Singapore Foreign Exchange Policy


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

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Singapore Foreign Exchange Policy

  1. 1. Case Study I. Emily Barr and Danny Purvis Exchange Rate Policy at the Monetary Authority of Singapore
  2. 2. Basic Information <ul><li>Currency: Singapore Dollar (S$ or SGD) </li></ul><ul><li>US $1.00 = S$ 1.2780 </li></ul><ul><li>One of the highest per capita GDP </li></ul><ul><li>Exports provide main source of revenue </li></ul><ul><ul><li>Electronics, chemicals, service </li></ul></ul><ul><li>Port of Singapore: </li></ul><ul><ul><li>Busiest port in the world </li></ul></ul><ul><ul><li>(Total Shipping Tonnage) </li></ul></ul>
  3. 3. Exchange Rate Systems <ul><li>Fixed Exchange Rate </li></ul><ul><li>Advantages </li></ul><ul><ul><li>Minimizes International Trade/Investment Risk </li></ul></ul><ul><ul><li>Elimination of Destabilizing Speculation </li></ul></ul><ul><ul><li>Requires Discipline in Economic Management </li></ul></ul><ul><li>Disadvantages </li></ul><ul><ul><li>Large holdings of foreign reserves are required </li></ul></ul><ul><ul><li>Fixed rates can also be unstable (devalue/revalue) </li></ul></ul><ul><ul><li>Loss of Freedom in terms of Internal Policy (interest rates) </li></ul></ul><ul><ul><li>Countries are vulnerable (and dependent) on the economic conditions of other countries </li></ul></ul><ul><li>Floating Exchange Rate </li></ul><ul><li>Advantages </li></ul><ul><ul><ul><li>Countries are more protected from the economic conditions of foreign countries </li></ul></ul></ul><ul><ul><ul><li>Central Bank interventions are not needed </li></ul></ul></ul><ul><ul><ul><li>Freedom in internal operations </li></ul></ul></ul><ul><ul><li>Disadvantages </li></ul></ul><ul><ul><ul><li>Promotes currency speculation </li></ul></ul></ul><ul><ul><ul><li>Exchange Rate Risk </li></ul></ul></ul><ul><ul><ul><ul><li>Investors and MNCs must spend considerable resources to protect against </li></ul></ul></ul></ul><ul><ul><ul><li>Inflation </li></ul></ul></ul>
  4. 4. Trends in Exchange Rate Systems <ul><li>Overall Shift… </li></ul><ul><ul><li>Fixed Exchange Rates  Freely Floating </li></ul></ul><ul><ul><ul><li>In 1975, approximately 87 percent of developing countries had some type of fixed exchange rate. </li></ul></ul></ul><ul><ul><ul><li>By 1996, that percentage had dipped well below 50 percent. </li></ul></ul></ul><ul><ul><li>Spurred by dissolution of the Bretton Woods Era </li></ul></ul>
  5. 5. History of Singapore’s Foreign Exchange Policy <ul><li>Prior to 1970: SGD pegged to Pound </li></ul><ul><li>1972: Pound came under speculative attack </li></ul><ul><ul><li>SGD briefly floated, than switched to US$ peg </li></ul></ul><ul><li>1973: Major devaluation of the U.S.$ </li></ul><ul><ul><li>Collapse of Bretton Woods, SGD floated again </li></ul></ul><ul><li>1974-1981: Shift of exchange rate policy towards money market operations and monetary policy for control </li></ul><ul><li>1981-2001: Managed Float </li></ul>
  6. 6. Current Exchange Rate System: Managed Float <ul><li>SGD managed against a basket of currencies based on major trading partners/competitors </li></ul><ul><li>Managed Float </li></ul><ul><ul><li>Trade-weighted exchange rate is allowed to fluctuate within undisclosed policy band </li></ul></ul><ul><li>Periodically Reviewed </li></ul><ul><ul><li>Typically every 3 mo. </li></ul></ul><ul><ul><li>Ensure currency valuation is aligned with fundamentals of economy </li></ul></ul><ul><ul><li>Choice of Exchange Rate for Target of Monetary Policy </li></ul></ul><ul><ul><ul><li>Implies that Singapore gives up control over domestic interest rates (and thus money supply) </li></ul></ul></ul><ul><ul><ul><li>“ Unholy Trinity” </li></ul></ul></ul>Since 1981, Singapore has focused on management of the Exchange Rate
