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Monday, July 21, 2003

Currency Problems in Singapore

Well here I am on holiday, in the lovely Spanish-French border village of Camprodon , right in the foothills of the Pyrenees. As is now becoming habitual I am continuing my survey of cyber cafees. This one is run by Brazilians. Having a quick Google, I find that Eddie has been busy again in Singapore. This time it's another visit to the problems of a high currency:

THE Monetary Authority of Singapore (MAS) took many people by surprise when it softened its hitherto strong exchange rate policy last week. After all, the strong-dollar policy has been well-ingrained. The MAS has established a large pool of foreign reserves - $153 billion at last count - as a deterrent to speculators. The net surpluses of the Central Provident Fund (CPF) and the government Budget surpluses, deposited with the MAS, have also put pressure on the currency to appreciate.

Now that the MAS has chosen to adopt a more transparent approach to policy-making, managing expectations is a tricky task. But ultimately, the role of monetary policy in Singapore is to establish the appropriate exchange rate, given the economic circumstances. While the MAS has often stated that its primary task is to maintain domestic price stability, with inflation virtually non-existent in the past three years, an appropriate exchange rate is now more often associated with a competitive rate. A surplus in a country's trade account is often used as evidence of a competitive currency. Surely, if a country is able to export more than it imports, it must have a competitive exchange rate. In reality, the trade account is often a poor guide. A surplus in a country's trade account does not necessarily reflect a competitive currency or even economic strength.

When the Thai baht collapsed in 1997, the country's trade account swung almost immediately from a deficit to a surplus. Of course, no one believed that indicated an equally swift improvement in the Thai economy. Thailand's trade surplus was required to repay the country's large foreign debt. The urgency of the matter meant that the only way the economy could quickly raise the foreign currency was via a deep recession that stopped imports. The consequence was the country suffered a tremendous fall in its standard of living. The typical developing economy tends to run a trade deficit because it needs to import the capital it requires to grow.

Singapore is under no pressure to generate a large trade surplus to repay foreign debt. But it is a non-starter to argue that its large trade surplus validates a strong currency. Causality runs the other way around. The preference for a strong Singapore dollar induces a policy to generate a trade surplus. Singapore does this, partly by building institutional features into the system that allow for the bias.Budget and CPF surpluses take away purchasing power that could have gone into imports. This enables the economy to build up foreign reserves to support the strong Singapore dollar policy.

But as it turned out, the strength of the currency made it hard to generate such a large surplus in the trade account without other compensating price adjustments. Based on the MAS' basket of currencies, the Singapore dollar rose about 10 per cent during the past decade.However, export prices fell by around 23 per cent. Part of the reason for the sharp decline in export prices was the deflationary trend of technology goods being exported. Still, import prices fell just 8 per cent in comparison. The economy, it seems, found it hard to sustain both a strong currency and a large trade surplus without sharply lowering its export prices. Something had to give.

Arguably, it is better to have a strong exchange rate policy to counter the inflationary environment during a period of rapid economic growth, like the 1990s. Stripped of the advantage a cheap currency gives, export-oriented manufacturers will be induced to look for productivity improvements. This stick, however, turns into a rod in a weak economic environment. When the MAS adjusted its exchange rate policy last week, it implicitly acknowledged this. But by keeping a neutral stance, the MAS signalled to the financial market that the downward adjustment is to be viewed as a one-off. While it is understandable that central banks want to discourage excessive speculation on their currencies, questions have been raised. The MAS move was viewed by currency analysts as late. And if the economic situation was worse than the central bank had earlier thought, was last week's single move sufficient? Mr Cliff Tan, chief of Citigroup's Asia-Pacific economic and market analysis, asked in a report this week whether the central bank needs to clearly define its 'neutral' policy. He noted that, while Singapore's stance has been mostly 'neutral' in the past four years, the Singapore dollar policy has been adjusted twice and is now weaker by about 3.5 per cent. It is to be hoped that, in the months ahead, the incipient economic recovery, as signalled by the strong rise in exports and the equity markets, will gather a sustainable momentum. Otherwise, even maintaining the current level of the Singapore dollar rate will be a delicate task.
Source: Eddie Lee, Straits Times

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