After my post on Currency exchange rate there are good comments from my friends and bloggers. Thanks to everyone who appreciated my article and this post is regarding Singapore monetary policy and its economy.

I usually try to explain the views on layman terms and refresh the basics before getting into details. Hence here also I will follow the same.

What is monetary policy?

Monetary policy is the process by which central bank of the country controls money supply in the economy. Most of the central banks in today’s world targets inflation or interest rates as a monetary tools.

Is Singapore (MAS) differs from rest of the central banks?

Yes, they are always unique from rest of the world and because of that reason only they achieved unbelievable growth in the short term of fifty years. Singapore is not using inflation or interest rates to control the money supply in economy. They are using exchange rates to control inflation and money supply in the economy. MAS is the central bank for Singapore who manages the exchange rate against undisclosed basket of currencies.

To understand more about Singapore Exchange Rate policy we need to understand economy so that we can understand why they are different from rest of the world.

Singapore Economy:

Singapore is a country has no natural resources even for water in olden days they depend on neighboring nations (even today yes, but not full dependent). They completely depends on the imports from other countries almost nearly 40 cents out of every $1 spent going to imports. By this you can understand they need huge export to offset this import.

With no natural resource, how they achieved this?

Singapore is an open economy with no restriction on current account and capital account of the country.

Let’s go one by one.

What is open economy?

Open economy means citizen of the country can do import/export with any country and there won’t be any trade barriers. International funds can flow and move out without any restrictions. To understand the open economy we need to understand more on current and capital account of the country.

Current account:

Current account of the country defines actual trade of the country with other nations. Actually other factors like remittance, tourism, private consumption will be part of it and for easy understanding I am ignoring those.

If current account is positive means there are more exports in the country. Then it will be called as Current Account Surplus (CAS).

If country is negative means there are more imports in the country than exports. Then it will be called Current Account Deficit (CAD).

Capital account:

Capital account of the country is the net result of public and private international investments in the country. In simple terms, we can say it is sum of money flowing into the country by FII (Foreign Institutional Investor), FDI (Foreign Direct investment) and Portfolio investors (stock and bond markets) and citizen of the country buying international assets.

Same like Current account here also deficit and surplus applies.

Now let’s go back to question again,

How Singapore achieved growth without natural resources?

Is it right to say they are open economy and smaller in size?

Even they are countries in this world with abundant natural resources and smaller as well but they are not grown as like as Singapore.

In my view, they maintained the open economy concept very well.

Is it easy to maintain open economy?

1. First thing you need trust from International investors by maintaining Stable Government.
2. Skilled labor force (look at the literacy of the Singaporean, awesome)
3. Low corporate and income tax.
4. Attract talents from domestic and international.
5. Less corruption
6. Encourage citizens to save more (CPF). Singaporeans savings rate is higher in this world and government always encourage the citizens to save more.
7. Developed capital markets so that it is easy for MNC’s to raise money in debt and equity market.
8. Maintaining stable exchange rate for international investors.

Now clear, is it because of open economy they achieved this growth?

In my view, Singapore government crafted the country with strong economic fundamentals which have to be appreciated.

To explain in more detail, you cannot achieve growth in one single night and that too for a country it will take generation to achieve that (at least 15 or 20 years to train or form skilled labor force).

After independence first thing they increased the literacy rate and remained competitive destination for FDI’s. Once you have skilled labor and less corporate tax for MNC’s they will start the operation in the country. This is how Singapore becomes export hub for electronics, purified petroleum and chemical products. Now current account is balanced because they depend on everything for outside world like rice, vegetables, fuels etc and it offset by exports. Singapore also becomes current account surplus nation.

Once MNC’s starts to operate they need strong capital market for funding. Singapore becomes financial hub for international investors by branding himself as ASEAN Gateway with less transaction tax and no capital gain tax. You can compare Singapore transaction tax and capital gain tax against any other country they always remain competitive in the world and because of this reason MNC’s wants them to list in Singapore capital market.Internatioal investors are flowing inside Singapore for investing in Capital markets which in turn make Current Account Surplus. Once you have stable government and less tax you can remain competitive among other financial hub (Singapore still remains competitive with less tax and liquid market for equity and bond market).

Now you can understand without natural resource how they became surplus nation!. Always admired about the great leader Lee Kuan Yew!! He crafted the entire country with a great vision! A good leader needs to predict the future and plan it (he did it)

Now going to back Singapore monetary policy, why Singapore adopted exchange rate not interest rate?

As Singapore is gifted with no natural resource using interest rate you can stimulate the production in economy. Since they depend on imports using exchange rate MAS is able to control consumer price inflation. MAS is monitoring the exchange rate against undisclosed currencies and intervenes the FX market by buying/selling the SGD against those currencies. Using exchange rate they able to control inflation and they have necessary foreign reserves as well.

Singapore dollar is managed against a basket of currencies of major trading partners (also known as the Singapore dollar nominal effective exchange rate or S$NEER). Hence, its movements are less volatile than if it were pegged to an individual currency.

Singapore’s choice of the exchange rate (rather than interest rates) as the principal tool of monetary policy is predicated on its small size and high degree of openness to trade and capital flows. A basic philosophy underlying Singapore’s exchange rate policy is to preserve the purchasing power of the Singapore dollar in order to maintain confidence in the currency and preserve the value of workers’ savings.

This marks end of my post and for queries you can ping me! Thanks everyone!