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SINGAPORE’S EXCHANGE RATE MANAGEMENT SYSTEM

Nugraheni Vita Dyana

041724353022 – Angkatan 50 A

UNIVERSITAS AIRLANGGA
FAKULTAS EKONOMI DAN BISNIS
MAGISTER MANAJEMEN
2019
 SINGAPORE’S EXCHANGE RATE MANAGEMENT SYSTEM
General Economic Environment :
Economic turbulence and political uncertainties had become pertinent features of the new world
economy in the aftermath of the September 11, 2001 terrorist attacks in the United States.

Regulations and Financial Stability

The Monetary Authority of Singapore (MAS) is the integrated regulator and supervisor of financial
institutions in Singapore. MAS establishes rules for financial institutions which are implemented
through legislation, regulations, directions and notices. Guidelines have also been formulated to
encourage best practices among financial institutions. Combined with close supervision, these
instruments help MAS achieve the outcome of a sound and progressive financial services sector.

Monetary Policy
Singapore’s monetary policy has been centred on the management of the exchange rate since the early
1980s, with the primary objective of promoting medium term price stability as a sound basis for
sustainable economic growth. The choice of our monetary policy regime is predicated on the small
and open nature of the Singapore economy.

There are three main features of the exchange rate system in Singapore.
1. The Singapore dollar is managed against a basket of currencies of our major trading partners.
2. MAS operates a managed float regime for the Singapore dollar with the trade-weighted exchange
rate allowed to fluctuate within a policy band.
3. The exchange rate policy band is periodically reviewed to ensure that it remains consistent with
the underlying fundamentals of the economy.

History :
1965 - Singapore achieved independence after breaking out of the merger with Malaysia to
become a small and open economy.
1971 - Monetary Authority of Singapore (MAS) was established
1972 - Singapore switched its peg from the pound to the US dollar (USD)
1973 - MAS decided to abolish the fi xed exchange rate policy
early - 1980s, the institutional mechanism that marked a major shift in Singapore’s monetary
policy was finally put in place
mid-1980s - developing the services sector in Singapore
late-1990s - creating a knowledge based service, a high technology sector and an entrepreneurial
domestic economy
1994 - Singapore became the fourth largest foreign exchange trading centre in the world, after
New York, London and Tokyo

Singapore journeyed through four distinct phases of economic growth :

1. The government pursued an exportled industrialisation strategy by attracting foreign investors to set
up labour-intensive manufacturing bases in Singapore to curb massive unemployment.
2. Industrial restructuring from labour-intensive to capital-intensive activities.
3. Introduced after the first major recession in the mid-1980s, was aimed at
developing the services sector in Singapore.
4. Began in the late-1990s was directed towards creating a knowledge based service, a high
technology sector and an entrepreneurial domestic economy.

A key fiscal feature unique to Singapore was the Central Provident Fund (CPF), a compulsory
savings scheme mandated by the government. Residents in Singapore had a portion of their salary
deducted and deposited in the fund. This resulted in a large amount of private sector savings placed
with the government rather than in domestic financial markets. The CPF scheme enabled the
government to maintain a current account surplus and export capital abroad.

Unlike some of its neighbouring countries that borrowed external capital when faced with a current
account defi cit, the Singapore government seldom had to import capital to finance its current account.

Opportunity :
- the language is English
- 37k percapita GDP
- oil refining was the 3rd world largest
- busiest container port for logistic
- a strategic location,
- strong domestic economy,
- stabilised currency,
- active domestic banks,
- financial expertise,
- new financial instruments and regulations
- an effective network of financial institutions providing sophisticated financial services

The dramatic events in the world financial landscape which began with the collapse of the Bretton
Woods system followed by the oil crises and global economic downturn made the Singapore
government develop its own exchange rate management system

The ultimate policy objective was to promote price stability while ensuring sufficient liquidity to
sustain real economic growth. The administration of the new exchange rate policy came under the
jurisdiction of the MAS.

