An Ageing Singapore Forces Monetary Policy Reform
CPF, MAS, SGS, Ageing in 5
Singapore’s central bank, the Monetary Authority of Singapore (MAS), uniquely intervenes in exchange rates to conduct monetary policy. This leaves the domestic short-term rates to be policy-influenced rather than purely policy-driven.
Each intervention in the SGD market distorts the domestic money supply. Efforts to weaken the SGD (by selling SGD and SGD assets) injects liquidity, potentially distorting credit markets and triggering demand-push inflation. In response, many central banks sterilize their intervention by soaking liquidity via short-term securities.
MAS does not fully sterilize its FX intervention but relies on public sector operations to drain SGD liquidity domestically. MAS Bills play a complementary but not primary role in liquidity management. This article argues that MAS Bills and other short-term SGD securities should be expanded to offset the declining effectiveness of public sector operations. Especially given that demographic ageing reduces the effectiveness of public sector operations in withdrawing liquidity.
How Singapore’s Monetary Policy System Started
Originally, Singapore used reserve requirement ratios (RRR) and bank cartels to enact monetary policy. To manage inflation, MAS would raise RRR to curb credit growth and drain liquidity. Concurrently, MAS worked with the Association of Banks in Singapore to set minimum interest rates.
In a relatively underdeveloped financial market, this works well. However, such a hands-off approach by the central bank creates information gaps. Banks are left to estimate liquidity conditions themselves, which may lead to erratic movements in interest rates when they fail to anticipate fund shortfalls. In such cases, they turn to fund houses for cash, selling assets to raise liquidity. This, of course, is not ideal as it contributes to volatility in domestic interest rates.
In 1981, MAS opted to intervene in the burgeoning FX market in Singapore to enact monetary policy. This decision likely helped deepen the local FX market while providing MAS a highly liquid avenue to influence local credit and monetary conditions. (Source: MAS)
MAS Exchange Rate Policy
MAS manages the SGD against an undisclosed currency basket, likely weighted by Singapore’s trade exposure. MAS intervenes in the SGD strength through the spot and forwards market with activity being funded by FX reserves. They also enter the market only when there is too much volatility in the market or when the S$NEER approaches the upper or lower band. This band is kept confidential to prevent speculative attacks, the above figure is just a best guess as to what the band is.
How does the intervention work specifically? If the MAS desires to weaken the SGD, they are forced to sell SGD and SGD securities to buy the FX in the S$NEER. This is the most common intervention, given that the S$NEER has had a good track record of persistent appreciation due to a consistent budget surplus, high government creditworthiness, and current account surplus. This intervention is effective in maintaining the policy band but has a strong drawback: monetary base distortion.
Failure to soak up this additional monetary supply would lead to an overly liquid domestic market, which may spur non-prudent credit decisions and demand-push inflation. A successful sterilisation operation would result in little to no unexpected monetary supply growth, and the risks of an overly liquid market are reduced. The need for sterilization is universal, as every central bank that intervenes in the FX market has to sterilize these operations.
MAS’s Unique Sterilization Regime
MAS sterilization operations are rather unique, mostly due to the existence of CPF and Singapore’s persistent budget surplus.
MAS’s monetary policy operations monograph was last released in 2013, with no subsequent updates. Still, the 2013 release offers insight into MAS’s balancing act, highlighting two baskets of variables affecting liquidity: MAS FX and Money Market Operations, and Money Market Factors.
Money Market Factors consist of public sector operations, currency in circulation and SGS issuances. On the other hand, MAS FX and Money Market Operations represent the MAS’s activity in the market to achieve monetary policy goals (FX operations) and any other intervention to ensure monetary stability (Direct Borrowings and SGS Repos).
The most significant source of SGD injections are FX interventions.
MAS’s interventions aim to ensure that the S$NEER remains within the ideal policy band or is used as a tool to execute monetary policy shifts. These interventions mainly focus on achieving MAS’s macroeconomic goals and not on stabilizing the monetary supply. As such, year-by-year net FX interventions are reactive to the economic cycle, making SGD injections difficult to plan for.
Public sector operations, on the other hand, are the main source of liquidity withdrawal
Every Singaporean worker is mandated to contribute 20% of their salary to the Central Provident Fund (CPF), with gradual withdrawals permitted only upon reaching retirement age. This results in a persistent inflow of funds to CPF, which are sent to MAS as advance deposits before being transferred to public fund management services. This process constitutes a major withdrawal of cash from open market circulation in Singapore
For the Government Budget Surplus, the Accountant-General Department (AGD), which acts as the government’s accounting department, send the surplus to MAS, which acts as the government’s banker. MAS would bank the funds but is unable to make decisions on its usage. In short, MAS receives the budget surplus from the AGD to provide deposit services for the Singaporean government.
Both CPF and AGD transfers represent the “public sector operation” effect in the figure above. Due to large CPF inflows and Singapore’s persistent budget surplus, public sector operation represents the largest source of SGD withdrawal from circulation.
Since SGD injections via FX intervention are cyclical and volatile, and SGD withdrawal via public sector operations is structural and stable, MAS Bills are issued to account for the mismatch.
