MAS Annual Report 00/01 - External Environment

Strong Start to 2000

For a large part of 2000, the economies of Singapore’s main trading partners were characterised by buoyant expansion and optimism. (See Chart 3). The US economy surged in the first three-quarters of the year on the back of strong domestic demand, supported by gains in the equity market and demand for technology products. The Euro zone also experienced broad-based expansion, underpinned by improving consumer and business confidence, as well as healthy external demand. Even the Japanese economy appeared to be on a recovery path, fuelled by growth in private investment.

In East Asia, countries affected by the Asian crisis continued to grow strongly following their dramatic recovery in 1999. (See Chart 4). Stable financial conditions and expansionary fiscal policies supported an upturn in domestic demand and services in the first half of 2000. Exports and manufacturing production generally rebounded strongly, especially in electronics-exporting countries.

Emerging Signs of Slowdown

Towards the end of the third quarter of 2000 however, global economic activity began to show signs of weakening. The industrial and regional countries saw robust growth give way to significant softening in the fourth quarter of 2000, followed by further deterioration in early 2001. The US economy slowed more sharply than expected, triggering fears of a hard landing. Moreover, the initial optimism over the Japanese economy waned, as economic conditions remained weak, weighed down by continued sluggishness in private consumption and a downturn in investment spending. The cyclical rebound of some economies in the Euro zone also peaked.

East Asia was adversely affected by the fall off in external demand, particularly in the global electronics industry. Domestic demand growth also weakened, on the back of poor stock market performance and diminished business prospects.

Global Financial Markets Affected

International financial markets reflected the changing expectations for growth, partly due to the uncertainties related to the prospects in the technology sector. The year began on an optimistic note, with the smooth passage of the Y2K cross-over and expectations for continued strong global growth. The technology sector, in particular, was to be the foundation of a "New Economy", characterised by low inflation and high rates of sustained growth. However, over the course of the year, this optimism changed to concern as the hype surrounding the technology sector waned, monetary policy tightened, and US growth slowed.

Financial markets adjusted to reflect changes in these expectations. In the foreign exchange market, the US Dollar initially remained strong against both the Euro and the Yen, as the US economy outperformed its European and Japanese ounterparts. However, the Euro eventually rose against the US Dollar in the last few months of 2000, as market participants assessed that Europe was likely to be most resilient to a US slowdown. Meanwhile the Yen remained weak, reflecting uncertainty over the Japanese economy. Regional currencies followed the Yen and were also weaker against the US Dollar.

Short-term interest rates rose in early 2000 on the back of strong growth before the US Federal Reserve and the Bank of Japan (BOJ) started to loosen monetary policy. After maintaining a tightening stance for much of 2000, the US Federal Reserve signaled its intention to loosen monetary policy by moving towards a weakening bias in December, on the back of concerns over slowing growth. It subsequently cut the Federal Funds target rate by 250 basis points to 4%. Similarly, the BOJ reversed a 25 basis points hike in the overnight all rate made in 2000 and effectively returned to a zero interest rate policy, again to support a weakening economy. The European Central Bank (ECB) kept monetary policy tight for much of 2000 and early 2001 before lowering its reference rate by 25 basis points in May 2001. This surprising move was justified by a more adverse external environment, moderate wage pressures, and slower monetary growth.

After reaching highs in the first quarter of 2000, equity markets declined on the back of tighter monetary policy (initially), slower growth,and most importantly, a major revaluation of the technology, media, and telecommunications (TMT) sector. The reversal in the TMT sector is perhaps starkest. Since its peak in the first quarter of 2000, the Nasdaq composite index has lost over 50% of its value - much larger than the declines in broader indices. Poor US equity market performance, in turn, had negative effects on regional equity markets. This was compounded by domestic political uncertainties, and concerns over slow corporate reforms.