Crunch time for Singapore Dollar and Renminbi

We estimate that the USD-value of central bank FX reserves – adjusted for currency-valuation effects – in China, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand rose by about $342bn (1.5% of GDP) between end-March 2020 and end-February 2021 (see Non-Japan Asia: NEERs and FX intervention, 26^th March 2021).

The increase, which ranged from 0.3% of GDP in China to nearly 28% of GDP in Singapore, was partly the result of central banks buying foreign currency in the FX market. At the very least NJA central banks’ FX intervention capped the pace of appreciation (CNY, KRW, IDR, THB and TWD) or contributed to (modest) NEER depreciation (INR, MYR, PHP), in our view.

Of course the matrix of exchange rate policy AND balance of payment flows, and their underlying drivers, is key to past and future currency performance.

In the past 12 months the MAS has kept the Singapore Dollar NEER within a very narrow range of about 1.2%, effectively neutralising Singapore’s significant current account surplus, to support the critical external sector and ultimately reflate the economy.

However, the Singapore Dollar NEER’s recent rally and jump in Singapore CPI-inflation in February arguably complicate the currency’ near-term outlook.

Along with consensus, we forecast that the MAS will leave the parameters – (zero) slope, width and central rate – of the Singapore Dollar NEER band unchanged at its forthcoming semi-annual policy meeting. We think the NEER could dip temporarily before rebounding.

The People’s Bank of China has allowed large external trade surpluses and capital account inflows into China to push the Chinese Renminbi NEER to a 270-week high.

But the Renminbi is showing some signs of altitude sickness. The pace of monthly appreciation has halved recently and the PBoC has fixed USD/CNY higher in 6 of the past 7 sessions. Importantly CPI-inflation remains stuck at the bottom of its five-year ranges.

In this context, we think the risk is biased towards the PBoC more actively negating FX inflows into China and towards modest Renminbi NEER downside near-term.

Non-Japan Asia central banks’ FX reserves have steadily increased since March 2020 dip

In Part One of this FIRMS report, we estimated that the US Dollar-value of central bank FX reserves – adjusted for currency-valuation effects – in China, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand increased in aggregate by about $342bn (6.4%) between end-March 2020 and end-February 2021 (see Non-Japan Asia: NEERs and FX intervention, 26^th March 2021). As a percentage of GDP, this increase in adjusted FX reserves amounted to about 1.5% for Non-Japan Asia (NJA), ranging from only 0.3% in China to nearly 28% in Singapore (see Figures 1 & 2).

NJA central banks do not disclose details about the currency or asset composition of their FX reserves nor about the timing or size of their interventions in the FX markets[1]. Therefore some of this increase in FX reserves was conceivably due to realised investment gains on these central banks’ holdings and transactions between central banks and their governments.

However, in our view, it was at least partly the result of central banks buying foreign currency (selling local currency) in the FX market, commonly referred to as FX intervention. For example the central bank of Taiwan’s Department of Foreign Exchange Director-General Tsai Chiung-min has argued that the rise in the US Dollar-value of FX reserves to a record-high of $543.33bn at end-February was partly due to higher returns from the bank’s investments and other reserve currencies’ appreciation versus the US Dollar. However, he also publicly acknowledged that the CBC in the past few months had taken measures (including buying US Dollars) to slow the Taiwan Dollar’s appreciation.

NJA central bank FX intervention’s twin objectives: cap volatility and pace of appreciation

NJA central banks’ active currency management, which includes FX intervention but also foreign exchange regulations for both domestic and foreign entities, seemingly has two interlinked objectives, namely to:

1. Curb short-term FX volatility to ensure amongst other things the smooth functioning of financial markets; and

2. Influence their currency’s medium-term directionality

• • The Bank of Korea (BoK) refers to FX Market Stabilisation Measures.

• • The Bank of Thailand (BoT) operates a “managed float exchange rate regime”, with a “foreign exchange management framework that aims to maintain its stability. The BoT does not target the exchange rate at any specific level, but monitors and oversees the exchange rate movements to be in line with economic fundamentals and not too volatile as it might deter economic sector adjustment and cause severe adverse impacts on the economy”.

• • In Taiwan, the CBC operates a flexible exchange rate system, with the Taiwan Dollar exchange rate determined by the market. “However, when the market is disrupted by seasonal or irregular factors, the Bank will step in”.

Importantly, while NJA central banks may try to curb short-term volatility against major trading partners’ currencies (e.g. the Chinese Renminbi and US Dollar), we would argue that they attach greater importance to their currency’s Nominal Effective Exchange Rate (NEER), when setting their medium-term exchange rate and interest rate policies, than to their currency’s bilateral exchange rates. The NEER – a trade-weighted average of nominal bilateral rates between a country’s currency and the currencies of its main trading partners[2] – is arguably a far more relevant measure of a country’s export competitiveness and a currency’s potential impact on imported prices.

