An upcoming deal between Singapore and Indonesia for a US$10 billion (S$13.8 billion) local currency swap and US dollar repurchase agreement is aimed at shoring up monetary and financial stability in the region, even as rising interest rates shake up global markets, the head of Singapore's central bank said yesterday.
Mr Ravi Menon, managing director of the Monetary Authority of Singapore, noted that there has been greater volatility in global markets, with the gradual hiking of interest rates in the United States.
This has, in turn, resulted in an outflow of funds from emerging markets, including South-east Asia, which he said is to be expected.
"But you want to make sure there is no snowball effect, that it is not overdone," he told the media on the sidelines of a Leaders' Retreat, where the bilateral financial arrangement was announced.
"We feel that in this part of the world, Asean economies continue to be strong - fundamentals are sound, policy responses have been good. So, we should try to avoid a situation where the mar-ket overreacts."
Having financial arrangements, like the one Singapore and Indonesia are planning, will help to build confidence in the region amid this turbulent climate, he added.
Such arrangements can help central banks defend their currencies or deal with short-term liquidity needs, while being protected from exchange rate fluctuations, he said.
The Indonesian rupiah has been depreciating steadily against the US dollar in recent months amid broader financial market volatility, even hitting a two-decade low against the greenback earlier this week.
A bilateral currency swap is a standby arrangement between two central banks. If either central bank decides to activate it, the two will then exchange a certain amount of their currency with the other.
So, for example, the Singapore central bank may swap US$5 billion worth of Singdollars for Indonesian rupiah amounting to the same value, at the prevailing exchange rate.
After a set period of time, the two central banks will return the swapped currencies to each other at the same exchange rate as when the swap was made.
Under a US dollar repurchase agreement, one central bank will provide the other with US dollars in exchange for US treasuries, Japan government bonds and German bonds - high-quality collateral.
"So, basically, it is a collateralised loan, but it is called a repurchase because at the end of the period, the original transaction is reversed - the securities pledged are repurchased with US dollars," Mr Menon explained.
"If they need US dollars, or we need US dollars in the short term, then instead of selling assets, we can pledge the assets and use the US dollars."
Mr Menon added that the bilateral financial arrangement helps ensure that Indonesia, where Singapore has many investments, is well-placed to ride out this period of uncertainty. "We have confidence in the Indonesian economy. The macro fundamentals here are sound, policy responses have been judicious, and it is important that they remain so."