Question :
1. In the early years of nationhood, Singapore followed a fixed exchange rate policy. How did this
benefit the economy in those initial years?

In the early years Singapore government had relied on tight regulation on money control, with
targeting to reduce growth in bank deposit and limiting the availability in foreign assets in
domestic banks. The government had direct influence over domestic interest rates which were
fixed by the Association of Banks in Singapore in consultation with MAS. Two main measures,
credit ceiling and reserve requiments, were used to regulate money and were successfull in
reversing rapid growth and curbing the inflation in the early-1970s.

2. How had Singapore's fiscal and monetary policy served to drive the country's economic growth
over the past few decades?

 Central Provident Fund (CPF), a compulsory savings scheme mandated by the government.
Residents in Singapore had a portion of their salary deducted and deposited in the fund. This
resulted in a large amount of private sector savings placed with the government rather than in
domestic fi nancial markets. The CPF scheme enabled the government to maintain a current
account surplus and export capital abroad. As a result of the CPF scheme, Singapore’s fiscal
current account had maintained constant surpluses in the early years. Net surpluses of the
provident fund as well as public sector surpluses were deposited with MAS. With these large
 surpluses, MAS had an effective means to contract liquidity, whenever necessary, to
strengthen the exchange rate.
 The implementation of special incentives to increase international trade flows and investments
in the country.
 Shift from direct controls to market intervention in regulating money supply to meet the needs
of an increasingly complex and integrated financial system
 The exchange rate, which had a direct influence over prices and profitability of traded goods
and resource allocation, was chosen as the main target. The ultimate policy objective was to
promote price stability while ensuring sufficient liquidity to sustain real economic growth. The
administration of the new exchange rate policy came under the jurisdiction of the MAS. Under
the new exchange rate management regime, the purchasing power of the SGD and confidence
in the currency were maintained and the value of workers’ savings was preserved. This was
consistent with the aims of the policy makers in maintaining a strong and stable currency to
attract capital inflows and promoting integration with international financial markets.

3. Why was Singapore unable to maintain its fixed exchange rate system?

 First, the Singapore economy has highly diversified trading links, subtantial fiscal surpluses,
and a long track record of low inflation, Both inflation and interest rates have been lower in
Singapore than in teh US. There is thus a little need for nominal anchor for the SGD to
manage inflationary expectations, or for the discipline imposed by monetary polisy of a
foreign country – most likely the US – to switch the SGD is pegged.
 Second, there would be a cost resulting from adoption of the anchor country’s monetary policy
because of the divergence in bussiness cycles. This is shown by Hong Kong’s example, While
Hong Kong’s business ans economic cycle has become increasingly aligned with that of
China, its peg to the USD ties its monetary polocy closely to that of the US. During the early
1990s, the Hong Kong economy was growing rapidly and warranted tighter monetary
conditions, but interest rate fell in line with those in the US, which was experiencing the
economic slowdown.
 Third, a fixed exchange rate would make it difficult for Singapore to absorb shocks from
abroad, and adjust the value of SGD exchange rate inline with changes in the country’s
underlying macroeconomic fundamentals. This would be so even if the SGD were pegged to
trade-weighted basket rather than a single anchor currency. For example, during the Asian
crisis from late-97 to early-98, when the regional economies depreciated sharply against the
USD, the SGD too depreciated against the USD, but by much less. In trade-weighted terms the
SGD actually appreciated moderately, because MAS exercised flexibility to allow the NEER
to rise above the policy band. If the SGD had been required to remain strictly within the policy
band, or had been pegged to the NEER, the MAS would have had to force the SGD to
depreciate much more against the USD, at a time when market sentiment was weak. This
could have resulted in a loss of confidence in the SGD. Instead, MAS only brought down the
NEER to within the policy band months later, when financial markets had stabilised and
conditions had become more conducive.

4. What are the likely factors (both domestic and international) that prompted the government of
Singapore to shift to an open-market, flexible system of exchange rate management?

