Expected Exchange Rate of SGD1.00 with Other Currencies via Interest Rate Parity Theory.

 

In the Table above, IR stands for the interest rate of the country as set by Central Bank or Monetary Authority. The Table shows that SGD is not either significantly over or undervalued, and the Governments 'control' of the SGD is just about right. The currency to watch out for is the JPY. Japan's current economy is fragile. With a Debt/GDP ratio of 260%, rising inflation and the impact of Trump's trade tariffs on Jaoanese automobiles and steel yet to be felt, we may see the Yen extend its downard trend.  Add to that, yesterday's Upper House elections in which Ishiba's LDP coalistion performed badly, we may see the conservative, nationalistic and right-wing faction of Japanese politics extend its influence  on foreign and domestic policies and create an environment of insatbility-all to the detriment of the JPY. The SGD/JPY chart below shows that JPY may cross below its 10-year low.

Calculating the intrinsic value of a currency is complex because currencies are not assets that generate cash flows like stocks or bonds. Instead, currencies derive their value from their role as a medium of exchange, a store of value, and a unit of account.

Currencies are influenced by a wide range of factors, including economic fundamentals (such as a country’s productivity growth, external debt, balance of payments, money supply, interest rate, terms of trade etc) market sentiment, and geopolitical events. Add to that the policies and actions of Central Banks and Government in deciding on the desired exchange rate for the country’s currency that aligns with the country’s economic strategy. Therefore, while there are many theories and methodologies for calculating the intrinsic value of a currency, most of these including Purchasing Power Parity and the Big Mac Index (based on the cost of a McDonald hamburger in different countries) are flawed and give a false sense of accuracy.  

A ‘quick and dirty’ but valid and practical way to calculate the intrinsic value of a currency is the Interest Rate Parity (IRP) method. The IRP theory states that the difference in interest rates between two countries should equal the expected change in their exchange rates over time. This method is straightforward because interest rate data and exchange rates are widely available. The Table above calculates what should be i.e. statistically expected rate for a foreigh currency versus the SGD. IR=Interest rate. Overvalue is (+) and Undervalue is (+)

IRP Formula

Why the IRP Method is Practical

Simplicity: The IRP method uses only three inputs—domestic interest rate, foreign interest rate, and the current exchange rate—making it easy to calculate.

Quick Insights: While it doesn’t account for all factors influencing exchange rates (e.g., government intervention, geopolitical risks), it provides a baseline expectation for currency movements.

Real-World Use: It’s especially useful for travellers, importers, and exporters who want a quick estimate of how exchange rates might shift based on interest rate differentials.