interest Rate Policy, Singapore was put to the test. With high inflation back in 2010-2013, Singapore was forced to keep the appreciation stance of 2.5%. That meant that any foreigner buying SGD would be almost guaranteed of a 2.5% per annum appreciation against the NEER basket – A FREE LUNCH ? https://tradehaven.net/market/singapore-mps-and-the-free-lunch-machine/
Singaporeans did not enjoy this because their base currency is the SGD.
But it led to inflows and low interest rates, with SOR turning negative back in Aug 2011, which could be attributed to the asset bubbles and increased borrowings and risk taking behaviour. - There is little the Exchange Rate Policy could do for domestically generated inflation that we have been experiencing in recent times.
So the MAS has been going in circles like I said in 2012 that they are trying to fix Singapore inflation by reducing offshore demand for Singapore goods and services ?
“I salute the government for their vision but I do not salute the NEER. It is evidently clear that the NEER has outlived its purpose and is unable to manage the CPI which is mostly domestically generated. Why go the ROUNDABOUT way ? to UNDO a FAILING by trying to temper offshore demand for Singapore goods & services to dampen inflation when the NEER is supposed to help fix that ?” https://tradehaven.net/market/who-needs-sgd-neer-we-have-sgd-reer-the-great-singapore-economic-debate/
That is about all I can think of at the moment. Hope it helps.
More reading taken from some old articles :
MAS is the central bank of Singapore. Their mission is to promote sustained non-inflationary economic growth, and a sound and progressive financial centre.
- To act as the central bank of Singapore, including the conduct of monetary policy, the issuance of currency, the oversight of payment systems and serving as banker to and financial agent of the Government
- To conduct integrated supervision of financial services and financial stability surveillance
- To manage the official foreign reserves of Singapore
- To develop Singapore as an international financial centre
Singapore DOES NOT HAVE A MONETARY POLICY. They opt to use an Exchange Rate Policy adopted in the early 1980’s when the economy was in deficit. It has been effective in the past when managed with a non internationalisation policy whereby offshore parties cannot borrow more than SGD 5 million from onshore sources.
http://www.mas.gov.sg/publications/monographs/Singapore_Exchange_Rate_Policy.html
It is stated in this 2001 paper that the “basic philosophy underlying Singapore’s exchange rate policy is to preserve the purchasing power of the SGD, in order to maintain confidence in the currency and preserve the value of worker’s savings, especially their CPF balances. Over the years, the managed float has served Singapore well in this respect. Inflation and interest rates have been low, expectations are for the SGD to appreciate over time.”
https://tradehaven.net/market/singapore-and-switzerland-never-the-twain-shall-meet-monetary-policy/
Related Articles :
Singapore MPS and The Free Lunch Machine
Singapore and Switzerland – Never The Twain Shall Meet ?
Trading Against A Black Box -USDSGD
Using Negative Rates To Fight Inflation ! Singapore Style
Where’s The Party ? QE Goes To Singapore
From the SGD Dollar Battlefront – SGD MAS Monetary Policy Statement
What A Safe Monetary Policy Statement !
Fed is From Pluto, BoJ is From Mars and Santa is From Singapore
Putting the Funky SGD Policy to the Test
Singapore Banks Headache & The USDSGD
Likonomics Vs Abenomics and Singapore
REHASH : The Economists in Feb Said USDSGD at 1.2 ! GDP Next Week
SGD interest rates – payback time
Backing Down on The SGD – MAS Inflation Outlook
Thanks for the recap. Very timely, and I wonder if my daughter can do that when she grows up. I, for one, am not one of the hundred who understands the SIBOR either.
Come on, you telling me that my article failed to pull of an explanation again ?
Actually, if you don’t get it, you are sane. Because it is a bit of a Mind F** for the logical person. Takes years of conditioning to accept the concept.
Thank God. For a moment, I thought I was just dim.
Somehow, SIBOR does not make good conversation over drinks.
Can MAS influence the SIBOR by inviting the contributing banks to drink kopi? 😉
That is a difficult feat these days with the new regulations and Dodd Frank.
People get fired for telling MAS things over the wrong channel i.e. without consulting compliance.
I hope your article reaffirms my understanding of the SGD monetary policy.
I agree with the double whammy. Relative to Foreign, lower int rates when Ccy strong, and higher int rates when Ccy weak.
Trouble is : can you imagine higher interest rates when Ccy strong? It’s just exacerbating already large volume of hot money flow when the economy is red hot already.
So I would postit that home loan interest rates should not be competed away to cost plus by way of solution a 2nd undisclosed policy rates in the economy : that for property loans.
Given that mortgage repayments can take up as much as 60pct of a person’s disposable income… deliberately engineering a method to allow for property rates gradient to run counter to SOR/SIBOR gradient will greatly increase economic stability.
It is deliberately counter cyclical.
However, the devil is in the details.. including complicated accounting and some good old accrual methods.
Nevertheless, will be a world first, avant garde.
Ours is like negative rates when currency is expected to be strong. That exacerbates domestic inflation and asset bubbles like in 2011-2012 when property went mad.
The textbook prescription is that EM country can afford lower rates when currency is strong – assume that inflation is lowered by strong currency and discourage further strengthening because hot money flows will get poor returns. Vice versa when the currency is weak which is perhaps why Malaysia dare not cut rates now.
Exactly !
Round hole square peg.
A large component of asset inflation that can only result from swing from high rates to low rates to negative rates is property loans.
The textbook prescription mentioned is such a sweeping statement for lower inflation…. lower import consumption driven inflation may be countered by increased domestic inflation due to equity release for cyclical inflated property values.
Why settle for a temporal cyclical advantage when we have the capacity to implement a structural perpetual advantageous monetary policy.
My vote is for 2 policy rates 😉 the banks will hate me. But +1 for SG society and our social fabric.
Sibor is a survey benchmark set collectively by a panel of banks daily. The text book prescription explains a general relationship among financial variables.. just need to place Singapore’s unique measure into the context.
Wow ! You got the formula to derive the benchmark ?
As far as I can see, for the only country in the world without an official benchmark, the Ones Who Controls The Majority of The Liquidity Wins – local banks’ deposit bases and I bow to that.
Only SGD SIBOR, which the majority of mortgages in Singapore are pegged to, will continue to be calculated by reference to surveys from banks. This is because unlike
the FX markets, SGD SIBOR benchmarks are a reflection of inter-bank borrowing costs and these costs differ across banks.