Non-Internationalization of the Singapore Dollar

Arising from the use of the exchange rate as a benchmark policy instrument, the policy of non-internationalization of the Singapore dollar was adopted in the early 1980s as a rather limited form of capital control. Singapore has eradicated all exchange controls since 1978 in order to promote the development of its offshore financial markets. Hence, residents and non-residents are free to remit Singapore dollar funds in and out of Singapore and are also free to purchase or sell Singapore dollars in the foreign exchange market. Singapore's role as an international financial center has also led to the development of a large offshore banking sector, the Asian Dollar Market (ADM), whose assets are denominated in foreign currencies. There are no controls on capital flows between the ADM and the domestic banking system, so holders of Singapore dollars can easily convert their funds into foreign currency deposits and vice versa.

However, the absence of capital restrictions means that speculative attacks on the Singapore dollar could compromise the conduct of the exchange rate-centered monetary policy. The non-internationalization policy, which restricted the international use of the domestic currency, essentially protected the Singapore dollar from speculative attacks to facilitate the effective conduct of monetary policy. At the same time, the policy ensured that the growth of the Singapore dollar market was in line with the development of the economy. Under the non-internationalization policy, safeguards were put in place to prevent a buildup of offshore deposits of the currency that could be used by speculators to short the Singapore dollar. These included allowing bank credit in the Singapore dollar to be extended to non-residents only in cases where borrowing was meant for funding real economic activities. Additionally, restrictions were imposed on inter-bank Singapore dollar derivatives to limit access to liquidity in the onshore foreign exchange, currency, and interest rate swaps and options markets in order to hinder leveraging or hedging of Singapore dollar positions. These restrictions mainly took the form of consultative requirements to limit speculative activities in Singapore's financial markets, and did not seem to have impeded trade and capital mobility (Lee, 2001).¹¹

Nevertheless, the restrictions became overly binding as the Singapore economy became more globalized and its financial industry matured. In the first place, increased demand by corporate players and financial institutions for the Singapore dollar and its derivatives for commercial transactions called for the liberalization of the policy. Secondly, the noninternationalization policy hampered the development of Singapore's capital markets, particularly the bond market. For instance, short-sales of securities and access to domestic currency credit lines are essential to deepen market liquidity (see Gobat, 2000). Hence, under the imperative to foster greater financial sector diversification the restrictions on the non-internationalization of the Singapore dollar were progressively relaxed. Four major reviews were undertaken after the Asian crisis, resulting in the lifting of restrictions to avert obstruction of market activities. Table 2 [ PDF 31.6KB | 1 pages ] below traces the evolution of the non-internationalization policy.

The current policy has only two core requirements, as stated in the revised MAS Notice 757 of 28 May 2004. First, financial institutions may not extend Singapore dollar credit facilities exceeding S$5 million to non-resident financial entities where they have reason to believe that the proceeds may be used for speculation against the Singapore dollar. Second, for a Singapore dollar loan to a non-resident financial entity exceeding S$5 million or for a Singapore dollar equity or bond issue by a non-resident entity that is used to fund overseas activity, the Singapore dollar proceeds must be swapped or converted into foreign currency before use outside Singapore. These restrictions do not apply to non-resident financial institutions and there is currently a large offshore market in Singapore dollars abroad. Nevertheless, the MAS deems the current policy useful to deter offshore speculators from accessing liquidity in Singapore's onshore foreign exchange swaps and money markets (MAS, 2002).

On the first restriction, there is clearly an element of judgment involved in determining whether a client intends to engage in speculative activities. In the words of the MAS, “Financial institutions are expected to institute appropriate internal controls and processes to comply with this restriction...[these] include [obtaining] written confirmation from the non-resident financial institution specifying the purpose of funding… and [executing a] formal evaluation process of the client profile, which provides a clear basis for assessing that the client is unlikely to use the Singapore dollar proceeds for currency speculation” (MAS, 2006, p. 3). In view of the reputation the MAS has for toughness, the financial institutions are expected to err on the side of caution when implementing this policy. As for the second restriction, which has been in effect since 28 May 2004, non resident non-financial issuers of Singapore dollar bonds and equities are no longer required to swap their Singapore dollar proceeds into foreign currencies before remitting them abroad. The amendment to the policy relieves foreign issuers from incurring the additional cost of swapping, thereby removing an advantage in directly issuing foreign currency bonds. For non-resident financial institutions, however, the requirement is retained.

With the lifting of the various restrictions, there is no longer a non-internationalization policy per se. Rather, the policy has been reduced to a lending restriction and is now known as MAS' policy on lending Singapore dollars to non-resident financial institutions. Has the liberalization of the non-internationalization policy resulted in the Singapore dollar being at risk of speculative attacks, or has the policy outlived its purpose? The past restrictions by themselves are unlikely to have been the single most important factor in protecting the Singapore dollar against speculative attacks. Rather, it is the maintenance of both internal and external macroeconomic balance as well as the absence of balance sheet vulnerabilities that offers little incentive for speculators to wage attacks against the currency or to circumvent the restrictions for speculative purposes. Furthermore, the MAS places great emphasis on the prudential supervision of financial institutions, ensuring sound credit practices and a strong capital position.¹² In addition to its strong banking system, Singapore continues to develop deep and liquid capital markets for the efficient intermediation of financial flows, thereby enhancing the resilience of its financial system to shocks.

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