  7. 7. Monetary Authority of Singapore (MAS) <ul><li>Mission: Promote sustained, non-inflationary growth and a sound and progressive financial center </li></ul><ul><li>MAS is the central bank of Singapore </li></ul><ul><ul><li>Has the authority to regulate all elements of monetary, banking, and financial aspects within the country of Singapore </li></ul></ul><ul><li>Vision for Singapore: Be a World Class Financial Center </li></ul><ul><ul><ul><li>Full service provide in capital and money markets </li></ul></ul></ul><ul><ul><ul><li>Regional hub for retail and wholesale financial services </li></ul></ul></ul>
  8. 8. The “Unholy Trinity”
  9. 9. The “Unholy Trinity” <ul><li>Illustrates various tools a country can use when determining monetary policy </li></ul><ul><li>A country can exercise 2 out of the 3 , but cannot utilize all 3 concurrently (“tri-lemma”) </li></ul><ul><ul><ul><ul><li>Monetary Independence </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Ability to control the supply of money in circulation (and thus influencing the interest rates) </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><li>Exchange Rate Stability </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Altering the exchange rate by various methods in order to depreciate/appreciate and maintain a stable ER </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><li>Financial Integration </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>The free and continuous conversion of currency for FDI and changes in the holdings of stocks, bonds, loans, bank accounts, currencies, etc </li></ul></ul></ul></ul></ul>
  10. 10. The “Unholy Trinity”: Singapore’s Trade-Off <ul><li>Trade (in terms of exports/imports) is the cornerstone to Singaporean Economy </li></ul><ul><ul><li>Imports and Exports consistently > GDP </li></ul></ul><ul><ul><ul><li>Because of this, it is essential that Singapore maintain an open capital account </li></ul></ul></ul><ul><li>Interest Rate Control vs. Exchange Rate Control </li></ul><ul><ul><li>Historically, larger economies are more responsive to changes in interest rates because they have an expansive domestic banking industry </li></ul></ul><ul><ul><li>Changes in Exchange Rates: yielded much quicker results </li></ul></ul><ul><ul><ul><li>Since trade was imperative to everyday life </li></ul></ul></ul>
  11. 11. Nominal Exchange Rates <ul><li>The nominal exchange rate is the value of a country’s currency in relation to other currencies without the adjustment for inflation. </li></ul><ul><li>The nominal exchange rate measured the ratio at which Singapore dollars were traded for other dollars on the spot market. </li></ul>The Difference Between Real and Nominal Exchange Rates
  12. 12. Real Exchange Rates <ul><li>The real exchange rate is the actual exchange rate for the two currencies of concern adjusted for inflation. </li></ul><ul><li>The real exchange rate measured the ratio at which Singapore dollars were equivalent to other currencies in terms of purchasing power. </li></ul>The Difference Between Real and Nominal Exchange Rates
  13. 13. Singapore’s Exchange Rates Prior to 2001 <ul><li>From 1981 to 2001 the Singapore dollar had been on an appreciating trend against the main global currencies, including the United States. </li></ul><ul><li>During this time, Singapore experienced rapid economic development, high productivity growth, and a high savings rate. </li></ul><ul><li>The S$ nominal exchange rate appreciated by 74% while the S$ real exchange rate appreciated by 92% from 1981 to 2001. </li></ul>
  14. 14. How Pegged Currencies Led to the Asian Financial Crisis (1997-98) <ul><li>Some Asian countries pegged their currencies to the US dollar from 1995 to 1997 </li></ul><ul><li>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. </li></ul>
  15. 15. <ul><li>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. </li></ul><ul><li>In July 1997 the Thai Baht collapsed and this spread to the rest of the region. </li></ul><ul><li>What started out as a currency crisis quickly spread to the wider economy and led to economic downturns in several countries. </li></ul>How Pegged Currencies Led to the Asian Financial Crisis continued
