How does MAS’ monetary policy affect Singapore’s international competitiveness and external balance?
This section aims to clarify some misconceptions about Singapore’s unique exchange rate-centred monetary policy framework.
MAS does not use the exchange rate to bolster Singapore’s international competitiveness or to target a current account surplus.
Instead, Singapore’s international competitiveness is underpinned by its economic and institutional fundamentals, while its current account surplus reflects a level of national saving that is higher than domestic investment.
5.1 Does MAS aim to keep the S$ weak in order to boost Singapore’s international competitiveness?
No. Pursuing international competitiveness through an artificially weaker Singapore Dollar Nominal Effective Exchange Rate (S$NEER) is unsustainable and not in Singapore’s interest.
First, a persistently low S$NEER will not keep the S$ Real Effective Exchange Rate (S$REER) undervalued for long.
If MAS were to opportunistically try to keep the S$NEER undervalued to boost Singapore’s competitiveness, this would eventually result in an excess demand for factors of production and higher wages and prices in the economy. Moreover, many exporting industries in Singapore are part of global value chains, which implies that there is a high degree of imported content in Singapore’s merchandise exports.
Thus, a persistent weakening of the exchange rate would be accompanied by a rise in the costs of imported intermediate inputs, wages and rentals, and ultimately, prices. This erodes any competitive gain from the initial nominal exchange rate depreciation as the real exchange rate strengthens because of higher domestic costs. This would also be incompatible with MAS’ aim to keep inflation low and stable.
Second, the competitiveness of Singapore’s exports is not determined by the S$REER, or relative international prices, alone.
Singapore specialises in producing and exporting sophisticated, high value-added products and services that are relatively price-insensitive. This ability to do so is underpinned by the underlying factors that determine Singapore’s international competitiveness: human capital, infrastructure, connectivity and institutional quality, among others.
Economic research has shown that there is a very limited role for the exchange rate in determining the export competitiveness of economies which produce high-value goods. Empirical analysis by the IMF has shown that demand for a wide range of Singapore’s merchandise exports is relatively insensitive to changes in price (which includes a nominal exchange rate component) but is instead more sensitive to changes in global income.
Chart 5.1 plots the medium-term relationship between the change in the S$REER and that of the current account since 1981. The scatter plot does not provide prima facie evidence that an “undervaluation” of the exchange rate supports the current account surplus.
Chart 5.1: Current Account Balance and the S$REER (1981–2017)
Overall, it is not in Singapore’s interest to keep the S$NEER weak. Apart from fostering inflationary pressure in the economy, a cheap exchange rate will hamper the necessary reallocation of resources that would allow producers to move up the value chain.
Singapore’s economic strategy has been to continuously restructure its economy and move into higher value-added industries and products over time. This has been the underlying source of Singapore's sustained economic competitiveness.
In fact, a strong S$NEER, high domestic wages supported by high productivity, and full employment are prime indications of a highly-competitive economy.
5.2 Does the current account surplus mean that Singapore’s exchange rate is undervalued?
It is sometimes asserted that the Singapore Dollar Real Effective Exchange Rate (S$REER) is undervalued. That is, in common currency terms, domestic wages and prices in Singapore are “too low” relative to those in other economies. The main evidence put forth is that Singapore’s current account surplus, of which a component is the trade balance, is “too large” relative to GDP.
It is important to appreciate that the current account is fundamentally the difference between a country’s gross national saving and domestic investment. Singapore’s current account surplus implies that, on a net basis, a proportion of national saving is invested abroad. Meanwhile, the current account deficit in other countries reflects higher domestic investment than national saving can finance. Indeed, on a global basis, surplus countries effectively fund the excess of investment (or consumption) over national saving in deficit economies.
Notably, the ability to smooth consumption over time through external saving or borrowing benefits both lending and borrowing countries, as countries face different demographic trends and rates of potential growth over time. In the decades since independence, Singapore has benefitted from both the ability to borrow and lend abroad. (See Question 5.3)
Even as current account surpluses and deficits are often linked to ‘misaligned’ exchange rates, it may also be argued that such imbalances are due to ‘misaligned’ interest rates or fiscal policies. Countries with current account deficits (surpluses) could have interest rates that are too low (high) or fiscal policies that are too loose (tight). There is therefore no reason for attributing current account imbalances to misaligned exchange rates alone.
However, it is widely accepted that countries should tailor their monetary and fiscal policies to achieve internal balance—or full employment and low and stable inflation—even though such policies may impinge on the current account balance.
Singapore sets its macroeconomic policies to ensure internal balance.
Fiscal policy in Singapore is primarily used to enhance the supply side potential of the economy through facilitating the restructuring and upgrading of the economy. It is also used as a counter-cyclical policy tool when necessary. Most importantly, it is calibrated to ensure long-term financial sustainability.
Singapore’s exchange rate-based monetary policy is directed at securing medium-term price stability. It does not target the current account, nor does it aim to maintain an undervalued exchange rate. Indeed, the IMF has consistently endorsed the appropriateness of MAS’ monetary policy settings against the objective of medium-term price stability.
5.3 Why does Singapore have a current account surplus?
The current account should be understood in the context of the evolution of national saving and domestic investment. Long-term trends in Singapore’s saving and investment rates are well explained by the shifting stages of Singapore’s development, its demographics, as well as the fact that as a small country, risk diversification dictates that it invests a portion of its saving abroad.
Charts 5.2 and 5.3 show Singapore’s saving-investment gap, as well as its constituent series, scaled by Gross National Disposable Income (GNDI).
Chart 5.2: Singapore's Saving-Investment Gap
Chart 5.3: Singapore’s Saving and Investment
In the early stages of development after independence in 1965, Singapore had a young population and a rapidly growing economy. As domestic investment needs could not be met with national saving alone, foreign capital was sought to finance this investment. Singapore ran a current account deficit until the mid-1980s, which enabled the rapid build-up of capital stock in the economy and the catch-up of labour productivity and incomes to near-developed economy levels. (Chart 5.3)
Subsequently, Singapore switched to a current account surplus, as saving rose while the need for domestic investment moderated.
As the economy matured, the rate of investment in fixed capital declined, as signalled by a fall in the returns to capital. At the same time, national saving has grown in line with rising incomes and as Singaporeans stepped up saving for old age. Singapore has a fully-funded, defined contribution pension scheme called the Central Provident Fund (CPF) in which Singaporeans save for retirement and medical needs.
In addition, the government had deemed it prudent from the beginning that Singapore diversify some of its saving abroad. Singapore is a small economy, and cannot diversify its risk domestically, unlike a large country. As an economy with no natural resources, there is also a need to preserve Singapore’s international purchasing power during crises, since a large proportion of domestic consumption is imported.
Thus, Singapore’s economic development and the shift in demographics over the years resulted in it having a current account surplus since the mid-1980s, which gradually rose to a peak of 27% of GNDI in 2007 before trending down to an average of around 20% of GNDI in recent years.
Over the last decade, the trend growth rate of the maturing Singapore economy has slowed, while expenditure to provide for an ageing population has grown. This demographic-driven trajectory of the current account surplus has been broadly as predicted.
Singapore’s current account trajectory is thus the outcome of shifting saving and investment behaviours in the domestic economy.
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IMF (2009), Balance of Payments and International Investment Position Manual, 6th Edition.
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