Recap of the Monetary Authority of Singapore’s exchange rate policy
Due to Singapore’s small and open economy, where gross exports and imports of goods and services account for more than 300% of GDP and domestic expenditure has high import content, the Monetary Authority of Singapore considers the exchange rate a much stronger instrument in controlling inflation than interest rates. The MAS’s monetary policy framework is, therefore, centred on managing the SGD against a trade-weighted basket of currencies (S$NEER). There are three main components to managing the SGD against this basket: 1) the mid-point of the band, 2) the width of the band (from the mid-point) i.e. the MAS’ tolerance to exchange rate volatility and 3) the slope of the band.
Since 2001 the MAS has never taken dual action in easing, until now
The MAS decided to bring forward its April meeting to March 30th due to the impact of Covid-19. After the Q1 GDP release saw an annualised contraction of 10.6% in the economy and the government revised down its GDP prediction for 2020 from between 0.5 and -1.5% to a range of -1% to -4%, the MAS opted to lower the mid-point of the S$NEER trading band and switch from an appreciating channel to a neutral slope. This marked the first time the MAS has taken dual easing measures since records began in 2001. In the monetary policy statement, the central bank asserted that the actions taken were to supplement the record historic resilience budget announced by Finance Minister Heng Swee Keat on the 26th of March, and that the exchange rate would not be the main driver of growth.
Graph 1: Singapore dollar firms after March sell-off despite MAS signaling increased tolerance for a weaker trade-weighted currency
The re-centering of the mid-point “at prevailing level of S$NEER” suggests that the current mid-point estimate is around the current 125 level. Goldman Sachs estimates that this equates roughly to the 1.41 level on USDSGD given the current trade weighted estimate of the dollar (graph 2). In addition, the 0% appreciation band suggests that the MAS is content with the current level of the exchange rate given both the domestic and global climate.
While the Singapore dollar can trade within an undisclosed band, the tweaks to the exchange rate policy suggests USDSGD may struggle to break the 1.40 level.
This is in part due to the premium the SGD has regained over its Asian peers since the March sell-off (graph 3), suggesting that further USDSGD downside is unlikely unless driven by broad USD weakness that is also witnessed in other Asian crosses. Outside of this scenario, the S$NEER is likely to begin testing the central bank’s tolerance level within its current neutral framework.
Graph 2: USDSGD trades around the MAS estimated mid-point as S$NEER estimates shows stablisation at a lower level
Graph 3: SGD outperformance since March sell-off suggests rally vs USD may begin to find resistance
The recent strength in the Singapore dollar comes at a time when the city state is in discussion with other countries to potentially lift travel restrictions. The Q1 GDP reading highlighted the impact border closures had on the economy. Services shrank 15.9% with airlines, hotels and restaurants hit by the drop in tourism. Coupled with construction falling by 22.9% due to supply-chain disruptions and delays in the return of foreign workers given the travel restriction, the current lockdown measures add downside risks to the domestic growth outlook.
While the Singapore dollar has rallied off of early exit measures being implemented, the situation remains fluid.
Weak global growth and trade volumes may lead to a contraction in the economy, as estimated by both the government and MAS in 2020, despite the historic fiscal package announced in the resilience budget. The SGD48bn stimulus package (9.5% of 2019 GDP) should contribute about 3.8 percentage points to growth, adding to the 1 percentage point driven by the primary fiscal deficit, but estimates suggest that 2020 growth will remain in negative territory for 2020. The resilience budget merely balances the risks to such forecasts.
With the current economic outlook and policy measures implemented by the MAS, we don’t expect USDSGD to take another leg lower back towards its pre-virus levels without a broad softening in the US dollar.
This would keep the S$NEER rate relatively stable as the Singapore dollar doesn’t open up a further premium on its trading partners. However, a widespread softening in the US dollar is unlikely in the current environment without dramatic additional easing measures from the Fed, a sudden uptick in global growth conditions, or a vaccine for Covid-19.
With the MAS next meeting in October, the global backdrop may have altered somewhat allowing for authorities to alter the exchange rate regime to allow unilateral deviations in the Singapore dollar from current levels.
Author: Simon Harvey, FX Market Analyst