quicktake

A Central Bank With No Key Rate? Yes, in Singapore

A Central Bank With No Key Rate? Yes, in Singapore

The Monetary Authority of Singapore.

Photographer: Bryan van der Beek/Bloomberg
Photographer: Bryan van der Beek/Bloomberg

Singapore monetary policy can sound a little back-to-front. While for most countries tighter policy equates to higher borrowing costs, it’s not necessarily the case for the Asian city-state, where interest rates can rise when the central bank is loosening policy. That’s because the Monetary Authority of Singapore uses the exchange rate -- not interest rates -- as its main policy tool in its biannual reviews in April and October.

1. Why target the exchange rate?

Because Singapore is a small (population 5.6 million) open economy that’s heavily dependent on trade. The currency affects inflation more sharply than in other countries, so targeting the exchange rate rather than interest rates is more effective for achieving price stability -- the central bank’s main goal. Added to that, the exchange rate is relatively easy to control through direct market interventions (ie the central bank buying and selling the Singapore dollar) and has a steady, predictable relationship with price stability.

Trading Places

Singapore trade as share of GDP is world's third-highest and eclipses the global average

Source: World Bank (2016 data)

2. How exactly does the MAS do it?

The Singapore dollar is managed against an undisclosed basket of currencies of the nation’s major trading partners. (Australia & New Zealand Banking Group Ltd. estimates the most heavily weighted are the U.S. dollar, ringgit, yuan, euro and yen.) But it’s not simply a case of picking a number to target. That trade-weighted exchange rate is allowed to fluctuate within a range known as the policy band. This gives the MAS three parameters it can tweak to guide the currency: the pace of appreciation of the exchange rate, known as the slope; the width of the policy band; and the level at which that band is centered.

3. Which does it like to deploy?

The slope is the most commonly adjusted of the three. Faster appreciation equates to monetary tightening because a stronger exchange rate makes for tougher action on inflation. The width of the policy band, which is undisclosed, is the least tweaked. A 2015 Bloomberg survey estimated the band’s width to be 4 percentage points compared with the Hong Kong dollar’s range of 1.3 percentage points. It’s generally widened to allow for more volatility or movement in the exchange rate. The center of the band has seen six changes since the start of 2001.

Parameter
Changes Since End-2000
Most Recent Change
Policy Tightening ActionPolicy Loosening Action
The slope13October 2018 (increased slightly)Increasing the slopeReducing the slope
Center of bandSixApril 2011 (re-centered upwards)Re-centering upwardsRe-centering downwards
Policy band widthFourApril 2012 (narrowed)--

4. Is depreciation an option?

Re-centering the policy band lower would be the equivalent of a one-off currency devaluation -- as the MAS did in the aftermath of the 2008 global financial crisis to guard against recession. However, a key tenet of central-bank philosophy is preserving the currency’s purchasing power and the value of workers’ savings. If the real exchange rate becomes too strong, the government prefers to cut wages rather than risk the inflationary fallout from weakening the exchange rate, according to a MAS document outlining policy.

5. Why might interest rates fall when policy tightens?

If monetary policy is tightened, the exchange rate will appreciate at a faster pace, inflation will ease and interest rates will fall because investors need less compensation to hold Singapore-dollar assets versus U.S.-dollar or other assets. Interest rates are largely determined by overseas rates and investor expectations of the future movements in Singapore’s currency under what is known as interest-rate parity. Singapore’s one-year interest-rate swap was 0.85 percentage point below its equivalent for the U.S. dollar in October 2018, suggesting the Singapore dollar is expected to appreciate 0.85 percent in the coming year against the greenback to compensate investors for the lower domestic rate. The computation of the key borrowing cost in Singapore for offshore banks -- the swap-offer rate -- takes account of this relationship.

6. Are there any drawbacks to this policy framework?

The loss of control over interest rates, which tend to track U.S. rates. When the MAS eases currency policy to stimulate inflation, borrowing costs could well rise and risk cooling consumer spending, as happened in 2015. The central bank has said interest rates are less effective than the exchange rate in influencing economic activity. But monetary policy geared toward imported inflation can be less effective when it comes to domestic demand-led factors, such as property prices. To address these, Singapore turned to so-called macroprudential measures, including tighter housing loan requirements and higher taxes on property transactions to cool the housing market.

7. When does the MAS meet?

It typically announces policy decisions twice a year, around the middle of April and October. There was, however, an out-of-cycle announcement in January 2015 that surprised markets, showing that the central bank is not intractably tethered to a six-monthly timetable. In the October 12, 2018 decision, the central bank increased the slope of the currency band slightly for the second time that year. Deputy Prime Minister Tharman Shanmugaratnam chairs the MAS board of directors.

The Reference Shelf

(Updated to include October 2018 policy decision.)