Singapore monetary policy (strengthening SGD) criticized

By Vidya Ranganathan
Reuters (Tuesday, April 15, 2008)

SINGAPORE: When Singapore announced a somewhat unusual monetary tightening measure last week, economists praised a move that they felt tackled soaring inflation and made up for an overdue policy adjustment in one stroke.

But, as the dust settles, market participants are increasingly worried about the side effects of what was effectively a revaluation of the currency and the pitfalls of the peculiar Singaporean policy settings.

Critics argue that by endorsing an appreciating trend in the Singapore dollar, the central bank is opening the door to more capital inflows and more cash in the local market.

The result could be downward pressure on domestic interest rates and so more inflationary pressure.

Others point to the unsuitability of a system whose main policy instrument is the currency and in which inflationary pressures force currency appreciation at a time when slowing economies in the United States and Europe could depress demand for Singaporean exports.

"If you had complete flexibility to move your various policy levers, you'd probably want a weak currency and higher interest rates," said an HSBC strategist, Daniel Hui. "You'd want to be a little more accommodative on the external sector which has a lot of downside risk ahead of it."

Singapore does not have that flexibility. The Monetary Authority of Singapore conducts policy by guiding the currency within a secretive trade-weighted band, rather than by setting interest rates.

Last week, the authority said it was recentering the currency's trade-weighted band around its current levels.

To most economists, that meant the central bank was effectively revaluing the Singapore dollar, to firmer levels that the market had already been trading it at for about six months.

The Singapore dollar hit a record high against the dollar after that announcement. Simultaneously, inter-bank rates fell as traders braced for more speculative inflows into a rising Singapore dollar.

One-month interbank rates hit 1 percent, their lowest in three-and-a-half years. Real interest rates, adjusted for inflation, turned more negative.

The Singaporean central bank keeps all parameters of its policy band secret, but economists estimate the trade-weighted currency band is being shifted up by at least 1 to 2 percent, which by some measures equals a policy tightening of at least 100 basis points.

That would help reduce the heavy cost of the food and fuel that the resource-deficient Singaporean economy must import. But what of the soaring rents within the country, rising transport and education costs and even wages in some sectors?

Singapore has enough grounds to focus on its currency. With exports equivalent to 185 percent of gross domestic product and imports at nearly 170 percent of gross domestic product, it is one of most exposed Asian countries to foreign markets.

"If there is a country in Asia that can use currency appreciation to quash inflation, then Singapore stands out as a leading candidate," said a Lehman Brothers' Asian economist, Rob Subbaraman.

Economic growth has held up well in the past 6 months, despite slowing U.S. demand and volatile credit markets.

The economy expanded 7.7 percent in 2007 and a current account surplus of 24 percent of gross domestic product affords it ample leeway on export earnings.

At the same time, much of the economic growth has been driven by investment and domestic housing demand, more sensitive to interest rates than currency levels.

Inflation, which hit a 26-year high of 6.6 percent in January, is driven in part by the huge amounts of fuel and food that Singapore imports. Yet, economists say local rents and wages drive a larger part of food inflation, while taxi fares and road tolls have pushed transport and communication prices.

Housing inflation is running near 9 percent, while health care costs are also rising at a more than 7 percent annual pace.

"A lot of inflation can be attributed to domestic factors and strong domestic growth and that does suggest that perhaps the current policy regime that Singapore has isn't well-suited to address the current challenges," Hui said.