A Managed Float: Singapore’s Exchange Rate-Centred Monetary Policy

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In this Explainer, find out...

1. What is monetary policy?

2. How does Singapore’s exchange rate-centred monetary policy operate?

3. What are the strengths and trade-offs of an exchange rate-centred monetary policy?

Introduction

Interest rate cuts and hikes by the United States (US) Federal Reserve often capture keen attention from an international audience. This is not surprising: interest rates have an impact on a range of economic outcomes, including the price of everyday products and the cost of borrowing. For the average consumer, therefore, these changes in interest rates play an important role in shaping the cost of coffee and monthly rents.

More broadly, managing interest rates is one (although not the only) way authorities conduct monetary policy. Monetary policy refers to actions taken by monetary authorities to influence economic and financial conditions in a country. These interventions aim to achieve broad macroeconomic objectives, such as sustained economic growth, low and stable inflation, and low unemployment.

In most economies, these policies are not implemented directly by Governments. Instead, they are carried out by a country’s central bank, which is a country’s primary monetary authority. The central bank conducts monetary policy in ways such as controlling the exchange rate or managing interest rates. This choice depends on the nature of the country’s economy. The central bank operates independently from the Government, although the degree of independence varies across countries.

In this Policy Explainer, we will explore what “monetary policy” is and what it aims to achieve. We will then consider why Singapore, unlike other countries like the US, operates an exchange rate-centred monetary policy. This means that Singapore’s monetary policy is implemented through changes in the exchange rate of the Singapore dollar, instead of interest rates. Thereafter, we will examine how Singapore conducts its monetary policy. Finally, we will survey the key strengths and trade-offs of this exchange rate-centred monetary policy.

A Small and Open Economy

Singapore, being a small city-state, lacks natural resources and is heavily reliant on imports. Imports of goods and services account for 144.13 per cent of Singapore’s gross domestic product (GDP). Furthermore, Singapore’s absolute share of global consumption is minimal. Even significant shifts in Singapore’s domestic demand and supply are insufficient to sway global market equilibrium. As a result, the economy remains highly sensitive to international price fluctuations. Thus, it is a price taker in the global economy and must accept these prices as given.

Singapore’s domestic expenditure is heavily focused on imports, as the country relies on them for most of its basic needs, such as food, energy and raw materials. With about 40 cents of every dollar spent domestically going towards imports, Singapore’s heavy reliance on imports makes it vulnerable to foreign inflation. When the cost of raw materials or energy rises globally, it drives up domestic production costs and exacerbates the already high cost of living. By targeting the exchange rate, Singapore can directly moderate the domestic price of essential imports, thereby reducing the impact of cost-push inflation.

Singapore’s openness has played a major role in its economic growth, with gross exports and imports of goods and services exceeding 300 per cent of its GDP. This creates a high degree of import sensitivity. A weaker currency typically makes exports cheaper. However, for Singapore, it primarily increases the unit cost of production by raising the price of imported raw materials. As Singapore’s exports have a high import content, these rising input costs eventually force exporters to raise their prices. Consequently, any gain in export price competitiveness from a weaker currency is offset by higher costs of imported inputs. This ultimately reduces the quantity demanded by foreign buyers, thereby decreasing the amount of exports.

As Singapore is an economy that is driven by exports, the exchange rate has a more direct and powerful transmission mechanism. Since exports and imports dominate the economic landscape, managing the exchange rate is crucial. It allows the MAS to effectively filter out global inflationary pressures before they seep into the domestic economy.

However, while some countries ensure price stability through interest rates rather than exchange rates, Singapore does not adopt this strategy. This is attributed to the Mundell-Fleming trilemma, which explains that a country cannot fully achieve all three of the following at the same time:

1. Maintaining an open capital market with free movement of capital;

2. Managing the interest rate; and

3. Managing the exchange rate.

It can only choose two of the three policy choices.

As a global financial hub, Singapore prioritises the free movement of capital to foster a competitive and open economy. This approach helps to attract more foreign direct investments. It also uses a managed exchange rate to ensure price stability. By making these two choices, Singapore must give up control over its domestic interest rates. Since Singapore is deeply integrated into global financial markets, it is highly exposed to international capital flows. As a result, even small differences between domestic and foreign interest rates can trigger large and rapid inflows and outflows of foreign capital. This happens because investors move their money to countries that offer higher returns. Due to Singapore's high import dependence and open capital markets, attempting to control interest rates would destabilise the exchange rate. This volatility would lead to unpredictable fluctuations in the cost of essential imports. As a result, maintaining price stability would become difficult, undermining the core objective of monetary policy.

Overall, the exchange rate has a much stronger influence on inflation than the interest rate in Singapore’s context.

