The Singapore authorities would like to thank the IMF staff for the 2008 Article IV Consultation. The focus of the discussions on short-term conjunctural issues and policy challenges facing the Singapore economy was appropriate and useful. In general, there was agreement that macroeconomic policies should remain flexible and pragmatic. As the broad contours of the authorities’ views were already reflected in the staff report, we will focus our remarks on monetary policy and exchange rate.
1 Recent Economic Developments and Outlook
1.1 The global economy has slowed over the past few quarters, following several years of robust growth. The impact of the US subprime crisis through the ongoing credit squeeze and widespread financial turmoil since late last year continues to present a drag on economic activity. At the same time, inflation has been rising across both the industrialised and emerging market economies. The forces exerting downward pressure on growth and upward pressure on inflation are acute challenges for the global economy.
1.2 Being an open economy, Singapore is impacted by these global developments. Growth has moderated from an average of 7.4% y-o-y in H2 2007 to 1.9% y-o-y in Q2 2008. The slowdown in Q2 was exacerbated by a 5.6% y-o-y contraction in the manufacturing sector. Likewise, Singapore’s non-oil domestic exports remained weak, contracting by 10.5% y-o-y in May 2008, with electronics exports posting its sixteenth consecutive month of negative growth.
1.3 In the next few quarters, economic growth is expected to continue easing in view of slowing external demand, particularly from the developed economies. The downside risks are therefore not insignificant, although they should be mitigated partly by continued growth in a number of industries that are relatively resilient to a global slowdown. These include construction, financial intermediation and marine & offshore engineering, which are largely driven by industry-specific factors and therefore insulated to some degree from external conditions over the short-term.
1.4 Domestic CPI inflation picked up to an average of 7% y-o-y in the first five months of 2008, higher than the 3.4% in H2 2007. A deeper analysis of the inflation dynamics and trends reveal that the step-up in CPI inflation can in large part be attributed to external sources, even as one-off domestic factors also affected the headline figure. In particular, the surge in global oil and food commodity prices has strongly impacted domestic prices, given Singapore’s heavy import reliance and policy of allowing market forces to determine the appropriate relative price levels. In this context, the contribution of food and direct energy-related items to CPI inflation rose from 0.8% point in H2 2007 to 2.8% points in Jan–May 2008, accounting for 40% of overall inflation. At the same time, cost of accommodation in the CPI has risen, reflecting the upward revision in the Annual Values (AV) of residential property by the Inland Revenue Authority of Singapore (IRAS).1 This, together with the 2%-point hike in the Goods and Services Tax (GST) in July 2007, contributed another 40% to overall CPI inflation in Jan-May 2008.
1.5 Nonetheless, the strong S$ policy has mitigated the inflationary impact of high global oil and food commodity prices. While WTI oil prices in US$ have doubled from a year ago, domestic electricity tariffs and petrol prices have risen by slightly less than 30% each. Similarly, while the IMF food and beverage index has soared by 43% from a year ago, domestic food prices rose by a more moderate 9%.
1.6 Inflation is likely to have peaked in Q2 2008, and is expected to taper off from H2. A significant pass through of global commodity price increases and pent-up domestic cost pressures to the CPI has already taken place in H2 2007 and Jan–May 2008, and the pace of price increases going forward is expected to moderate somewhat. The anticipated slowdown in economic growth would also cause some abatement in cost pressures, while the dissipation of the GST effect from July 2008 onwards would further contribute to lower headline inflation rates in H2 2008.
1.7 The authorities are cognizant that further upside risks to inflation hinge on external price developments. Given the tight market conditions for global food and oil commodities, prices can react significantly to adverse developments on the supply side, such as weather-related supply disruptions. In such instances, domestic prices of food and oil-related items (direct and indirect) - which altogether makes up a third of the CPI basket - would increase in tandem.
2 Monetary Policy
2.1 Against the backdrop of an increasingly challenging external economic environment, the authorities would like to reiterate that monetary policy remains focused on its core objective of price stability in the medium-term. The policy of a modest and gradual appreciation of the S$NEER has been in place since April 2004. During the latest policy review in April 2008, MAS re-centred the exchange rate upwards at the prevailing level of the S$NEER to further moderate inflation against the backdrop of continuing external and domestic price pressures. The authorities are of the view that these monetary policy actions, complemented by other mitigating measures taken to address supply-side cost pressures in the economy, have and will continue to moderate consumer price inflation while providing support for sustainable growth over the medium term.
2.2 Between April 2004 and April 2008, the S$NEER has appreciated by a significant 11.4%. Against the US$, the S$ has appreciated by an even more substantial 23.4% between April 2004 and June 2008. This has directly dampened external price pressures as highlighted earlier. In addition, the stronger S$NEER helped to ease domestic cost pressures indirectly by narrowing the output gap. Estimates show that had the MAS not allowed the S$NEER to appreciate over the last two years, CPI inflation in 2007 would have averaged 3.8%, instead of the 2.1% that was actually recorded. Furthermore, given this pre-emptive tightening of monetary policy coupled with the inherent lags in the price transmission process, domestic cost and price pressures would continue to moderate in the periods ahead, thereby ensuring that the second round effects emanating from external price developments are minimized. The effectiveness of the strong S$ policy is enhanced by the presence of keen competition and relative flexibility in Singapore’s factor and product markets, which help to limit the propagation of cost increases in the economy.
2.3 With regard to (medium-term) exchange rate valuation, the authorities note that the degree of imprecision in the staff’s assessment has increased. In particular, compared to the 2007 Article IV consultation estimate of 15–20% undervaluation in the (real) exchange rate, the lower bound estimate of a 5% undervaluation in the current range is not significantly different from fair valuation in view of the relatively large standard errors associated with such statistical estimates. This underscores the authorities’ point that model-based estimates of equilibrium exchange rates are unreliable and subject to large margins of statistical uncertainty. This brings into question the usefulness and relevance of such yearly assessments to policymakers. Indeed, the staff’s estimated range of the equilibrium exchange rate has increased from last year’s assessment.
2.4 The authorities would also like to reiterate that the current account surplus reflects savings that have been increasingly generated by the private sector - particularly the corporates - against the backdrop of strong income growth. Such surplus savings are efficiently intermediated by the financial sector, including for investments abroad. Significantly, the current account surplus has narrowed from a peak of 29% of GDP in Q3 2007 to 14% of GDP in Q1 2008, with private investment increasing by more than 8% of GDP over that period. Over the longer term, the authorities wish to reiterate that the current account surplus is expected to narrow further as the population ages and economic growth moderates.
2.5 The authorities would like to express appreciation to the IMF staff for their excellent in-depth research and empirical analysis in the selected issues paper. In particular, the studies on “The Effects of Monetary Policy in Singapore” and the “Effectiveness of Fiscal Policy in Singapore” will provide the authorities with useful analytical tools for future research work on assessing the monetary transmission mechanism as well as the relative efficacy of fiscal policy measures.
Owner-occupied housing costs are computed on the basis of imputed rent, which is the expected rental that a property would fetch if it was leased. This is in turn based on the AV assessed by IRAS for tax purposes. The AV is the estimated annual rent on a property for the purpose of computation of property tax. It is useful to point out though that about 91% of households currently own their homes.