  16. 16. Overall Impact: The Financial Crisis and Asian Countries <ul><li>Many foreign investors began to panic, and lost confidence in the currencies of those countries and their overall economies. </li></ul><ul><li>In the countries that were most affected by the crisis, such as Thailand, banks and other companies collapsed or had to be rescued. </li></ul><ul><li>This resulted in massive unemployment </li></ul>
  17. 17. Asian Financial Crisis: The Impact on Singapore <ul><li>Singapore was not directly hit by the crisis, but still suffered from the effects of the economic slowdown of its neighbors. </li></ul><ul><li>As a result, Singapore fell into a recession during the second half of 1998. </li></ul><ul><li>Overall, the Singapore economy declined by 1.4% in 1998 in terms of real gross domestic product. </li></ul>
  18. 18. Singapore vs. Thailand : The Varying Affects of the Crisis <ul><li>Singapore engaged in several positive financial policies </li></ul><ul><li>The MAS signaled a willingness to allow the nominal exchange rate to depreciate somewhat, but in an orderly manner. </li></ul><ul><li>The MAS widened the band within which the exchange rate would be allowed to fluctuate. </li></ul>
  19. 19. <ul><li>Fiscal policy was adjusted by implementing significant cost-cutting budgetary measures </li></ul><ul><li>Employer contribution rates to the Central Provident Fund were reduced, which lowered the effective cost of labor. </li></ul><ul><li>The Singapore government also aimed to further reduce costs to businesses by implementing a 10% corporate tax rebate </li></ul>Singapore vs. Thailand : The Varying Effects from the Crisis continued
  20. 20. Recovery from the Financial Crisis <ul><li>During the crisis, Singapore still experienced a healthy inflation rate between 0-3% </li></ul><ul><li>By the beginning of 1999 the Singapore economy had already experienced a positive growth, powered by a strong rebound in the manufacturing sector </li></ul><ul><li>The recovery sustained through the year and overall GDP for the year increased by 7.2% </li></ul>
  21. 21. Recommendation <ul><li>Our Recommendation: Maintain the Managed Float </li></ul><ul><ul><li>Freely Floating Rate would introduce too much volatility and likely result in investors/MNCs re-evaluating trade/investment decisions </li></ul></ul><ul><ul><li>Fixed Rate would provide stability, but may skew the actual value of the currency </li></ul></ul><ul><ul><ul><li>Hong Kong example </li></ul></ul></ul><ul><ul><li>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. </li></ul></ul>
  22. 22. Recommendation continued <ul><li>Historically, Singapore has been famous for low inflation rates . </li></ul><ul><ul><li>A freely floating exchange rate system would go against the primary goals of MAS </li></ul></ul><ul><ul><ul><li>Freely floating system may actually encourage inflation since it allows the cost of imports to rise while the exchange rate falls </li></ul></ul></ul><ul><li>The country can attribute much of its success to the managed float that they have maintained and perfected over the decades </li></ul><ul><ul><li>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 </li></ul></ul>
  23. 23. Recommendation continued <ul><li>Singapore is still relatively small. </li></ul><ul><ul><li>Because of this, coordinated monetary and fiscal policy actions are possible </li></ul></ul><ul><ul><ul><li>Primary advantage of having a freely floating exchange rate system is to have the ability to pursue an independent monetary policy </li></ul></ul></ul><ul><ul><ul><li>Which at this point in time is not a feasible strategy for Singapore. </li></ul></ul></ul><ul><li>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 </li></ul>
  24. 24. Thank You!