Exchange Rate Policy at the Monetary Authority of Singapore

Why and how are the capital and current account tied together so closely?

Current account on one side and the capital and financial account on the other in the balance of payment, should balance each other out. A country with positive capital account ( a net financial inflow) means its debits are more than its credits. This is usually in line with a current account deficit. That means this country using other countries savings to meet its local investment and consumption demands and vice versa is true too.

In other worlds a country invests abroad when its domestic savings are more than sufficient to finance domestic investment expenditure. Such a country sends its surplus savings abroad in the form of foreign direct investment or investment in foreign stocks, bonds, or real estate. This stream of surplus savings is referred to as a capital outflow, making the country a net lender to the world. A country that does not generate savings sufficient to finance its own investment needs must attract surplus foreign savings in the form of a capital inflow. Such a country records negative net foreign asset purchases, or equivalently, is a net borrower from the world. A current account surplus is matched by an equal net outflow of investment funds overseas, while a deficit is matched by an equal net inflow of foreign investment funds.

In the case of Singapore, government extensively involved in the economy and stimulated high savings rates and accumulation of foreign reserves. As a result, Singapore became a net creditor to the rest of the world. It experience a large current account surplus and saving accumulation in excess of domestic investment demand helped to produce a long-term real appreciation of the Singapore dollar.

What is a real exchange rate?

Real exchange rate is the measure in terms of ratio at which that any countries own currency is equivalent to other currencies in terms of purchasing power. It is preferred over nominal exchange rates as...