VII the Central Banking Institution in an Extremely Open Economy

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The Central Banking Institution in an Extremely Open VII Economy

This section considers central banking institutions in tism and a stable political environment. Barriers to trade countries with market-oriented economies, open to both and to capital flows have been progressively removed; by trade and capital flows. As discussed in Section III, it may 1978 exchange controls had been completely dismantled. be very difficult in such countries to exert a strong influence Singapore has grown into a major financial center, and is on domestic interest rates or credit conditions. Moreover, now the largest external currency center in Asia. There are successful export-led growth depends on foreign confi- two main central banking institutions, the Board of Com- dence in the continuation of the liberal trade and payments missioners of Currency and the Monetary Authority of system and in the establishment of a stable monetary envi- Singapore, set up in 1967 and 1970, respectively; proposed ronment. To maintain such confidence, the central bank- legislation that would bring the former under the auspices ing institution must be financially prudent; it must hold of the latter has yet to be enacted. The Board of Commis- reserves, or at least have access to credit, sufficient to cover sioners of Currency operates as a strict currency board, normal fluctuations in demand for domestic currency, and controlling the issue of the Singapore dollar subject to hold- aim to restrict its own extension of credit to the increase in ing at least 100 percent foreign exchange reserve cover. The demand for its own liabilities. To provide some guarantee Monetary Authority of Singapore is responsible for the of such behavior, the central banking institution may be bulk of the central banking functions and has a wide range statutorily bound by restrictions on its fiduciary issue and of supervisory and regulatory powers. Recently, however, on its lending to government. the task of managing the country's foreign exchange port- A common feature of economies open to trade and capi- folio has been transferred to a separate body, the Singapore tal flows is that the financial sector is an important focus of Investment Corporation, which is intended to provide a growth, often being a major source of foreign exchange more aggressive approach to foreign investment. earnings. As noted in Section III, success in this field The monetary operations of the Monetary Authority of requires the central banking institution to play a carefully Singapore consist largely of recycling funds deposited by judged regulatory role, designed to enhance confidence the Government into the commercial banking system without stifling initiative. This active role contrasts with the through the rediscounting of bills and open market opera- more passive conduct of monetary policy. tions. In the past, the Monetary Authority of Singapore Examples of central banking institutions in an open attempted to influence domestic credit conditions in line economy are provided by Singapore, Hong Kong, Kuwait, with macroeconomic policy objectives. This policy was Saudi Arabia, and the United Arab Emirates. In Singa- bolstered by regulations intended to keep domestic and pore, the fiduciary powers of the central banking institu- offshore markets distinct. Since 1975, domestic deposit tions have been deliberately restricted but the regulatory and lending rates have been freely determined in the mar- powers of these institutions are extensive. In Hong Kong, ket and have followed the Singapore interbank rate, the monetary authorities have limited powers and finan- which in turn has followed the Asian dollar rate and, cial success has been achieved through almost unfettered hence, world financial conditions. The Monetary Author- entrepreneurship. Finally, in the oil exporting Gulf ity of Singapore has, for the most part, kept the rediscount states, the strong fiscal position has led to a shift in re- and the treasury bill rates in line with these market rates, sponsibilities between the central banking institution and recognizing that a policy aimed at setting independent the government. interest rates could not be sustained for long, given the ready domestic access allowed to international capital markets. After a period in which the Monetary Authority Singapore and Hong Kong of Singapore attempted to steer domestic monetary aggregates along a target path, the current policy seeks to stabi- Since gaining independence, Singapore has combined lize the exchange value of the Singapore dollar. This strat- an export-oriented development policy with fiscal conserva- egy is believed to be a more effective means to control

