Download Monetary Policy in Singapore: Managing the Exchange Rate

Monetary Policy in Singapore: Managing the Exchange Rate
Observation: Countries like the United States, Canada, the U.K. use monetary policy
instruments to target short term interest rates (in the U.S, the target rate is the Federal funds
overnight rate). It is assume, during normal economic cycles that changes in the target interest
rate will produce macro-economic changes consistent with the goals of each country (e.g.,
economic growth or inflation targets).
However, there are a handful of countries that use something other than a short term interest
rate target to produce macro-economic outcomes. One such country is Singapore. Singapore
targets its exchange rate (i.e., the Singapore dollar) as a means of achieving its inflation target.
The Singapore Central Bank assumes that its primary objective is to promote price stability and
in doing so this will produce the basis for sustainable economic growth.
Since 1981, Singapore has targeted its exchange rate through intervention in the foreign
exchange markets. In doing so it manages the Singapore dollar against a trade-weighted basket
of its major trading partners. This arrangement is referred to as a managed float. The
Singapore central bank (called the Monetary Authority of Singapore) manages the Singapore
dollar with an undisclosed target band, which is reviewed periodically to ensure that it is
consistent with macro-economic objectives (i.e., its inflation target). If the exchange rate
moves out of the target band, the central bank will intervene in foreign exchange markets,
either buying or selling its currency so as to steer the rate back into the band.
The exchange rate as a monetary policy target assumes that a strong currency will result in
downward pressure on the country’s rate of inflation. The downward pressure is exerted
through the country’s import transactions; specifically a strong country results in a lower (in
local currency terms) cost for imported goods, raw materials, etc and thus holds down domestic
price increases.
Note: The Singapore Central Bank sets an interest rate (called Liquidity Facility) whereby
commercial banks can borrow, generally overnight, to cover their reserve requirements
(currently at 3% of a bank’s liabilities). This rate is set at 200 basis points above the 1-month
Singapore Interbank Offer Rate (SIBOR). SIBOR (which is similar to USD LIBOR) is “fixed” each
day at 11:00am (local time) by the Associate of Banks in Singapore.
Historical note: In the past some major countries have used an exchange rate target as their
primary monetary policy objective. For example, the Bank of England pursued an exchange
rate target policy from 1985 to 1992. However, in recent years major countries have preferred
to allow the financial markets to determine exchange rates, rather than manipulate them for
policy objectives.
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The Bloomberg article which follows discusses recent economic developments in Singapore and
the prospects for Singapore Central Bank policy actions.
Singapore Raises 2011 Inflation Forecast to 3%-4% after Record GDP Expansion
Bloomberg.com, February 17, 2011
Singapore raised its inflation and export forecasts for 2011 after the economy expanded at a
record pace last year, sustaining pressure on the central bank to allow greater currency
appreciation. The economy expanded a revised 14.5 percent in 2010, with gross domestic
product growing an annualized 3.9 percent in the three months to Dec. 31 from the previous
quarter.
Consumer prices may climb 3 percent to 4 percent this year, up from a previous forecast of 2
percent to 3 percent, the trade ministry said in a statement today. Price gains may reach 5
percent to 6 percent in the first few months of 2011. Inflation accelerated to 4.6 percent in
December, the fastest pace in two years.
“The economy has recovered so strongly and is operating by almost everyone’s estimates at
above potential and warrants a tightening,” said Yougesh Khatri, a senior economist at Nomura
Holdings Inc. in Singapore. “The higher inflation forecast supports our view that they will
tighten further.”
The Monetary Authority of Singapore, which uses the exchange rate as its main tool to manage
inflation, revalued the currency in April 2010 and said in October it would steepen and widen
the currency’s trading band while continuing to seek a “modest and gradual appreciation.” The
stance is next scheduled for review in April.
“The key macroeconomic challenge this year will not be growth but dealing with emerging cost
pressures,” Ravi Menon, permanent secretary at the trade ministry, said at a briefing today. “At
this juncture, we expect these pressures to be relatively contained although there may be some
pockets of tightness that we should continue to be watchful for.”
Singapore’s “main constraint” is labor and the government expects “some upward pressures”
on wages in 2011, the trade ministry said. Still, cost pressures won’t be as “acute” as in 200708, when annual inflation reached a record 6.6 percent in 2008, the ministry said.
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