THE RELATIONSHIP BETWEEN THE REAL EXCHANGE RATE AND NET DOMESTIC" EXPORTS IN SINGAPORE"

Abstract

In today's world of managed exchange rates, the exchange rate of a country can be manipulated to turn a part of world trade in its favour, through the effect on the current account and, to a smaller extent, the capital account of the balance of payments. Trade is the lifeblood of Singapore because her small size imposes restrictions on the use of a given piece of land for different activities, for example, agriculture and fishing or manufacturing. Furthermore, the small domestic market cannot generate sufficient demand for the goods that might otherwise have been produced. By exporting our products, we tap into the vast world market. This provides the impetus for the Singapore economy to grow. In this academic exercise, we focus on the relationship between the real exchange rate and "net domestic" exports in Singapore. Singapore's case is rather unique: she needs a new concept of GDP (as in indigenous GDP) as well as a new concept of exports; the latter being due to the highly open nature of the Singapore economy. The concept of "net domestic" exports would be more relevant in Singapore's context than gross exports or the official definition of domestic exports because of the high import content in Singapore's exports. This is because entrepot trade is still important and also because of the relatively large amounts of imported intermediate inputs required in the production of exports. Conventional trade theory says that by keeping the value of the Singapore dollar low in terms of foreign currencies, we can stimulate exports. Due to the highly open nature of the Singapore economy, our exchange rate against any one currency would not be indicative of how net domestic exports are faring. Thus, we have calculated an exchange rate adjusted for relative inflation and the relative importance of our trading partners: the real effective exchange rate (REER). Our focus would be on the REER calculated based on net domestic export weights ( REERn ) and the REER based on competitor weights ( REERcw ). The latter REER index would give a greater weightage to our competitors, such as Japan and the other three NIEs, and would reflect changes in our export competitiveness relative to these countries more than what is indicated by the REERn index. The purpose of this academic exercise is to examine if there is any relationship between the REER and net domestic exports, the extent of the relationship, and the implications for a small open economy like Singapore. Specifically, we would like to know what are the factors that might account for the relationship between the REER and net domestic exports and what changes in these factors would mean for Singapore in terms of export competitiveness. If we cannot sell our exports on world markets, our economy will decline. In light of the increasingly protectionist nature of many countries, the position of our exchange rate may become an even more important determinant of our export competitiveness, especially if our exchange rate is favourable for our export markets and is complemented by other factors as well.