MAS’ attempt at currency control is mission impossible: DBS

DBS says the central bank’s US$17bn intervention in currency markets in October is part of its attempt to do the impossible— to control the currency and interest rates at the same time that capital is free to come and go.

In a statement, the bank said Singapore is “butting heads with the impossible trinity” Nobel Prize-winning economist Robert Mundell theorised — that currency and interest rates cannot be controlled at the same time as capital.

For DBS, it seems as if Singapore, wants all three.

“As capital flowed into the country in October more than at any other time in history (save for Mar08), 3m Sibor remained almost rock-steady, dropping by a nearly nonexistent 6bps to 0.44%. If that’s not having your cake and eating it too, nothing is,” the bank said.

Massive capital inflows forced the central bank to intervene in foreign exchange markets to the tune of US$17bn in October, equivalent to 90% of October GDP. The amount was split about equally into $8.2bn of spot market intervention and $8.6bn of forward market intervention .

The bank said that inflows are likely to continue as a consequence of the currency regime in place that is forcing Singapore’s interest rates skyward.

According to DBS, the management of the Singapore dollar against a basket of 20 or more trading partner currencies should mean that as the currency appreciates by 3%, the interest rates should now be 3% below the basket interest rate, which is not the case.

“Sing rates, [however], are not negative. The point is that’s where Sibor needs to be, given the 3% currency appreciation, if capital flows are to stabilize,” the bank said.

DBS said that for the inflows to stop and for the rate to bounce back positively, Singapore must do a combination-- but not all-- of the following:

• lower interest rates
• a large currency overshoot
•  implement wider currency bands
• undertake an ever greater intervention in the forward market
• put controls on inflows or
• [launch an] event which “frightens investors away.”

DBS said that as Singapore is likely to fail defying the “impossible trinity,” it should just settle for control of any two variables-- not all.

" Something, it seems, has to give," the bank said.

View the graph here.