Domestic and International factors are :

- the traded goods sector was extremely important, as a 12th largest export market
- the language is English
- 37k percapita GDP
- oil refining was the 3rd world largest
- busiest container port for logistic
- have a strategic location,
- strong domestic economy,
 - stabilised currency,
- active domestic banks,
- financial expertise,
- new financial instruments and regulations
- an effective network of financial institutions providing sophisticated financial services
- have 7.000 MNC’s, 1.500 US
- Aviation : airlines, maintenance
- Financial : forex, funds
- Education : global universities : NUS, Nanyang NTU
- Medical, bioscience : healthcare, research
- Pharmaceutical : manufacturing, R&D
5. Identify the various economic challenges faced by Singapore over the years. What are some of the
economic strategies and policies used to deal with these challenges?
In 1972 a massive speculative attack on the
pound led to its eventual floating in
June that year
In 1973 a major devaluation of the USD
triggered a chain of events that caused
the disintegration of the Bretton Woods
regime
after 1973 In the transitional phase, before the
adoption of an exchange rate focused
monetary regime in the early-1980s,
In July the bank interest-setting cartel system
1975 was eradicated.
In 1985 rising domestic costs, high wage
policies and deteriorating international
competitiveness resulted in the fi rst
economic recession in Singapore’s
history.
In July following the devaluation of the Thai
1997 Baht, the Asian financial crisis broke
out
Consequently, Singapore
switched its peg from the pound
to the US dollar (USD)
MAS decided to abolish the fixed
exchange rate policy. The
Singapore dollar (SGD) was
floated upwards as a final resort
to fight against inflation
the Board of Commissioners of
Currency in Singapore stepped in
to maintain a strong and
convertible domestic currency by
backing the issue of domestic
currency with foreign reserves
As a result, MAS no longer had
direct control over interest rates
although it could still intervene
indirectly through money market
operations. The liberalisation of
interest rates supported by
substantial progress in combating
inflation had positive results, one
of which was the further
deepening of Singapore’s
financial market
In facilitating economic recovery,
the exchange rate was allowed to
depreciate sharply in conjunction
with other temporary cost-cutting
measures, including wage freeze
and labour cost reduction, which
were effected through reducing
the employers’ contribution rate
to the CPF scheme.
In response to the Asian crisis,
MAS widened its exchange rate
policy band so that it could
manage the exchange rate more
flexibly in the more volatile

In 2001 a severe electronics slump swept across MAS announced an exchange rate
the globe.
On terrorism took centre stage in world
September politics, triggering off new economic
11, uncertainties with severe global
impacts. The economic downturn
worsened in the aftermath of the
terrorist attack.
Technological advances had resulted in To remain competitive in this new
a globally integrated marketplace.
To help promote a more vibrant and
competitive environment
foreign exchange market. The
subdued inflationary environment
also allowed an easing of
exchange rate policy to cushion
the economy from the adverse
effects of the crisis and facilitate
its recovery
policy shift from a gradual and
modest appreciation of the SGD
to a neutral policy in July 2001.
In response, MAS widened the
trade-weighted exchange rate
bandwidth to inject greater fl
exibility into Singapore’s
exchange rate management
system. After the international
financial markets stabilised, the
policy band was narrowed to refl
ect the regained stability although
the neutral policy stance remained
unchanged.
global economy, Singapore
recognised the need to deregulate
closed sectors and shift into a
knowledgebased economy. The
government took steps to deregulate
key sectors of the economy such as
the fi nancial services,
telecommunications and power. In
the fi nancial services sector, MAS
opened the domestic banking and
insurance industries to greater
foreign participation. At the same
time, MAS also adopted a more
open and consultative approach
both in terms of supervision as well
as development of the sector, and
shifted the emphasis from
regulation to risk-focused
supervision.
actively attracting new activities
and players to Singapore. Various
intiatives were launched to give
fund managers greater access to
domestic funds, develop the debt
market and overhaul corporate
governance. To shift successfully
into a knowledge-based economy,
Singapore had to strengthen its IT
capabilities. the educational
system was changed so as to
encourage creativity and innovation
from young. As such, various
 manpower initiatives were launched
to encourage the continual
retraining and re-skilling of the
workforce. Another important
component of the government’s
labour market policy was the effort
made in attracting foreign talent to
Singapore. Taken as a whole, these
measures helped position
Singapore to contribute to, and
partake of, the benefi ts of the
global economy.

