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!