Managing Exchange Rates

The central bank uses the value of domestic currency, rather than interest rates, as its main tool to achieve macroeconomic stability. It aims to manage the currency by:

1. Allowing appreciation to curb inflation;

2. Allowing depreciation to support economic growth; or by

3. Taking a neutral position, depending on the economic conditions.

It does this by varying the monetary base through the consistent buying and selling of its own currency in the foreign market. This policy reduces imported inflation and keeps the prices of essential imported goods and services stable for the local population, moderating the cost-of-living. This strategy is extremely effective in small and trade-reliant economies, such as Singapore and Brunei. In such economies, the currency’s strength has a more immediate effect on the cost of living than the domestic cost of borrowing. 

Singapore’s Monetary Policy

The Monetary Authority of Singapore (MAS) is the central bank of Singapore. It employs a unique policy approach where the exchange rate is the primary method to regulate price stability. More specifically, it uses the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) as its main policy tool. The MAS manages the Singapore dollar against a trade-wide basket of currencies within an undisclosed policy band. The policy band is defined by three main parameters, namely:

1. The slope or rate of appreciation;

2. The mid-point or level of the band; and

3. The width, which is the range of fluctuation.

Using all three, the MAS is able to control the strength of the currency. In severe economic conditions, such as a recession or surging global prices, the MAS may implement a policy shift. This may involve recentering the midpoint of the exchange rate band, an adjustment that can help to stimulate economic growth. Therefore, by varying the monetary base through market intervention, the MAS ensures the currency is stabilised within the policy band. This helps curb imported inflation by keeping the price of imported goods lower, as well as protecting the domestic cost of living in Singapore.

Examples of Singapore's Policy Implementation

2008 Global Financial Crisis

The 2008 Global Financial Crisis showed how the MAS used Singapore’s exchange rate-based monetary policy to support the economy during a recession. The crisis began in the US due to a collapse of the housing market and financial institutions. This served as a catalyst for a sharp reduction in global trade and capital flows. As an export-oriented country, the crisis led to Singapore experiencing a sharp decline in external demand in 2009.

Therefore, MAS adjusted its exchange rate policy by adopting a zero dollar appreciation stance and re-centering the policy band downward. This effectively allowed the Singapore dollar to weaken modestly, which helped to support export competitiveness. As goods became cheaper and more attractive to foreign buyers, there was a significant boost in international sales volume. Hence, local businesses were able to expand their global market share. This facilitated the return of foreign income into the domestic economy, cushioning the downturn.

2026 Strait of Hormuz Crisis

Tensions around the Strait of Hormuz stem from a long history of geopolitical rivalry and conflict in the Middle East. The crisis escalated following the February 2026 US-Israeli airstrikes on Iran. Iran retaliated by suspending operations and traffic in the Strait of Hormuz. The Strait is a vital global shipping route, and its closing impacts the supply of various goods, with severe implications for global economic security. The crisis caused sharp spikes in commodity prices, leading to potential inflation and cost of living pressures.

This is a problem for Singapore, a small and open economy that imports almost all of its energy, as higher global oil prices translate to higher domestic costs. In response, the MAS utilised its exchange rate-based monetary policy by allowing the Singapore dollar to appreciate at a slightly faster pace. This helped to slow down rising prices and reduce cost of living pressures. 

Opportunities and Concerns

Given the above, we are now ready to consider the relative strengths and weaknesses of Singapore’s exchange rate-centred monetary policy.

Success of the Policy

To begin, it is clear that an exchange rate-centred monetary policy has been fit for purpose. One of the key goals of a monetary policy is to maintain a low and stable rate of inflation. Since 1981 when MAS first officially adopted an exchange rate-centred monetary policy, inflation has remained low and stable. Singapore’s domestic inflation has averaged 1.9 per cent per annum between 1981 and 2023. This is a significant change from the highs of 8.4 per cent inflation in the early 1980s and some 7 per cent in the 1970s.

That this policy has been successful is perhaps not surprising. As pointed out above, an exchange rate-centred policy fits the needs of Singapore’s unique economy. Particularly, it targets the most likely source of inflation, since Singapore’s economy is small and open and hence particularly vulnerable to external shocks.

Trade-offs

That said, there are also trade-offs to an exchange rate-centred monetary policy.

First, a stronger Singapore currency will mean that Singapore’s exports become less competitive. This is because Singapore’s exports will be more expensive for foreigners in terms of their domestic currency. This will be a bane for Singapore’s exporters.

Indeed, it was only recently that a “tough Singdollar policy decision” had to be made because of the war in the Middle East. This difficulty arose out of a surge in the prices of energy and electricity, raising the question of whether Singapore’s currency should be appreciated. As has been noted, Singapore’s GDP is still dependent on the global demand for its exports. Changes in exchange rates therefore have significant bearing for the larger economy.

