Why Singapore’s central bank uses the exchange rate, not interest rates, to manage the economy

By Xinghui Kok

SINGAPORE, July 27 (Reuters) – Singapore’s central bank stunned markets on Monday by tightening its monetary policy settings earlier than expected, as policymakers warned that inflation would likely pick up in the coming months.

What sets Singapore apart from nearly every other major economy is the tool it uses to control price pressures: the exchange rate. The Monetary Authority of Singapore (MAS) manages the value of the Singapore dollar against a basket of currencies of its top trading partners, rather than tweaking domestic interest rates like the Federal Reserve or the European Central Bank.

This unique framework reflects the city-state’s heavy reliance on trade. With gross exports and imports of goods and services totaling more than three times its gross domestic product (GDP) – and nearly 40 cents of every dollar spent at home going toward imports – the exchange rate has an outsized impact on domestic inflation. A stronger Singapore dollar, for example, lowers the cost of imported goods and services, helping to cool price pressures for households.

Why Singapore uses this method

For a small, open economy like Singapore, the exchange rate is the most direct lever to influence the cost of living. Domestic interest rates, by contrast, are largely determined by global financial conditions and have a weaker effect on local inflation. By managing the currency’s path, the MAS can more precisely steer imported inflation – the main driver of price swings in the country.

This approach has given Singapore a degree of insulation from global interest rate cycles, though it also requires the central bank to constantly monitor currency movements and intervene when necessary.

What is the S$NEER?

The S$NEER (Singapore dollar nominal effective exchange rate) is a trade-weighted index that measures the value of the local currency against those of its key trading partners. The MAS uses this index as its policy target, arguing that a collective measure against the countries Singapore does business with is what matters most for overall price levels.

How does the policy band work?

The MAS does not fix the exchange rate at a specific level or control it in real time. Instead, it sets a policy band – the exact boundaries of which are kept secret – within which the S$NEER is allowed to fluctuate. If the rate breaks out of this band, the central bank steps in by buying or selling Singapore dollars to bring it back.

The band has three adjustable parameters:

• Slope: Determines the pace at which the Singapore dollar strengthens or weakens over time.
• Level (mid-point): Allows for an immediate shift in the currency’s value. This is a more aggressive tool, reserved for situations like a severe recession.
• Width: Widening the band gives the S$NEER more room to move, allowing for greater volatility without triggering intervention.

Until 2024, the MAS reviewed these parameters at least twice a year, typically in April and October. But with inflation proving more stubborn than anticipated, the central bank began holding quarterly policy meetings to respond more nimbly to economic shifts. The move toward quarterly announcements – adopted earlier this year – was designed to give policymakers a more timely platform to communicate their outlook and adjust settings if needed.

That flexibility was on full display during the 2022 inflation surge, when the MAS delivered two off-cycle tightening moves outside its regular schedule. Monday’s unexpected tightening follows a similar logic: forward-looking policy adjustments can help prevent inflation from becoming entrenched.

Broader implications

Singapore’s exchange-rate-centric policy regime means that traders and investors pay close attention not just to the band’s parameters but also to the tone of MAS statements. A tighter policy – like Monday’s – signals that the central bank expects higher inflation and is willing to let the currency appreciate more quickly. For exporters, that can mean thinner margins, but for consumers, it helps contain the rising cost of imported food, fuel and electronics.

With global supply chains still under pressure and food prices elevated, the MAS’s approach could serve as a model for other small, trade-dependent economies seeking to shield their citizens from imported inflation without following the U.S. or European rate cycle.

(Reporting by Xinghui Kok; Editing by Sam Holmes and Shri Navaratnam)