WHY MAS S$75B EXCESS FOREIGN RESERVES CANNOT BE SPENT ON SINGAPOREANS

7 Apr 2022 MAS announced it has transferred to the government S$75B excess OFR (Official Foreign Reserves). These are OFR in excess of their monetary policy management requirements. As a central bank, MAS do not undertake long term and risky investments. The government places these with the sovereign wealth fund GIC for long term investments with better yields.

As usual, such an event is followed by public outcry why with so much reserves, the government is reluctant to increase social spending and instead raise GST and other fees, especially at current difficult times. Government finance is sometimes complicated and the ordinary person does not understand this is not public money to be spent on them. I have kicked this dead horse several times, but I would like to share yet another primer, this time with simple graphics.

Fig.1 MAS buys foreign currency/sells S$

MAS manages the S$ exchange rates by setting a band within which it is allowed to move for each pair of currency. If there is an upward pressure on the S$ say for the S$/US$ pair, MAS intervenes in the FX market to sell S$ and buy US$. MAS pays for the US$ simply by crediting the reserve account of the counterparty bank with the S$. The counterparty bank transfers US$ to MAS account at the Federal Reserve in New York.

The MAS thus increases its foreign currency inventory (Official Foreign Reserve) with nothing. It simply credits a bank's account. This is commonly referred to as "printing" money. So technically, MAS has unlimited power to buy foreign currencies. Some people tend to see this as "money is for free".

On the other hand, to buy S$, MAS has to pay for it with real foreign currencies. MAS intervenes in the FX market to buy S$ when there is downward pressure on the local currency. Thus MAS needs to maintain a certain level of Official Foreign Reserves at all times.

Fig.2 Inflationary effect of 'printing' S$

Once the S$ is with the bank, it gets circulated into the market which increases the supply of money. Money gets deposited with banks and banks lend them out. Bank A lends to customer A who deposits at Bank B. Bank B lends to customer B who deposits at Bank C, and so on. This is called fractional banking and it has a multiplier effect on the supply of money. How much the money can multiply depends on the reserve requirements set by MAS. The reserve requirement means banks cannot lend out the full amount deposited with them. They need to keep a certain sum with MAS. If the reserve requirement is 10%, the S$1,000 can end up with S$10,000 through fractional banking.

Thus the 'printing' of S$ by MAS has a downside. Too much money supply creates inflationary pressure on goods and services. One of the key responsibilities of MAS is to ensure price stability. That means it has to find a way to negate the expansion of money supply when it purchases foreign currencies in its market intervention.

Fig.3 Sterilising the S$ 'printed' in market intervention

To remove from the market the S$ that was 'printed' to pay for the foreign currency, the central bank issues MAS Bills. These are S$ denominated  short term securities of 4 to 12 weeks. Investors buy these MAS Bills and pay through their banks which essentially means MAS debits the banks' accounts. The liability is recorded as a credit in the MAS Bills account. The S$1,000 is thus removed from the market, or sterilised.

The effect in the books is MAS has changed its liability from due to banks to a debt instrument, ie MAS Bills. In other words, the foreign currencies are actually funded by debt.

Fig.4 Transfer of excess OFR to government

MAS determines when to transfer excess OFR to the government. The Ministry of Finance issues RMGS (Reserves Management Government Securities) which are subscribed by MAS. RMGS are non-tradeable securities denominated in S$. They are issued solely as a mechanism for MAS to transfer excess OFR to the government.

MAS transfers the US$ to the bank in New York where GIC has their account. In MAS books, the asset has now changed from Foreign currency to Securities - RMGS. (There are other internal entries to deal with the dual currency transaction).

The excess OFR ends up with GIC to invest. In this example, GIC co-mingles the original OFR sum of US$1,000 into their investment portfolio. The currency risk is managed by GIC. What is important to note here is that the asset (investment) is carried in the books of GIC, but the ultimate liability, the MAS Bills, is in MAS books.

To put it bluntly, the GIC investments represented by this US$1,000 is not public money. The S$75 billion OFR transferred out of MAS into GIC is not for the goverment to spend.

Fig.5 Reserves and National Reserves

Reserves are sums of money that are set aside for specific purposes. These reserves include debt (various government securities) and national reserves (from accumulated budget surpluses, government land sales, and the original equities transferred to Temasek at its formation), This distinction is necessary because only the national reserves portion belong to the people of Singapore collectively.

How the national reserves can be spent is regulated by law. This prevents any political party, on winning the mandate to govern, to pursue frivolous fiscal policies.

The reserves from debt instruments cannot be spent. By law, money raised from the issuance of the various government securities cannot be spent. Those securities are not issued for fiscal purposes but for other specific objectives, eg SSGS and RMGS is for transferring CPF money and MAS excess OFR to GIC to invest

Closing words:

The S$75b transferred from MAS to GIC this month is not money the government can spend on Singaporeans. There is a debt on the liabilities side of MAS books to repay. Growth in the foreign reserves in MAS is not profits. Let's not criticise the government for not using this S$75B to help alleviate the people's problems.