6. Evaluate Singapore's current exchange rate management policy. What are some of the benefits and
limitations of this policy?

The strategy underlying Singapore’s monetary policy has been determined by two critical groups
of factors. The first is the small and open nature of the Singapore economy, both real and financial.
This means that the exchange rate is the most effective policy instrument for maintaining
domestic price stability. The second is the sound macroeconomic fundamentals and prudent fiscal
policy in particular. The Government's avoidance of fiscal deficits and its commitment to
preserving low inflation have allowed the MAS to concentrate on its primary responsibility of
maintaining price stability and reinforced the effectiveness of its monetary policy. Underpinning
the system is the credibility that the MAS has built up over the years in achieving its stated
objective of low inflation.

The managed float has been flexible enough to accommodate changes in the equilibrium value of
the SGD and prevent the currency from becoming seriously misaligned. For example, from 1985-
97, the SGD was generally on a secular appreciating path against the USD and the currencies of
the other trading partners. Econometric studies show that this was in line with the appreciating
trend of the equilibrium real exchange rate, reflecting the strengthening in economic fundamentals
during the period. Similarly, with the onset of the Asian financial crisis, the exchange rate
depreciated with the fall in the equilibrium exchange rate.

The exchange rate system has also helped to mitigate the adverse effects of excessive short-term
volatility in financial markets on the real economy. As our experience during the Asian financial
crisis shows, Singapore’s policy of managing the exchange rate within an undisclosed band has
provided us with the flexibility to cope with periods of exceptional volatility in foreign exchange
markets and uncertainty in economic conditions.

Risks to financial stability

 Singapore financial sector has been resilient in the face of major economic downturns in recent
years. It has weathered 4 major shocks – Asian crisis in 1997-98, a sharp drop in electonics
exports in 2000-01, outbreak of SARS in early 2003, and the economic crisis of 2008.

 The links between the ADM and the domestic financial system – via local banks and foreign
banks that are active in the Singapore domestic baking market – do not seem to present undue
sources of vulnerability.

 Local banks carry out considerable operations through overseas branches and subsidiaries.
They appear to be managed effectively and are supervised under the MAS consolidated
supervision network. The operations have been generally profitable enhancing the resilience
of Singapore’s banking system.
  The net market value of local bank’s derivative exposures is small in absolute amounts as well
as relative to their assets and capital positions. Net mark-to-market values amounted to only
$20.5 billion at end September 2008. Local banks derivatives activities are concentrated in
foreign exchange and interest rate products. Foreign banks account for 76% of the estimated
potential counterparty credit risk exposures in local banks’ derivative books.

 Stress results indicate that potential stress loss exposures of Singapore’s systemically
important banks are well contained.

 Operations of systemically important foreign bank branches appear to be managed prudently.

Despite a sharp decline in operating profits as a result of increased provisions, the 10 largest
foreign banks have remained profitable since 1999 and their net incomes have only grown
over the years.

 Nevertheless the financial sector is subject to a number of potential risks. The risks include i)
negative shocks in external demand ii) persistent weakness in the labor market iii) a sharp
increase in interest rates iv) declines in asset prices.

Reference :
Monetary Authority of Singapore, Economic Policu Group, Macroeconomic review, Volume XVII
Issue 2 Oct 2018, Xpress Print Singapore
Monetary Authority of Singapore, Singapore’s Exchange Rate Policy, February 2001, Xpress Print
Singapore