Deft move by MAS to tighten monetary policy

Exchange rate band re-centred upwards, 0% appreciation strategy dropped

The Monetary Authority of Singapore yesterday tightened its monetary policy as the economy staged a sharp rebound and inflationary concerns returned to the fore.

In an unexpectedly aggressive move, MAS let the Singapore dollar strengthen by re-centring the exchange rate policy band upwards at the current level. It also raised the slope of the band, allowing for 'modest and gradual appreciation'. This is the first time it has adopted both tightening measures at the same time.

The Singapore dollar rose against the greenback shortly after the announcement. At 7.30 pm local time, it hit a high of 1.3755 per US dollar, up from 1.3971 about a month ago.

'The recovery of the Singapore economy has been stronger than expected, and more entrenched since the beginning of this year,' MAS said in its half-yearly monetary policy statement. The economy is 'expected to continue on its firm recovery path given the more favourable global economic outlook'.

Yesterday, the Ministry of Trade and Industry's flash estimates showed that Singapore's GDP grew 32.1 per cent in Q1 on a seasonally adjusted quarter-on-quarter annualised basis.

The strong expansion prompted the ministry to upgrade its GDP growth forecast for 2010 to 7-9 per cent. It also raised the CPI inflation forecast for the year to 2.5-3.5 per cent, up from 2-3 per cent.

According to MAS, domestic CPI inflation averaged 0.6 per cent in the first two months of the year, rising from -0.3 per cent and -0.8 per cent in the last two quarters of 2009.

'Inflationary pressures are likely to pick up, driven by rising global commodity prices as well as some domestic cost factors,' the central bank said. The labour market has tightened, wage growth will begin to accelerate and commercial rents are likely to rise, it noted.

As a result, MAS re-centred the exchange rate policy band upwards and dropped its zero per cent appreciation strategy. There was no change to the width of the band.

Before yesterday's policy review, economists were split over how the Singapore dollar would move. Some believed MAS would let the currency strengthen, but none expected it to do so on two fronts.

'The aggressiveness of the policy move came as a surprise to us,' said Morgan Stanley economists in a report. 'We think it reflects MAS's view that inflationary pressures now look like a more significant risk compared to downside growth risks.'

MAS adopted a zero-appreciation stance since October 2008 and re-centred the policy band downwards in April 2009. Over the last six months, the Singapore dollar nominal effective exchange rate (S$NEER) had been moving within the upper half of the band, 'reflecting growing optimism about the strength of the economic recovery in Asia', MAS said.

With the latest change to the exchange rate policy, economists are expecting the S$NEER to gradually appreciate at 2 per cent per year. UOB economists see the Singapore dollar hitting 1.33 per US dollar at the end of the year, while OCBC economists project the year-end level at 1.357.

The stronger Singapore dollar will worry some exporters here. 'Manufacturers prefer to have a stable Singapore dollar,' said Singapore Manufacturers' Federation president Renny Yeo. 'For exporters, the strengthening of the Singapore dollar will make them less competitive.'

But he added: 'What companies can do is to increase their productivity to offset the appreciation to remain competitive. The other way is to keep exploring new markets.'

On the other hand, companies which derive their earnings in Singapore dollars but incur costs in foreign currencies could benefit. The head of a research firm cited Singapore Airlines as an example - fuel, quoted in US dollars, forms a large part of its costs.

MAS' tightening measures prompted a rise in other Asian currencies yesterday. The South Korean won rose to 1,113 against the US dollar, while the Indonesian rupiah climbed to 9,003. 'Today's aggressive move may be a signal that other central banks in emerging Asia could tighten sooner or by more than expected,' J P Morgan said.

Source: Business Times, 15 Apr 2010