Devalue Singapore dollar? It's going to hurt

Devalue Singapore dollar? It's going to hurt

Economists feel the Singapore dollar should be devalued, reports Reuters. Not because the currency is overvalued but because the economy is tanking.

That is what the Reuters report says: "The economy has been hit severely, more by collapsing external demand than an overvalued currency."

Currency devaluation usually means economic failure. It is necessary, nevertheless, says Reuters.

The Monetary Authority of Singapore (MAS) will have to "effectively devalue the currency if it wants to meaningfully achieve lower interest rates", says Reuters.

What's good for business could hurt consumers, though. Food and other necessities could cost more since almost everything has to be imported. And there's no guarantee that lower interest rates will stimulate the economy in the current recession. It hasn't so far in America, Europe or Japan.

And devaluation doesn't really work for long, according to the Economist. Its Economics A-Z explains:

DEVALAUATION
A sudden fall in the value of a currency against other currencies. Strictly, devaluation refers only to sharp falls in a currency within a fixed EXCHANGE RATE system. Also it usually refers to a deliberate act of GOVERNMENT policy, although in recent years reluctant devaluers have blamed financial SPECULATION. Most studies of devaluation suggest that its beneficial effects on COMPETITIVENESS are only temporary; over time they are eroded by higher PRICES.

However, Singapore has no choice, according to Reuters. The Singapore dollar has to fall from its current level of about 1.50 Singapore dollars to 1 US dollar. Reuters says:

Singapore's central bank announces its policy after a six-month hiatus next week, and barely anyone doubts that authorities will have to ease monetary settings to shore up an economy that is already in recession and toying with deflation.

Shifting the Singapore dollar's trade-weighted trading band down in one go, effectively a devaluation, would be the least ambiguous way of easing policy, said Emmanuel Ng, a strategist at OCBC Bank in Singapore.

That seems to be the consensus view, simply because other options could have some undesirable side-effects. The Monetary Authority of Singapore (MAS) could for instance allow the Singapore dollar to trade in a wider band, or gradually steer the centre of the band lower at a pre-determined pace so as to let the currency depreciate over time.

The former throws policy open to the whims of a market that could drive the currency up or down rather quickly, while the latter could push up market yields…

Singapore can fix its currency or its interest rates, not both at the same time.

The report adds:

Singapore has never had a policy encouraging a lasting depreciation of the currency in previous downturns. It widened the band in 2001, after the Sept. 11 attacks, and devalued the currency in 2002 and in 2003, after the technology bubble burst and during the SARS crisis.

This time though, well into the deepest recession on record, Singapore's authorities ought to do far more than merely announce a weakening of the currency, analysts reckon.

Policy was kept tight from April to October, and has been on neutral mode since then despite the severity of the downturn.

That has meant Singapore is one of a handful of countries in Asia where monetary conditions, measured by real exchange and interest rates, are tightening.

Central banks in other countries from America to Japan have lowered interest rates to stimulate the economy.

But that's not how the central bank operates in Singapore.

The Monetary Authority of Singapore says:

Monetary policy in Singapore centres on the management of the exchange rate. There is no independent policy targets for either interest rates or money supply.

Why? Partly because Singapore is an export-oriented economy. MAS says:

Exchange-rate changes have a major influence on inflation, and not insignificant effects on the international competitiveness of the real sector.

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