For this reason the Monetary Authority of Singapore (MAS) explicitly targets the Singapore Dollar NEER, using a number of monetary policy tools, including FX intervention, to keep the Singapore Dollar NEER in an undisclosed band which it officially revises twice a year, in April and October. Moreover, in December 2015 the China Foreign Exchange Trade System (CFETS), a sub-institutional organization of the People’s Bank of China (PBoC), introduced a new exchange rate index which values the Renminbi against a basket of 13 trade-weighted currencies (see Far more to Renminbi than USD/CNY cross, 8^th December 2020).

This would explain both the limited short-term volatility in NJA exchange rates against the US Dollar, Chinese Renminbi and in NJA NEERs as well as the limited monthly seasonality in Non-Japan Asian NEERs, including in the past 12 months (see Non-Japan Asia: NEERs and FX intervention, 26^th March 2021, and Currency seasonality’s slow comeback?, 2^nd February 2021).

At the very least FX reserve accumulation between end-March 2020 and end-February 2021 either capped the pace of appreciation or in some cases contributed to (albeit modest in most cases) NEER depreciation (see Figure 3). Specifically, according to our NEER calculations using BIS currency weights, in the 11 months to end-February 2021:

• Indian Rupee depreciated 3.7%;

• Malaysian Ringgit and Philippines Peso depreciated by respectively 0.6% and 1.8%;

• Singapore Dollar was broadly unchanged;

• Thai Baht, Taiwan Dollar and Korea Won appreciated by respectively 0.5%, 2.0%, and 2.1%;

• Chinese Renminbi and Indonesian Rupiah appreciated by respectively 4.2% and 7.4%.

The motives behind NJA central banks’ FX intervention against their currencies were likely numerous and flexible but, in our view, probably boiled down to the twin objectives of i) maintaining export competitiveness (and gaining market share in international trade) in a bid to spur economic growth during the pandemic and ii) limiting imported deflation.

Matrix of exchange rate policy and BoP flows key to past and future currency performance

Of course individual currencies’ performance over this 11-month period was conditioned by both the magnitude of central banks’ FX intervention AND the weakness or strength of (net) current account inflows (trade balance, tourism, worker remittances) and capital account inflows (foreign direct investment, equity and bond flows and other speculative flows). This matrix of exchange rate policy and market forces, and their underlying drivers, is a crucial determinant of the past and future performance of these NJA currencies – and the topic of Part Two of this FIRMS report which will focus on the Singapore Dollar and Chinese Renminbi. Part Three will cover the other NJA currencies.

As a starting point NJA NEERs have followed widely differing paths since mid-February (see Figure 4).

Singapore Dollar – Dip and rebound scenario

MAS monetary policy and domestic macro data have so far broadly stuck to script, in our view. However, the Singapore Dollar NEER’s recent rally to the top end of a 12-month range of about 1.2% and jump in CPI-inflation in February arguably complicate the currency’ near-term outlook. Along with consensus, we forecast that the MAS will leave the parameters (slope, width and central rate) of the Singapore Dollar NEER band unchanged at its forthcoming semi-annual policy meeting. We think the NEER could dip temporarily before rebounding.

In its April 2020 Monetary Policy Statement (MPS), released on 30^th March 2020, the MAS announced a flat (zero appreciation) Singapore Dollar NEER policy band, centered around the prevailing NEER level. The MAS does not disclose the width of the band or the currency weights in its NEER calculation and therefore it is only possible to estimate the Singapore Dollar NEER’s relative position within the band. We do so using BIS currency/trade weights, with the level on 30^th March 2020 denoted by a red diamond in Figure 5.

In its 14^th October MPS the MAS announced that the slope (zero), width and centre of the band remained unchanged. We would note that, according to our estimates, the prevailing Singapore Dollar NEER level on 14^th October was unchanged from 30^th March 2020 (see green diamond in Figure 5). The MAS also forecast that both core CPI-inflation (which excludes accommodation and private transport prices) and headline CPI-inflation would average -0.5% to 0% in 2020.

Importantly the MAS stated that in view of this benign core CPI-inflation forecast “an accommodative policy stance will remain appropriate for some time. This will complement fiscal policy efforts to mitigate the economic impact of COVID-19 and ensure price stability over the medium term”. MAS monetary policy and macro data have so far broadly stuck to script, in our view.

• In the past year the MAS has kept the Singapore Dollar NEER within a very narrow range of about 1.2% according to our estimates (see Figure 5). It has effectively neutralised Singapore’s significant current account surplus (17.6% of GDP in 2020) and other balance of payment inflows by accumulating FX reserves to the tune of 28% of GDP between end-March 2020 and end-February 2021 (see Figure 2).

• The Singapore Dollar’s competitiveness arguably contributed to robust export growth of 17% yoy in January-February 2021 and a more than fivefold increase in the goods trade surplus (see Figure 8). Seasonally-adjusted GDP growth in the small and very open Singaporean economy rebounded 14.5% in the second half of 2020.

• Core and headline CPI-inflation both averaged -0.2% in 2020, in line with the MAS’ October forecast. Year-on-year core CPI-inflation remained in negative territory in the 12 months to January 2021 (see Figure 6) while headline-CPI inflation oscillated around zero (see Figure 7). This can be attributed to depressed i) international commodity prices and ii) consumer demand-led inflation due to slack in the Singaporean labour market and limited wage pressures.