That said, it may be argued that in the longer term, this conflict between appreciating the Singapore currency and growth will cease to exist. This is because appreciating Singapore’s currency can help to keep production costs in Singapore low. For example, if there is a surge in global energy and electricity prices and Singapore appreciates the Singapore dollar, the rise in production costs for Singapore producers will be mitigated. In turn, this will mean that if energy and electricity prices remain higher globally, Singapore products may be more competitive economically. This is because domestic manufacturers produce at a lower cost and sell for cheaper prices, in turn helping to promote economic growth.

A second possible trade-off comes in the form of the corollary to the first one. At first glance, it might seem like depreciating the Singapore dollar is a good way to avoid threats to economic growth. However, such depreciation can lead to significant inflation. Indeed, MAS has recognised that in such a scenario, the benefit of the initial growth can be eroded quite quickly by the subsequent rise in inflation. Some individuals might also be significantly affected by a depreciation of the currency. For example, Singaporeans planning overseas trips or those who are paying large sums for their children studying overseas could be especially affected. Furthermore, MAS has also cautioned that “by acquiring a reputation for making the currency weaker, MAS’ commitment to a strong S$ and investors’ confidence in Singapore as a financial centre could be undermined”.

Limitations

There could also be limitations to an exchange rate-centred monetary policy.

A first limitation is that MAS requires large amounts of economic data to conduct an exchange rate-centred monetary policy successfully. An exchange rate that is too high or too low can create problems for Singapore's economy. Nevertheless, the reality remains that it is difficult to have complete information. This makes it challenging to forecast how international and domestic economic conditions may evolve. Therefore, implementing the policy remains a real challenge.

Second, there are also concerns that an exchange rate-centred monetary policy will take time to work. A key mechanism inherent in the policy lies in how different stakeholders in the economy respond to price changes. 

For example, if the Singapore dollar is appreciated, import costs will decrease in terms of Singapore dollars. This, at least in theory, should reduce the costs charged by importers to Singapore consumers and therefore lower the prices consumers face. In practice, however, this might not always play out immediately because there are other costs which are locked in under fixed contracts. For example, the importer might have an existing contract for warehouse and transportation services which in fact cannot be terminated as of yet. This means that the actual decrease in costs for the importer might be lower at least in the short term. Hence, consumers may not experience any immediate changes to the prices they face. Therefore, we should be attentive to the fact that any monetary policy move takes time to “gradually flow through the economy”.

Divergent Approaches to Monetary Policy

Different economies prioritise either interest rate-based monetary policy or exchange rate-based monetary policy to maintain price stability. For example, the US, with its large domestic economy, depends more heavily on domestic consumption than external trade to drive its growth. Hence, the Federal Reserve is able to focus on the cost of borrowing for its own citizens. This allows it to place little importance on the fluctuations in the dollar against other currencies, as most of their spending is internal.

However, economies that are smaller and more open experience frequent inflows and outflows of financial capital. For example, Hong Kong, with its smaller domestic market, relies heavily on international trade. To appeal to investors and ensure that trade remains constant, Hong Kong employs a Fixed Exchange Rate, pegging the value of its currency to the US dollar. This provides exchange rate stability at the expense of independent interest rate control. Should Hong Kong keep their interest rates low while the US raises theirs, there will be capital outflow, putting downward pressure on the Hong Kong dollar. The Hong Kong Monetary Authority, which is Hong Kong’s central bank, will then have to intervene. It would do so by selling US dollars and buying Hong Kong dollars to maintain the peg. This intervention can place upward pressure on interest rates and creates instability in the financial market.

Singapore adopts a “managed float” system, targeting the S$NEER. Instead of targeting interest rates, the MAS manages the value of the Singapore dollar against a trade-weighted basket of its major trade partners. This approach is a strategic mix of the above two techniques. This ensures that our economy is not overly affected if a particular major currency, like the US dollar, fluctuates drastically.

Conclusion 

Singapore’s status as a small and open economy is one that has required unique policy choices. Perhaps one of Singapore’s most significant policy choices has been its commitment to an exchange rate-centred monetary policy. Empirically, it is clear that this approach to monetary policy-making has served Singapore well, especially in maintaining a low and stable rate of inflation.

That said, trade-offs are often built into economic policies and Singapore’s exchange rate-centred monetary policy is no exception. Changing exchange rates can potentially affect economic growth. Issues relating to how fast the policy will take effect and how MAS acts in light of a lack of perfect information also complicate the implementation of the policy. There is, in turn, a fine balance to continuously tread.

MAJU_PE_17_A Managed Float_ Singapore’s Exchange Rate-Centred Monetary Policy.

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This Policy Explainer was written by members of MAJU. MAJU is a ground-up, fully youth-led organisation dedicated to empowering Singaporean youths in policy discourse and co-creation. 

By promoting constructive dialogue and serving as a bridge between youths and the Government, we hope to drive the keMAJUan (progress!) of Singapore.

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