RVHS_H1_ECONS_P1_Essay_Q4_Soln

2017 RVHS Prelims II (Y6 H1 8819) a) Explain the factors that will affect the externa l value of Singapore dollar. [10] b) Discuss whether exchange rate policy is the best policy to achieve price stability in Singapore. [15] ________________________________________________________________________ a) Explain the factors that will affect the externa l value of Singapore dollar. [10] Introduction The external value of Singapore dollar (SGD) (also referred to as the exchange rate of SGD) is the amount of foreign currency that can be exchanged for SGD. The external value of SGD is determined by the demand and supply of SGD. Body One of the factors affecting the external value of Singapore dollar is the amount of goods and services internationally traded. For example, with an increase in income and a change in taste and preferences towards goods and services from Korea like overseas trip to Korea, that will lead to an increase in supply of S GD from S 0 to S 1 in exchange for Korean Won as shown in Figure 1. At the same time, an increase in demand for Singapore exports like an increase in demand for electrical machinery from Korea will lead to an increase in demand for SGD from D 0 to D 1 as shown in Figure 1. As seen, it is the intersect ion of demand and supply of SGD that determines the extern al value of SGD. As the increase in demand is more than the increase in supply of SGD i n this case, SGD appreciates from E 0 to E 1. Another factor affecting the external value of Sing apore dollar is the amount of capital flows into and out of Singapore. As Singapore does not determine her own interest rate and is an interest rate taker, interest rate in Sin gapore is likely to increase with US interest rates on the upward trend. Comparing to countries where interest rates is lower e.g. Japan, this will lead to hot money inflows into Singapore. This will lead to an increase in demand for SGD and will cause SGD to appreciate. Another factor is the type of exchange rate regime in Singapore. Singapore adopts a managed float exchange rate regime and the characte ristics of Singapore exchange rate are basket, band and crawl. MAS conducts direct int erventions in the foreign exchange market to maintain the exchange rate within an undi sclosed policy band. For example, if D0 D1 S0 S1 Quantity of SGD KRW / SGD 0 Figure 1: Determination of the external value of SGD Q0 Q1 E0 E1

the exchange rate falls below the lower support lim it, MAS will then intervene by buying SGD using its foreign reserves, this will increase the demand for SGD in the foreign exchange market so that SGD falls within the band again. Illustrated above are some factors that will affect the demand and supply of SGD and thus, the external value of SGD. Knowledge, Understanding, Application & Analysis L3 Developed explanation, with examples, on three fact ors that will affect the external value