Ultimately, the MAS opted to keep the Singapore Dollar on a tight leash to help support the critical external sector and reflate the economy in real and nominal terms. The MAS arguably faced a similar macroeconomic backdrop during the 2008-9 financial crisis and adopted a similar exchange rate policy.

However, the Singapore Dollar NEER has appreciated about 0.9% in the past fortnight and 0.5% since the MAS Monetary Policy Announcement on 14^th October to its strongest level since 4^th February 2020, according to our calculations (see Figure 5). As of 31^st March 2021 the Singapore Dollar NEER was trading at the top of its one-year range of about 1.2%.

The MAS’ perception of the reflationary benefits of a “weak” currency may have shifted incrementally in recent weeks in favour of limiting imported inflationary pressures. Core and headline CPI-inflation rose to 13-months highs of, respectively, 0.2% yoy and 0.7% in February according to data released on 23^rd March (see Figures 6 & 7). While core CPI-inflation was within the MAS’ October forecast range for 2021 of 0-1%, headline CPI inflation exceeded its forecast range of -0.5% to 0.5%. Singapore, along with Taiwan, is one of only two NJA economies with headline CPI-inflation near the top of its (admittedly narrow) five-year range (see Figure 7). At the very least markets may have been testing the MAS’ tolerance to even a mild and temporary headline CPI-inflation “overshoot” and by extension to currency appreciation, with the ultimate goal of trying to ascertain the upper end of the MAS policy band.

The consensus forecast, which we share, is that the MAS will not change the parameters of its Singapore Dollar NEER band when it announces its April 2021 MPS on or before 14^th April, according to a Reuters poll of 15 analysts published today. If this proves correct, the NEER may dip temporarily (we would not expect a large correction on the basis that markets will have taken notes of analysts’ core scenario). However, we see a risk that markets again try to “force” the MAS in revealing the upper level of its band – i.e. the level at which MAS would intervene more forcefully in the FX market (buying foreign currency) – and therefore that the Singapore Dollar NEER rebounds. 

Chinese Renminbi at 270-week high but first signs of altitude sickness

The PBoC seemingly only intervened very modestly in the FX market in the 11 months to end-February 2021 – its currency-adjusted FX reserves rose by about 0.3% of GDP (see Figure 2) – allowing significant balance of payment inflows to appreciate the Renminbi NEER by about 4.2% (see Figures 3 & 9). Put differently the PBoC “neutralised” (by buying foreign currency) only a very small fraction of large foreign-currency balance of payment inflows into China, according to our estimates.

China ran a current account surplus of $334bn in Q2-Q4 2020 (about 3.1% of annualised GDP) and despite the Renminbi’s loss of export competitiveness, the $-value of merchandise exports rose over 60% yoy in January-February 2021 and the (annualised) trade surplus surged to nearly 3% of GDP (see Figure 8). Moreover, China’s rapid economic recovery and relatively high bond yields have attracted large FDI inflows ($26.1bn in January-February, +34.2% yoy), portfolio and speculative inflows (see Far more to Renminbi than USD/CNY cross, 8^th December 2020). Finally capital controls and restrictions on international travel have restricted, respectively, capital account outflows from China and outbound tourism.

The PBoC was seemingly not overly concerned that a stronger Renminbi would stop China from increasing its share of global trade and ultimately boosting headline economic growth. After all, throughout the pandemic China has been one of the few major exporting nations to have remained “open for business”.

However, while the Renminbi NEER was trading at a 270-week high on 31^st March according to our estimates, it appreciated only modestly in March (+0.6%) and the pace of monthly appreciation has halved in recent days (see Figures 4 & 9). Notably the PBoC has fixed the USD/CNY central parity rate higher in six of the past seven trading sessions by a cumulative 0.8% (USD/CNY spot is allowed to trade +/-2% around the daily fix). The PBoC has effectively weakened the Renminbi against an appreciating Dollar, which accounts for about 20% of the Renminbi NEER according to the BIS, and thus capped the pace of Renminbi appreciation (see Figure 10). Assuming that balance of payment inflows into China have remained strong in the past week, this would imply that the PBoC may have stepped up its FX intervention (buying FX, selling Renminbi).

The PBoC will want to maintain its exports’ competitive edge in order to capitalise on a likely pick-up in global demand driven by an easing of national lockdowns (in the context of mass vaccination programs), in our view. Perhaps more importantly, the PBoC may arguably want to minimise deflationary pressures. While year-on-year PPI-inflation rose from +0.3% in January to a 26-month high of +1.7% in February, core and headline CPI-inflation were respectively zero and -0.2% (the second consecutive month of deflation), both at the bottom of their five-year ranges (see Figures 6 & 7).

In this context, we think the risk is biased towards the PBoC more actively negating FX inflows into China and towards modest Renminbi NEER downside near-term.

[1] The Bank of Korea releases the size of Dollars purchases/sales only on a quarterly basis and with a lag

[2]  For this reason the NEER is also referred to as the Trade Weighted Index (TWI).