MAS Bills and other securities like the SORA Floating Rate Note (FRN) have even been used to soak up the unforeseen excess liquidity, named as “Direct Borrowing and Lending and net MAS Bill Issuance and Maturity” in the table above. In the 2013 money policy operation monograph, it was a relatively minor factor, frequently gyrating between injecting and withdrawing liquidity.
Since MAS does not publish Money Market data and there is only data until 2013, I used Holt-Winters Method, Spline Interpolation and MAS’s Bi-Annual FX Market intervention data to estimate the present-day liquidity impact from Money Market Factors and MAS Operations. Much like the 2013 monograph, my estimates show that FX operations and Public Sector Operations remain the primary liquidity variables.
Preserving the current liquidity regime requires 3 factors: first, a persistently appreciating SGD, second, ample FX reserve for interventions (with willing counterparties); and third, large persistent savings from Governemnt Surplus and CPF contributions.
Singapore’s ageing economy could derail the persistent savings factor.
Although Singapore’s CPF is a self-funded pension, the effects of CPF contribution and withdrawal can be aggregated to study its macroeconomic effects. Singapore’s population pyramid suggests a quickly ageing society with a large cohort of people entering the retirement age bracket (65+). In the next 5-10 years, more than 500,000 people will be eligible for CPF fund withdrawal. This presents a possibility of a structural change in Singapore as CPF may see fund inflows slow or even turn into a net withdrawal.
At the same time, the Singaporean government have been raising healthcare spending in recent years to accommodate this larger cohort of elderly. Despite the recent step-up in GST rates, the gradual compounding growth of healthcare costs will likely lead to smaller budget surpluses over time.
As such, with CPF contributions likely slowing while budget surpluses look to narrow, public sector operations may be less effective at withdrawing liquidity from the system. This means that MAS Bills, which are used to flexibly soak up or add liquidity, have a growing importance in Singapore’s liquidity management regime.
Telok Ayer’s estimates suggest that MAS bills and related securities have helped offset almost 60% of the liquidity withdrawn via Money Market Factors in FY22/23. Although their stabilizing role has been focused on adding liquidity recently, this could quickly change once public sector operations’ liquidity withdrawal starts to slow. As such, MAS bills and related securities have grown in importance as money market instruments used to sterilize the effects of FX interventions.
Reforms to Make MAS Bills More Effective
Since MAS Bills and SORA FRNs issuances withdraw liquidity from the system via the MAS Bill market, and MAS purchases of those securities inject liquidity. As such, a deeper MAS Bill market has to be developed to facilitate a larger volume of liquidity injection and withdrawals. The most recent auction for MAS Bills had a bid-to-cover ratio of 1.97x, which is decent but lower than SGS auctions. An expanded role of MAS Bills and related securities may not be viable now as the demand for these instruments is simply not sufficient.
MAS needs to improve the attractiveness of MAS Bills, and Telok Ayer has a few suggestions to facilitate it.
First, MAS could expand their repo facility using the MAS Bills. Presently, banks can access MAS funding through MAS Standing Facility and Intraday Liquidity Facility using MAS Bills as collateral. However, this means that institutional investors can only access the SGD Term Facility, which does not require the use of MAS Bills as collateral. To boost its attractiveness to asset managers and hedge funds, MAS could establish a Tri-Party Repo arrangement to allow them to access repo facilities through a domestic bank like DBS or OCBC. This will boost the case for local fund managers to use the MAS Bill as a risk management tool with assurances of access to short-term funding. Increasing access to MAS reverse repo activity may also support the development of a derivative market for MAS Bills, further deepening the MAS Bill market. This would enhance the effectiveness of MAS Bills and related securities, enabling them to compensate for any shortfall in liquidity withdrawal should public sector operations take on a reduced role.
Second, MAS could regionalize MAS Bills and its related securities while preserving the “non-internationalization” of the SGD. In the wake of the 1997 Asian Financial Crisis and the 2008 Great Recession, Asian policymakers have flirted with the idea that SGD could act as a regional currency to mitigate risks related to relying on major external currencies. However, MAS have been staunchly opposed to internationalizing the SGD, although it has since softened its stance. Internationalizing MAS Bills could be a possible solution to please all parties.
Since regional economies require a stable safe haven asset, allowing foreign banks and intermediaries to hold MAS Bills and other related securities as a risk management tool could deepen Singapore’s MAS Bill market. Of course, several measures like ensuring that the foreign purchases of MAS Bills are fully hedged via FX Swaps are needed. This ensures that foreign buyers of MAS Bills use it as a risk management tool and not a speculative FX asset. Regionalization of the MAS Bill would introduce many more potential counterparties in the Singapore MAS Bill market and allow MAS Bills to play a greater role in liquidity management. Of course, this reform should be gradually rolled out and only undertaken when MAS have begun to rely on MAS Bills as one of the primary sources of liquidity management.
Conclusion
MAS have historically shown its pragmatism and has had rather creative solutions to unique problems. Ageing in Singapore has been extensively discussed, but its effects on the MAS Bill market are much less studied. A smaller budget surplus and shrinking net contributions from CPF due to ageing are quite likely, and the MAS have to anticipate these changes. Expanding the MAS Bill market by improving its attractiveness is a potential long-term solution to the weakening capability of public sector operations’ liquidity withdrawal function.