How Singapore manages its reserves

Singapore’s reserves serve three objectives: to serve as a buffer against crisis; to provide a stream of investment income to help finance part of the annual government budget; and to maintain confidence in Singapore’s exchange rate-centred monetary policy. The reserves are thus a rainy day fund, an endowment fund and a stability fund.

The imperative to hold a buffer against crises is rooted in Singapore’s geography and history. Specifically, it is a city state smaller than Greater London and has no natural resources. It has to import most of its food, including water. When it became independent, in 1965, it had no hinterland and meagre financial reserves, and depended mostly on entrepôt trade and hardly had an industrial base. It was not expected to survive, let alone succeed.

An acute sense of vulnerability has been part of Singapore’s DNA since its birth. This sense of vulnerability, in turn, underpinned two convictions: first, that the only way to survive and make a living is to make Singapore relevant to the world; and, second, it must build up strong buffers so that it can withstand the shocks that come with being so small and open to the world.

As Singapore grew and prospered as a business and financial centre, its vulnerabilities to the vagaries of global trade and financial cycles also grew. Total trade is currently three times the size of the Singapore economy and gross capital flows into and out of Singapore are 77% of GDP. The need to build up a sufficient rainy day fund to tide it through shocks and crises has remained as relevant as ever.

The role of the reserves as a rainy day fund is not theoretical, as these reserves have indeed served Singapore well in past crises. For instance, they helped underpin confidence in Singapore during the throes of the Asian financial crisis, and during the global financial crisis, the reserves were drawn down to finance a package of measures aimed at preserving jobs by subsidising employers’ wage bills and helping viable companies to stay afloat by sharing the risk of bank lending.

A second purpose of the reserves is to serve as an endowment. This has grown in importance, and salience, in recent years. The income from investing the reserves provides an increasingly important source of revenue to fund government expenditure. The size of government in Singapore is small, with government spending – comprising both operating and development expenditure – being just about 16% of GDP. However, tax and non-tax revenues are even lower, at 15% of GDP. In other words, Singapore runs a structural deficit on its primary fiscal balance.

This is where the investment income from the reserves comes in. The constitution of Singapore bars the government from borrowing to spend or to spend surpluses accumulated from previous terms of government. Instead, it allows the government to spend up to half of the expected long-term real returns from the net assets invested by MAS, GIC and Temasek. This is known as the Net Investment Returns Contribution (NIRC). The NIRC is already the largest single contributor to revenues in the government budget, accounting for about one-fifth of revenues.

The role of the reserves as an endowment from which to draw a steady stream of income to finance the government budget will become even more important in the years ahead. An ageing population will mean higher expenditures, especially for healthcare, and slower economic growth will mean lower tax revenues.

The third purpose of the reserves is to serve as a stability fund. More specifically, the reserves help to maintain confidence in Singapore’s exchange rate-centred monetary policy framework. As Singapore is a small and highly open economy, inflation and aggregate demand are more significantly influenced by the exchange rate than interest rates. Singapore’s monetary policy is therefore centred on managing the exchange rate of the Singapore dollar against a basket of currencies within a policy band. The reserves play an important role in enabling MAS to conduct monetary policy and secure macroeconomic stability.

So, how are the reserves accumulated and managed? As mentioned at the start of the chapter, Singapore’s reserves are held and managed in three distinct pots: the MAS, GIC and Temasek, see Figure 6.2 below. The government sets the overall investment objectives for the three entities, and monitors the risk and return profile of the total reserves. However, it plays no role in the investment decisions of the three entities, which are made on purely professional grounds.

MAS, as Singapore’s central bank, manages the OFR. The process of accumulating or using OFR is intricately tied to MAS’ conduct of monetary policy. The MAS may accumulate or sell foreign assets, principally through its intervention operations in the foreign exchange market, to manage the float of the Singapore dollar. Given Singapore’s positive net savings and persistent capital inflows, the nominal exchange rate often tends to appreciate more than what is required to keep inflation low and stable. The MAS accumulates foreign assets on average in the process of managing the Singapore dollar within its policy band even as it sells foreign assets during times of stress on the Singapore dollar.

As the central bank, the MAS is the most conservative of the three investment entities, with the OFR invested mainly in safe and liquid assets. The OFR is sized to take into account its role as a buffer against a large and sudden outflow of capital that would undermine confidence in the exchange rate and Singapore’s macroeconomic stability. Traditional measures of reserve adequacy, such as the number of months of imports the OFR could finance if all other sources of foreign financing dried up, are less relevant for Singapore. A sizable and liquid OFR sends a clear signal that MAS has the wherewithal to resolutely defend the Singapore dollar against speculative attacks.

The GIC is a professional fund management company that manages the government’s foreign assets. These assets are separate from the OFR. The history of GIC begins with the MAS. Through the 1970s, Singapore ran persistent fiscal surpluses, received sizeable capital inflows and had an elevated private savings rate. This led to a substantial accumulation of OFR, well in excess of what was required for MAS’ central banking operations. Therefore, in 1981 the GIC was set up – in today’s parlance, as a sovereign wealth fund – to manage part of the reserves for higher returns without the central bank constraints of liquidity. Part of the OFR was transferred from the MAS to the GIC, which was tasked with investing the reserves in a globally diversified portfolio of asset classes with a higher risk profile to deliver good long-term returns.

The third pot of reserves is managed by Temasek Holdings, an investment company wholly owned by the government. Temasek’s history also dates back to the early years of Singapore’s development. There was little private capital in those days, but a rapidly industrialising economy needed key infrastructure – in aviation, shipping, telecommunications, banking, and so on. The government therefore set up enterprises in these areas. Temasek was formed as a holding company for these enterprises in 1974 so that the government could focus on its roles of policymaking and regulation without conflict, while Temasek would own and manage these investments on a commercial basis.

Today, Temasek is an active equity investor that aims to deliver sustainable long-term shareholder value. More than a quarter of Temasek’s portfolio is invested in Singapore, with the rest invested in Asia and global markets. The initial portfolio was provided by the government, but since then Temasek’s funds have come mainly from the investment growth of its own portfolio. Compared to MAS and GIC, Temasek is further out on the risk/return spectrum.

The OFR is the portion of the reserves that MAS is responsible for. There are three prongs to MAS’ approach to managing the OFR: robust risk management; balanced asset allocation; and efficient investment process.

In Singapore, reserve management is a multi-objective, multi-agency and, most importantly, a multi-generational effort. The reserves serve as a buffer against bad times, as an endowment to finance current needs and as a foundation for macroeconomic stability. As custodians of the national reserves, MAS, GIC and Temasek owe a duty of care and responsibility to the ultimate beneficiaries of the reserves: current and future generations of Singaporeans. It is a duty that motivates their investment and risk managers as they go about their work each day, trying to extract value while staying clear of pitfalls, amidst the turbulence, tides and ebbs of the financial markets.

This chapter is taken from a speech given at the National Asset–Liability Management Europe Conference on 13 March 2019.