An introduction to Singapore Monetary Policy


Twice yearly, on the 2nd Friday of April and October, the Monetary Authority of Singapore (MAS) releases a concise  ‘Monetary Policy Statement’ to the public. In the two page release, the MAS announces its stance on the Singapore Dollar for the next six months and the considerations behind the decision.

Unlike proclamations of growth for the economy that inevitably hogs the headlines for days on end, traders and investors tend to dismiss this announcement without much consideration. However, this little nugget of concrete information is much more important than growth figures. We examine Singapore’s Exchange Rate Policy in more detail.

1. Why do we need a Monetary Policy?

Singapore is a small but open economy. We trade with many countries all over the world.

The Singapore Dollar is the bedrock and the lifeline of this trade. Overseas companies wishing to purchase goods and services manufactured in Singapore will have to first purchase the SGD with their home currency and exchange SGD for goods and services. Say Google wishes to establish a regional office in Singapore, they would have to use their USD revenue to purchase SGD and subsequently use this SGD to pay for office rent, staff wages, advertising costs, etc. This drives demand for SGD. On the same token, we produce very little of our consumption foodstuff. Most of our consumption is imported from overseas. A large portion of the rice we consume comes from Thailand, and in order to purchase rice, we need to first purchase Thai baht and use that to pay rice farmers in Thailand. This very act of purchasing THB can also be seen as selling the SGD.

In reality, the situation is a lot more complex, with individuals, businesses, and institutions engaging in millions of transactions every year with elements all over the world in their unique currencies. The aggregate of this demand and supply determines the value of the SGD. If we are able to produce higher-value goods and services in greater quantities, demand for SGD will increase, and inevitably SGD will become more expensive. Conversely, if our domestic economy falters, the SGD will be in lesser demand and its value should decrease.

2. How do currencies fluctuate?

Different countries adopt different ways of maintaining the strength of their currency. One could fix the home currency to another currency that is normally the biggest trading partner, like how the Hong Kong dollar is perpetually fixed at $7.8HKD to $1USD or the Brunei dollar at parity with the SGD. The biggest advantage of this currency regime is the stability it contributes to the economy. However, such a system would require constant intervention from the government and heaps of currency reserves to maintain some form of respectability in the currency peg. Any form of weakness detected in the central bank or misplacing of the currency would bring profit-seeking currency traders out in force, the most infamous occasion being how George Soros made billions from the devaluation of the British pound in 1992.

A pure floating regime, on the other hand, is where the value of the currency is allowed to float freely based on market supply and demand. In nations like these, the economy dictates the value of the currency. The currency will grow in value as the economy gets stronger and fall out of favor when the economy weakens. Most modern economies in the world operate in this manner.

3. What is the S$NEER?

The S$NEER is the Singapore Dollar Nominal Effective Exchange Rate.

The value of SGD has to be measured against something. Rather than using one single currency as a benchmark like what Hong Kong is doing, the MAS uses a basket of currencies of our major trading partners. It is trade-weighted such that the currencies of our larger trading partners bear more weight and make up a more integral part of the index.

4. Is the SGD a fixed or floating currency?

Our system is a hybrid of both. SGD is allowed to float freely, and the MAS will monitor the strength of the currency based on the S$NEER. In their bi-annual statement, (normally in the last paragraph and after setting out the rationale for the move) the MAS will announce three crucial factors that govern the behavior of SGD with respect to the $SNEER.

  1. The slope of the band
  2. The width of the band
  3. The centering of the band

Within the band, the SGD is subjected to day to day fluctuations just like any other currency. Businesses from overseas can buy or sell SGD to pay local companies for goods required. Institutions can buy or sell the currency to hedge against future movements. Speculators can trade it freely based on technicals. This freedom is essential for an open economy like ours to flourish.

However, once the SGD is deemed to be trading beyond the band, MAS will step in to buy or sell SGD to maintain its trajectory within the S$NEER band. The instances are few and far in between, and my most recent memory of that happening is in 2010 when the SGD hit a high of 1.341.

Technicalities aside, what MAS is doing is essentially modulating the strength of the SGD against the $SNEER. The band prevents the currency from becoming too strong, making exports prohibitively expensive or too weak, which will lead to higher inflation. The width of the band determines the volatility. By narrowing the band, the SGD will have less room to maneuver before the MAS reins it in. The slope gives an indication of how aggressive the MAS wants to be with the policy it is adopting over the next six months.

5. How does it affect retail investors like me?

a. Interest Rates and the property market

In a monograph published by the MAS in 2001 titled Singapore’s Exchange Rate policy, the central bank recognizes that in order to manage the currency, it will have to relinquish control over the interest rates of the country.

The choice of exchange rates as the immediate target of monetary policy implies that MAS has given up control over domestic interest rates (and money supply). In the context of free capital movement, interest rates are largely determined by foreign interest rates and investor expectations of the future movement of the Singapore dollar.

When rational foreign investors see that the MAS is adopting an appreciative stance on the SGD, they will be keen to purchase the currency or assets dominated in SGD. Foreign investment will flow into the country. The woes of the US and the EU have made the SGD extremely attractive in comparison and the quantitative measures have seen billions in inflow. As a result, there will be ample liquidity and interest rates will remain low.

This low-interest-rate environment has been deemed one of the main contributors to sky-high property prices in Singapore. Property investors would do well to keep a lookout for MAS’s stance on the SGD, for that will give a good indication of the interest rates and consequently, property prices.

b. Foreign investments

Investing in any assets not denominated in SGD would expose you to currency risks. Imagine you are planning to purchase shares in Apple. You will now sell SGD, purchase USD, and use this USD to purchase the shares. Six months later, assuming that the price remains unchanged and you have decided to close the trade. And because the MAS has been adopting an appreciative stance for the SGD, it has now grown stronger and the same amount of USD can only get you lesser SGD. Despite the trade itself breaking even, your exposure to currency fluctuations has resulted in a net loss for this particular trade. Of course, the converse is true and should the MAS be allowing the SGD to devalue, foreign investments would become a lot more attractive.

This is especially crucial for investors looking to purchase gold as a hedge against inflation. As the commodity is dominated in USD, any gains you might make on the asset might be eroded by the strengthening of SGD.

c. Bonds

Interest rates are negatively correlated with bond prices. An appreciating SGD would lower interest rates and consequently, keep bond yields low. When interest rates increase, yields would also increase and prices of bonds would decrease. The relationship between different asset classes, economic conditions, and government policies is highly intertwined but inescapable.

In the most recent announcement dated 12 Oct 2012,

MAS will continue to maintain a modest and gradual appreciation of the $SNEER policy band. There will be no change to the slope and width of the policy band, as well as the level in which it is centered.

The release could be found here. A thorough understanding of the Central Bank’s actions and intentions would make us more complete investors!