Singapore Dollar: Short term weakness, Long term strength?

March 23, 2001

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INTRODUCTION: This map gets behind the current infatuation with short term factors in pricing the Singapore dollar to look at the key supports and detraction from its role in supporting the Singapore economy and security. The past strength of the local currency is the fruit from the execution of correct and successful policies. Regarding the future, the jury is still out if she would succeed. Presently, the currency like most others are under pressure. Targeting inflation and letting the currency finds its level is a good idea when inflation is the big enemy. But if deflationary winds blow, then the current policy could turn into a liability unless monetary policy is managed with creativity, flexibility and timeliness. If we are not vigilant, we could find ourselves in Japan’s situation threatened with a deflationary spiral. (Fig 1)The deteriorating regional economic and political environment (box 1), and global deflationary forces (box 2) depress all currencies against the US dollar. Singapore’s currency, which is valued and guided against a basket of currencies on a trade weighted basis will also suffer loss. Like a pincer Box 1 and Box 2 acts in concern to weaken the Sing unit (box3). The market ignores all other significant background forces.	How to Read Maps Maps Investment Maps Business Maps Experts Maps Other Maps Local Interest
(Fig 2) There is more money than there are ideas and entrepreneurial confidence in Singapore (box 4) to back enterprises. As a result, the Singapore dollar assets suffers from low returns (box 5).The risk free rate for short term money is less than two percent. Looks impressive when inflation is an enemy, but it is potential for trouble when deflationary winds are blowing. The currency could weaken considerably in order to keep domestic prices from falling and the country from entering into a deflationary spiral not unlike Japan! Furthermore, in the pursuit of higher yields, money including those released from CPF would have to be invested outside Singapore (box 7), i.e., Sing dollars would be sold for foreign currencies. Again it is a pincer effect, two solid arrows from Box 5 and Box 6 pushing into Box 7. This is the structural negative for the local currency. It is a capital surplus economy that has scant opportunities to invest at home. The grouse that the local market is small is only partly true as you will see in the next chart.
(Fig 3) EDB has an excellent track record of attracting foreign direct investments into Singapore. The situation here is reversed from the local one. In many cases, foreigners bring with them more knowledge and skills capital than money (box 6). That is why, we sometime co-invest with them. Since the net result is still billions of dollars into Singapore every year, it promotes Sing dollar strength. (dotted line from Box 6 to Box 3)
(Fig 4) These are significant supports for the Sing dollar which are conveniently ignored, and which politicians and central bankers liked to label as “strong fundamentals” . In the midst of trading the Sing unit, nobody remember that unlike any other currency, every Singapore dollar is backed with hard assets - the modern equivalent of the gold standard (box 9). The Sing dollar does not just have a fair value, it has real value. Another support for the currency is the consistent pattern of running budgetary surpluses (box 10).
(Fig 5) Long term plans are afoot to lift ourselves from the liability of Box 4. Slow acting but it is an absolutely important imperative to grow indigenous entrepreneurs (box 1) to supply the shortfall in ideas and expertise to match the surplus funds. At the moment, this is what counts. In currency markets, the strong winds pushing kites up and down make it appear that “gravity” is absent. But in the extremes of over and under valuation, “gravity” will appear to act. This will become obvious in the extremes of crisis. In the longer term, if Box 1 succeed, the risk free rate will “rise”, i.e., the Singapore way is low interest rates but a stronger currency. Also if the foreign investments succeeds, the repatriation of profits home will also strengthen the currency. Except for those who sell their Unit Trusts to fund retirement, you can argue about what you want do with bringing the money back home. Conclusion It is possible to have a strong currency and low interest rates provided the returns of investing them with Sing dollar assets are high. But if we fail, the Japan type of scenario will materialize.