A rising capital account deficit poses a challenge to
the MAS
30 May 2001
Yet another economist has come out saying that the Monetary Authority of Singapore (MAS) may soon have to relax its exchange rate policy.
In today's Business Times, SG economist Steven Xu was reported to have written in a May 28 report that "because of the likelihood of a rising capital account deficit, associated with capital deregulation, we suspect that the MAS will increasingly demonstrate a benign neglect towards the exchange rate".
Actually, it seems that the MAS has all along demonstrated a certain amount of neglect, allowing the Singapore dollar to depreciate to around S$1.81 despite its stated preference of a "gradual and modest appreciation" of the trade-weighted Singapore dollar. In fact, if capital deregulation -- or whatever condition for that matter -- results in a rising capital account deficit, it might be fair to say that the MAS needs to intervene more, not less, by feeding the foreign exchange market with US dollars or other foreign currency to keep the Singapore dollar from dropping too precipitously, and to ensure that any local entity that needs foreign currency -- the acquisitive SingTel and DBS, for examples -- can get it at a reasonable rate.
Apparently, Xu thinks that excessive MAS intervention in the foreign exchange market may drain its foreign exchange reserves. He mentions that the value of Singapore's foreign reserves has fallen by more than US$3 billion since January. He suspects that this fall was exacerbated by foreign exchange losses resulting from the divestment of US dollars in favour of euros. This is probably true, since in Singapore-dollar terms, the fall in the reserves is only about S$1 billion.
Xu goes on to suggest that "the weakness of the euro could well persist and this will affect the way central banks such as MAS manage their exchange rates" especially in the light of the US dollar's strength and the associated deflationary forces if the slowdown in the US economy is greater than expected.
However, Xu's concerns may be misplaced. The foreign reserves that the MAS still has -- at US$76.8 billion or about seven months' of imports -- should be more than sufficient to fend off depreciation of the Singapore dollar, especially since in his report, Xu himself forecasts a current account surplus of about US$20 billion this year, not significantly different from last year.
As for managing the foreign exchange reserves by aligning it more with the US dollar so as to reduce foreign exchange losses, that seems unnecessary. The strength of the US dollar has actually made it overvalued, as reflected in persistently high US current account deficits. And the deflationary forces in the US economy may prove non-existent; recent indicators still show inflation is alive and well in the US, and inflation is bad for the currency as it erodes its purchasing power.
Xu is not alone in suggesting that selling US dollars may be a bad idea. Despite the fact that the US dollar appears overvalued (and none of those who have suggested that the US dollar would continue to strengthen have shown that it is not), there have been many similar suggestions to the MAS to let the Singapore dollar depreciate and not fight the US dollar's strength. The trend is your friend. Well, to a speculator perhaps. But to a central bank?
Let's not forget that the goal of a central bank -- which is what the MAS essentially is -- is to maintain a stable monetary environment. Following trends does exactly the opposite. In fact, carried to extremes, it feeds bubbles. Speculators like hedge funds may be able to ride a trend to its extreme and then quickly reverse position when the trend reverses. But expecting the MAS to operate like a hedge fund is not being very realistic.
What seems more realistic is for the MAS to gradually dispose of assets that it considers overvalued -- namely the US currency -- while gradually accumulating assets itt considers undervalued -- namely the Singapore dollar and, probaably, the euro. Over the long term, this should help it attain the twin goals of monetary stability and preservation of the foreign exchange reserves.
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