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Singapore Foreign Exchange Policy

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Proposal for mitigating foreign exchange risk in Singapore. Based on a Harvard Case Study

Proposal for mitigating foreign exchange risk in Singapore. Based on a Harvard Case Study


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  • 1. Case Study I. Emily Barr and Danny Purvis Exchange Rate Policy at the Monetary Authority of Singapore
  • 2. 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)
  • 3. 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
  • 4. 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
  • 5. 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
  • 6. 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
  • 7. 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
  • 8. The “Unholy Trinity”
  • 9. 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”)
          • Monetary Independence
            • Ability to control the supply of money in circulation (and thus influencing the interest rates)
          • Exchange Rate Stability
            • Altering the exchange rate by various methods in order to depreciate/appreciate and maintain a stable ER
          • Financial Integration
            • The free and continuous conversion of currency for FDI and changes in the holdings of stocks, bonds, loans, bank accounts, currencies, etc
  • 10. 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
  • 11. 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
  • 12. 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
  • 13. 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.
  • 14. 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.
  • 15.
    • 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
  • 16. 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
  • 17. 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.
  • 18. 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.
  • 19.
    • 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 Crisis continued
  • 20. 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%
  • 21. 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.
  • 22. 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
  • 23. 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
  • 24. Thank You!

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