The Facts Of Life: Singapore’s Monetary Policy And The SGD Exchange Rate

Since the Ringgit has recovered (a little) there’s probably less of a need for this post. But given how angst ridden Malaysians are about Singapore and the Singapore Dollar (one commentator described it as humiliating), it’s probably still appropriate.

So here’s my take on this subject, and given how TDM is in the news so much these days, done “che det” style:

1. Once upon a time, the SGDMYR exchange rate was at parity. Now however, SGD1 buys MYR2.67. This is popularly viewed as a barometer of how badly the Malaysian economy has done vis-a-vis Singapore.

2. However, this would only be true if the SGD was a free floating currency. It is not; it is in actuality a policy variable.

3. Bank Negara Malaysia conducts monetary policy by regulating the short term interest rate. Therefore, the overnight interest rate in Malaysia is the monetary policy variable. BNM regulates the overnight rate by buying and selling MYR versus BNM Bills in the interbank market, so that it hits the Ovenight Policy Rate target. The implication of this is that the MYR exchange rate “floats” – it is largely determined by inflows and outflows of capital as well as trade in goods and services.

4. The Monetary Authority of Singapore does not do this. It uses the exchange rate instead. MAS regulates the exchange rate so that the SGD achieves, quote “a modest and gradual appreciation” unquote. This has a similar effect on money supply and inflation in Singapore, as interest rates do in Malaysia.

5. MAS targets what is called the nominal effective exchange rate (NEER) of the SGD, which is the trade-weighted exchange rate of the SGD. MAS buys and sells SGD against other currencies so that it engineers a “modest and gradual appreciation” of the SGD against the currencies of Singapore’s trade partners. The implication of this is that interest rates in Singapore “float” – they are determined by inflows and outflows of capital, as well as trade in goods and services.

6. One other interesting implication is that this policy helps underwrite Singapore’s development as a financial centre. A gradually appreciating currency means you have a return built into holding the SGD, irrespective of anything else.

7. Since Singapore is an island nation with no natural resources or agriculture, almost everything consumed in Singapore has to be imported, from petrol, to food, to sand, to water.

8. The SGD NEER targeted by MAS is not disclosed, nor are the parameters involved: neither the centre target, the intervention band, nor the slope of appreciation are publicly known. These are state secrets.

9. However, the methodology of constructing an NEER is not a secret, and we can guess at the components of the NEER, as well as the parameters.

10. Malaysia is Singapore’s second largest trading partner, at 11.3% of Singapore’s total trade, and only just behind China, and ahead of the EU and the US (all data from 2014). The currencies of all these nations/regions are thus subject to buying and selling by MAS, either directly (USD, EUR) or by proxy (CNY, MYR).

11. To put it simply, the Ringgit depreciates against the SGD, because it is MAS policy that makes it so.

12. Let’s take a look at the charts (SGD-based exchange rate; 2000-2015):

Note that of the four major trading partners, only CNY appears to have kept its value against the SGD, while the MYR appears to have depreciated the most. The reason for this is that of all the countries involved here, the Singaporean trade partner with the highest trade in consumables is probably Malaysia.

13. I once read a research paper from the 1990s that described the SGD exchange rate regime as a “Ringgit peg”. That is a very apt description. The SGD will follow where the MYR goes, even as it “modestly and gradually” appreciates against it.

14. Another possibility is that MAS’ policy of “modest and gradual appreciation” is in reality a soft peg against the CNY, in which case Singapore’s monetary policy is actually being run by the People’s Bank of China (PBOC). I prefer the former explanation, as the variance of the SGDMYR exchange rate is orders of magnitude lower than any other SGD cross rate, and it more closely fits MAS’ description of its exchange rate regime.

15. In a very real sense, also due to this exchange rate regime, interest rates in Singapore are determined by Janet Yellen (FRB), Mario Draghi (ECB), Zhou Xiaochuan (PBOC), and Zeti Akhtar Aziz (BNM).

16. Singapore’s exchange rate regime is unique. What makes it even more unique is that it won’t work for anyone else. This is not to say that Singaporeans are smarter than everyone else. It is because if more than one country tries this, it won’t work for anyone, Singapore included.

17. Two countries trying to appreciate their currencies against each other will only destroy both economies, as the attempt will progressively raise interest rates in both countries (remember, under this regime, interest rates “float”). During the Cold War, they had a term for this – Mutually Assured Destruction (MAD).

18. Malaysians should not be concerned or humiliated over MAS policy or the role of the SGD as a policy variable – it is what it is and it (mostly) works well for Singapore. BNM’s policy on the other hand, works well for Malaysia. But the result is that the SGDMYR exchange rate is not in any way, shape, or form, a reflection of the relative performance of the two economies.