Singapore Dollar to weaken against the US dollar?

I read with interest the recent prediction by Morgan Stanley that Singapore Dollars will depreciate against the US dollar to $1.80 by next year. I decided to explore this prediction further, fundamentally.

Monetary Authority of Singapore Policy (MAS) on Singapore Dollar (SGD)

A check with policy statement of MAS's website shows that MAS manages SGD exchange rate. The following is quoted from the website:

... The objective of Singapore's exchange rate policy has always been to promote sustained and non-inflationary growth for the Singapore economy. Since 1981, monetary policy in Singapore has been centered on the management of the exchange rate. MAS manages the Singapore dollar against a basket of currencies of Singapore's main trading partners and competitors.

The trade-weighted exchange rate is allowed to fluctuate within a policy band, and where necessary, MAS conducts direct interventions in the foreign exchange market to maintain the exchange rate within this band. The exchange rate policy path and the band are regularly reviewed to ensure that they remain consistent with underlying economic conditions. ...

In order words, MAS manages SGD exchange rate directly and regularly review the strength of SGD against major trading partners for sustained non-inflationary economic growth for Singapore.

In fact, MAS reviews the exchange rate policy twice a year and publish them on its website.

Trade-weighted Exchange Rate

It is explicitly mentioned in the policy that the exchange rate is trade weighted. MAS neither reveal the exact currencies in its basket of currencies nor their weightage, thus I decided to compile a list of major trading partners of Singapore and estimate how the various currencies' will affect SGD.


A few points to note on compiling the above table:

1. Other than the interest rate which is current, the rest of the data are full year results for 2007.
2. Estimated trading volume are estimated by totaling import and export to these economies. These data are taken from Statistics Singapore.
   
3. Due to the difficulty (or rather, my laziness) in compiling data for the entire European Union (EU), I estimated EU's data with France and Germany, two large entities in EU that are somewhat representative.

Major Conclusions that can be drawn from the table above

1. Simplistic trade weighted equation?

In the simplest case:

SGD = 0.18 x MYR + 0.15 x RENMINBI + 0.145 x USD + ...

If SGD exchange rate is derived simplistically as above, SGD's strength (or weakness) against any single currency will just depend on that currency against all others in the basket. In other words, SGD should not fluctuate much against major currencies. If so, the recent USD devaluation is less about the strengthening of SGD, but more of a weakening of USD against all other currencies.

2. Strengths of currencies in the basket

Assuming most (if not all) of the currencies in the table are found in the basket and my simplistic trade weighted formula approximates the SGD exchange rate, then the strength (or weakness) of SGD will very much depend on how well these currencies perform.

While many factors affect the strength of a currency, important ones include economic growth, trade balance, current current balance, central bank rates etc. Prolonged current account deficit can be sustained so long as influx of capital continues, either due to high central bank interest rates (high yield attracts capital) or high demand of goods and services (including commodities).

Australia is a case in point. Its account balance is highly negative (even higher than United States in terms of percentage of GDP) but it has sustained so for a relatively long time due to its high interest rate and huge demand for its resources. With the onslaught of global financial crisis (sparking a cut in its interest rate) and ensuing drop in demand of its raw resources, Australian dollars plunge against major currencies.

Looking at the current central bank interest rate and their current account balance of these economies, those with huge account deficit, high interest rate or both are most prone to weaken. These include, United States, Australia and United Kingdom. Together, these accounted for 21.3% of 'my' estimated basket. If these were to weaken against the rest of the 78.7% of the basket, then it is more probable that SGD will strengthen against them.

Conclusion

Though being a major and important trading partner, Singapore don't just trade with United States alone. The basket of currencies is meant to price SGD to sustain Singapore's economic growth. Since US borrow in USD (selling US dominated bonds), they can and are already printing USD as much as they need, it will be quite surprising if USD does not depreciate against major currencies and consequenty against SGD. Unless MAS intervened (directly or indirectly with a policy change) for the sake of Singapore export oriented economy, it is more likely SGD will appreciate against USD.