The Monetary Authority of Singapore (MAS) has finally tightened monetary policy. But this is no ordinary central bank. Its target is not the price of money – interest rates – but the price of its currency via a trade-weighted Singapore exchange rate. It discloses the index value on a weekly basis, but does not reveal the weights, the exact targeted slope of the index, and the band in which they can move.
So what exactly did the MAS decide to do?
It stated: “MAS has therefore decided to increase slightly the slope of the S$NEER [Singapore dollar nominal effective exchange rate] policy band, from zero percent previously. The width of the policy band and the level at which it is centered will be unchanged. This policy stance is consistent with a modest and gradual appreciation path of the S$NEER policy band that will ensure medium-term price stability.”
The MAS is trying to have its cake and eat it too, by having both a competitive currency and low real rates to shelter growth. It is succeeding so far
Before we discuss the implication of such a shift in policy, let’s explain in layman’s terms what the statement essentially says. The MAS is stating that the Singapore dollar will be appreciating gently on a weighted basis, rather than being neutral as previously.
Singapore is a massive current-account-surplus economy (26% of GDP), and thus its structural bias is on an appreciation basis. But a weak global trade environment is causing the central bank to engineer limited appreciation via targeting zero appreciation of the S$NEER via a band.
A more price-competitive Singapore dollar, improving oil prices and global demand in general, and the bottoming out of the local real estate market all support an economic recovery in Singapore, albeit a fragile one.
The advance release of first quarter 2018 numbers shows that Singapore’s GDP grew by 1.4% quarter-on-quarter, a slowdown from 2.1% in the fourth quarter of 2017. On a year-on-year basis, GDP accelerated to 4.3% in Q1 2018, following growth of 3.6% for all of 2017.
By sector, semiconductors were strong, but the marine and offshore engineering industry remains subdued. In services, retail and food services saw some deceleration, suggesting that domestic demand remains fragile. The central bank was upbeat in its statement and expects the recovery to continue. In other words, economic recovery makes the case for the decision to raise the slope of the S$NEER from neutral to allow for some appreciation.
The most important FX cross for Singapore is CNY/SGD, as China is a key trade partner. Although the SGD appreciated versus the USD by 6.3% in the past year, the MAS ensured that it is competitive versus the CNY – by depreciating the SGD against CNY by -2.8% in the past year. The SGD also depreciated versus the ringgit and the euro by 6.4% and 8%, respectively.
In other words, despite a weighted appreciation in the index overall, the SGD is not appreciating versus its key trade partners, which means that the MAS is mindful of bilateral FX competitiveness to ensure that the recovery is not derailed.
There are signs that exports are slowing across the region, including Singapore. This means that the SGD appreciation will be more index-based and key partners such as China, the Eurozone, and Malaysia will still carefully watched.
Capping the Singapore Swap Offer Rate
Although the MAS’ official target is geared towards external competitiveness via the exchange rate, interest rates also matter because domestic demand makes up 73% of Singapore’s GDP. With worsening demographic trends and declining house prices, the central bank has to ensure that a cheap FX does not cause interest rates to rise too sharply.
But the central bank does not have control over one key component of its domestic rates – USD rates, which are determined by the US Federal Reserve. And rate hikes have filtered through to push LIBOR [London Interbank Offered Rate] upward.
The central bank is mindful that higher interest rates will cause corporates to spend more of their income servicing debt, impacting their balance sheet
In other words, the only component of the Singapore Swap Offer Rate that the MAS can influence is the expectations of the SGD via the forward FX rates. As such, the MAS is trying to have its cake and eat it too, by having both a competitive currency and low real rates to shelter growth.
By allowing for a modest appreciation of the index but making it still competitive versus key partners, the MAS is also tempering the rise of domestic rates.
For the most part, the MAS has been successful in supporting an economic recovery. The Singapore Swap Offer Rate has indeed risen, but the pace has been gradual. The MAS, by creating appreciating expectations in markets, is essentially capping the rise of the Singapore Swap Offer Rate and thus negates some of the rise in LIBOR.
The right move
And why is it doing this? There are two key reasons: the nascent recovery of Singapore’s real estate market and the elevated corporate leverage ratio. We have already argued in previous research that real estate wealth is key for Singaporeans, as home ownership ratio is above 90% and most household assets are in real estate.
The wealth effect coming from house price impacts consumption in the economy. The rise of interest rates and macro prudential measures dampen house prices. Property prices have staged a nascent recovery, but the speed is still slow.
Moreover, the MAS is unlikely to allow rates to move up as fast as LIBOR, to support not just the property market but also the overall leverage in the economy, particularly corporate debt.
Singapore has the third highest corporate leverage ratio in Asia. At such a level, the central bank is mindful that higher interest rates will cause corporates to spend more of their income servicing debt, impacting their balance sheet. As such, the tolerance of some appreciation is also partly driven by the desire to cap the rise of the Singapore Swap Offer Rate to support debt serviceability and demand for credit.
Our Natixis February Monetary Condition Index shows that most of the tightening of Singapore’s monetary condition comes from the real interest rate. This means that the central bank is making the right move by letting some appreciation of the Singapore dollar work through the Singapore Swap Offer Rate to temper the rise of LIBOR rates.
In summary, we expect the MAS’ decision to allow the S$NEER to gradually appreciate will help keep the spread between Singapore and US rates. We expect the SOR to continue its gradual increase, but will not follow the LIBOR as it is capped by the expectations of appreciation of the SGD, which is further anchored by the MAS’ April 13 decision.
And the MAS is unlikely to let the SGD appreciate too excessively versus key partners such as the Eurozone, China and Malaysia even if the index rises. This will ensure that the domestic recovery stays on track.
About the Author
Natixis is the second-largest banking group in France. This article is excerpted from “Asia Hot Topics: Singapore Tightened Monetary Policy But Do Not Worry; It is Doing So to Cap the Rise of Domestic Rates,” published on April 13, 2018.
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