inflation in a highly open economy, and is conducted to take a less prominent part in guiding the evolution of through swap operations in the foreign exchange market. the financial system and in supervising foreign branch The regulatory functions of the Monetary Authority of banks. Singapore are directed at the promotion of the Singapore financial system. Entry into this system is limited by tiered licensing, which allows less than half of registered banks Kuwait, Saudi Arabia, and the United Arab to conduct the full range of banking operations; other Emirates banks hold "restricted" or "offshore" licenses. The Mon- etary Authority of Singapore imposes a series of liquidity The economies of Kuwait, Saudi Arabia, and the requirements on banks and finance houses, issues direc- United Arab Emirates fall into a distinctly different cate- tives guiding their lending operations, and controls their gory of open economy than those of Hong Kong or Singa- nonbanking activities. It has also been instrumental in pore. They are dominated by exports of oil, which provide encouraging the development and diversification of the the countries with considerable world market power to Asian dollar market. Not only are offshore operations influence their terms of trade. A basic feature of their released from liquidity requirements and eligible for con- rapid development over the last decade has been the rap- siderable tax benefits, but, in addition, the Monetary idly increasing deployment of government oil revenues Authority has been fully involved in setting up offshore into domestic investment. Financial sectors have grown markets for bonds, certificates of deposit, and commer- with the accumulation of financial wealth and the rising cial paper. requirements for internal financial intermediation, and The experience of Singapore may be contrasted with have been encouraged by governments seeking focuses for that of Hong Kong. The economy of Hong Kong is very diversification. Access to world capital markets is effec- similar to Singapore's, but the former's colonial adminis- tively good: there are few restrictions on financial flows, tration has been much less involved in financial affairs. while the substantial stocks of both financial assets and oil Indeed, in Hong Kong, currency issue is performed by the reserves imply that marginal shifts in net lending cannot two foremost commercial banks, the Hong Kong and much affect these countries' aggregate net worth or Shanghai Bank and the Chartered Bank, which also act as threaten their credit rating. lender of last resort, serve as banker to the government, Kuwait and the United Arab Emirates both have Cen- and administer the interbank clearance mechanism. The tral Banks; Saudi Arabia, a Monetary Agency. These range of functions entrusted to public institutions is lim- monetary authorities are legally entrusted with the issue of ited and divided. The Commissioners of Banking and of currency, the roles of banker to commercial banks and Deposit-Taking Companies undertake the licensing, government, the regulation and promotion of the banking supervision, and regulation of banks and deposit-taking system, and the execution of monetary policy. companies, respectively. The Secretary for Monetary Of these roles, banking regulation is crucial to the Affairs takes responsibility for the management of official development of these countries as financial centers, espe- assets and liabilities, for the issue of coinage, for foreign cially as all three countries are intent on local ownership exchange operations, and for relations with international and management of their financial institutions. In the monetary institutions. United Arab Emirates, the Central Bank has only recently Official monetary policy in Hong Kong was purely displaced a currency board, endowed with little regulatory laissez-faire until the financial crisis in 1978. This crisis power, following a banking crisis arising from rapid followed excessively rapid credit creation by the banking financial expansion and speculation against the domestic cartel, leading to a collapse in the value of the Hong Kong currency. This new institution has applied a minimum dollar. Since then, the Commissioner of Banking and the restriction on the capitalization of domestic commercial Secretary for Monetary Affairs together have attempted to banks, and has required banks to accumulate out of their restrain the growth of domestic credit. Their influence has profits a reserve fund, the value of which should be at least been exerted primarily through moral suasion that 50 percent of capital. Commercial banks must provide the encourages domestic interest rates to follow world levels Central Bank with extensive information on their opera- more closely, in combination with closer supervision of tions and establish proper auditing facilities. The govern- financial operations. Neither open market operations nor ment intends to establish a separate Credit Risk Bureau discount rate manipulation are available in the absence of charged with monitoring local lending to support this either government securities or central bank lending. supervision. Kuwait and Saudi Arabia have also taken In Hong Kong, in strong contrast to Singapore, the steps to strengthen monitoring and enforcement proce- monetary authorities have never been much involved in dures. A particular problem now being faced in all three the promotion of the financial system. Even so, the finan- countries is set by the money changers, whose activities cial development of Hong Kong has proceeded at a rapid have extended beyond their eponymous role but have hith- pace. It is therefore interesting to observe the recent reor- erto been unregulated. The authorities are taking steps to ganization in Singapore, where the Monetary Authority is restrict licensing, to limit the range of activities under-

©International Monetary Fund. Not for Redistribution VII • THE CENTRAL BANKING INSTITUTION IN AN EXTREMELY OPEN ECONOMY taken, and to establish proper monitoring facilities; but deposit rates. This action is consistent with Islamic law, whether such controls can be effective in a traditionally which prohibits interest payments, and also reflects a informal business sector remains to be proven. desire to encourage local investment. Narrow, even nega- In all three countries, the role of banker to the govern- tive, spreads between savings, deposit, and lending rates ment is relatively limited. Given the substantial budgetary are feasible for commercial banks receiving a high propor- surpluses, governments have not required loans from tion of deposits as noninterest-bearing demand deposits their bankers; rather, they must determine the allocation and having access to low-cost central bank credit. Saudi of their accumulated financial resources between central Arabia and the United Arab Emirates both impose ceil- bank deposits and other uses. In the United Arab Emir- ings on some deposit rates of interest. Given the minimal ates, deposits with the monetary authority claimed a par- controls on capital mobility, these policies have led ticularly small percentage of government assets in the domestic wealth holders to invest a substantial portion of past, although this proportion has now risen to around 50 their portfolios offshore, as well as in foreign currency- percent following the establishment of the Central Bank, denominated deposits with domestic banks bearing inter- as the individual emirates hold considerable foreign assets nationally competitive returns. In consequence, domestic on their own account. In Saudi Arabia, government finan- monetary aggregates do not fully reflect the total money cial resources are recycled into the domestic economy via balances held by residents. the five government-owned, specialized credit institutions An implication of these arrangements is that the gov- which provide long-term credit to priority sectors at highly ernments of these countries have more influence on concessional rates; the amount of this credit is, in fact, domestic credit conditions than do the monetary authori- about double the total of commercial bank funds made ties. It is up to the government to decide how much to available to the private sector. The Saudi Arabian Mone- deposit with the monetary authorities and the extent of tary Agency itself receives government deposits intended credit subsidies; these decisions determine how far the for investment abroad. In Kuwait, government funds monetary authorities and other specialized institutions reach the domestic economy at concessional rates both via can expand domestic credit and at what price. In addi- three specialized banks and via the combined intermediation, the government domestic budget deficit, that is, gov- tion of the Central Bank of Kuwait and commercial ernment revenue from domestic sources less government banks—the Central Bank provides cheap rediscounting domestic expenditure, is the main source of increase in facilities to subsidize commercial bank lending, and is privately held wealth.19 To the extent that this wealth is itself financed by government deposits and subsidies. placed in domestic bank deposits rather than being spent In these countries, monetary policy has attempted to on imports or deposited abroad, it provides the commer- influence domestic financial conditions. The Central cial banks with funds to expand their own credit. Bank of Kuwait is empowered to limit the lending rates of domestic banks and has imposed low ceilings relative to those rates obtaining elsewhere and to uncontrolled 9See Morgan (1979).