Sunday, 28 June 2015

Why Singapore Interest Rates Might Rise Faster than Expected

Beginning this year, a friend asked me what I thought about interest rates. My reply was it should not exceed 1% this year and 2% next year. Of course, I was referring to the US federal fund rate instead of Singapore housing loan rates. Still, when the Singapore Interbank Offered Rate (SIBOR) shot up to 1% in Mar, I was quite surprised. Now, I think I know the reason why.

Before explaining the reason, let us first understand the basics of Singapore housing loan rates. There are 2 ways of getting a SGD loan. The first and most straightforward way is to borrow in SGD and repay in SGD. This is the basis for SIBOR loans. The bank that loans you the money will borrow from other local banks at the SIBOR rate and loan you the money with a spread above SIBOR, e.g. SIBOR + 0.75%. The alternative way is to borrow in a foreign currency, say, USD and convert it into SGD. When the loan is due, convert the repayment from SGD into USD and settle the loan which is actually denominated in USD. This is the basis for Swap Offer Rate (SOR) loans. The bank that loans you the money will do the borrowing in USD and conversion into SGD (and the reverse path) for you, so you will only see the middle portion in which you borrow from and repay to the bank in SGD. As there is conversion between currencies, there is forex risk involved in such loans. If USD were to rise against SGD when the loan is due, more SGD is needed to repay the USD-denominated loan. The bank will hedge this currency risk at the point of initiating the USD-denominated loan by buying USD in advance through a currency forward. The cost of converting between the currencies is included into the interest rate known as SOR. Thus, SOR includes the USD interest rate and a currency factor. The general formula for computing SOR is as follow:

The precise formula for computing SOR, which takes into account different loan tenures, by the Association of Banks in Singapore can be found in this link.

Usually, the tenure of the USD-denominated loan is a short one, ranging from 1 month to 6 months. At the end of the loan tenure, the bank will repay the original loan and initiate a new loan at new interest rate and new currency forward rate, so the roll-over is transparent to borrowers. The term 1-/ 3- /6-month SOR refers to the tenure of the USD-denominated loan and reflects how frequently the SOR will vary. Generally, the SOR for longer tenure will be higher than that for shorter tenure, to reflect the greater uncertainty in credit risks and forex rates. Also, since forex rates are volatile, SOR tends to be more volatile than SIBOR and the shorter the tenure, the more volatile is the SOR.

While it appears that SIBOR is not affected by forex rates, capital flows freely in and out of Singapore. Just as a Singapore borrower can borrow money in USD, a US borrower can also borrow money in SGD at SIBOR-pegged rate and convert to USD if SIBOR is much lower than SOR. Eventually, both SIBOR and SOR must converge for capital flows to be in equilibrium. Thus, both SIBOR and SOR will move in tandem with each other.

Having understood the workings of SIBOR and SOR, we can go on and discuss the recent movement of SIBOR and SOR. Since SOR is directly affected by forex rates, a rising USD against SGD will lead to higher SOR (and SIBOR). The figure below shows the movement of USD against SGD (orange line) since mid last year. 

USD Movement against SGD (orange line)

As shown in the figure, USD has risen by nearly 7% against SGD, with a small spike in Mar. This coincided with the spike in SOR and SIBOR in Mar. USD has since retreated slightly, which is again reflected in the slightly lower SOR and SIBOR after Mar. See the figure below from on SOR and SIBOR movements.

SIBOR/SOR Rate Movements

Moving forward, USD is likely to keep on rising against major international currencies as discussed in Getting Ready for US Interest Rate Rises. On the other hand, SGD cannot rise too much against regional currencies to avoid losing competitiveness. This means that SIBOR and SOR are likely to rise faster than the US federal funds rate. Add on to the fact that the federal funds rate is likely to start increasing in Sep or Dec, it can only mean that SIBOR and SOR will rise further.


  1. Thank you so much for the informative write-up. Your effect is crystal clear.

    1. Sorry, it should be effort and not effect…….fat finger effect.

    2. No problem. Glad that you liked the blog post.

  2. Nice write up. Learn something from you today.

  3. Hi, thanks for your clear explanation. Why would sor and sibor have to rise faster than fed fund rates for singapore to avoid losing competitiveness? Wouldn't that result in the appreciation of the sgd

    1. Hi RI, to keep the explanation simple, just note that USD is expected to rise against SGD (base scenario). Based on the formula explained in the post, it will result in SOR & SIBOR being higher than US fed funds rate. The weaker SGD is against USD, the higher will be the SOR & SIBOR rates.

      Now, regional currencies will also weaken against USD, more so than SGD. If the strength of SGD against these regional currencies is not kept in check, it will reduce S'pore's competitiveness. This means that SGD will be weaker than in the base scenario to be more in line with regional currencies, which means that SOR & SIBOR will be higher than in the base scenario.

      Hope the above provides a clear explanation.

  4. Hi Chin Wai, that was very clear. I got it now, thank you! I learnt lots reading from your posts.