1 In early 2000, against the backdrop of a favourable external environment and a strong rebound in the Singapore economy, MAS adopted an exchange rate policy that allowed for a gradual, modest appreciation of the Singapore dollar on a trade-weighted basis. In the event, the Singapore economy expanded strongly in 2000, particularly in the second half of the year, accompanied by a significant tightening of the labour market and a rise in domestic inflationary pressures. The Singapore dollar trade-weighted exchange rate (S$NEER) trended upwards for most of 2000, reaching the upper bound of the policy band by the end of the year. (Chart 1)
2 In January 2001, MAS decided to maintain this stance of a modest appreciation of the trade-weighted Singapore dollar within an unchanged policy band. It aimed to cap medium-term inflationary pressures, while continuing to be supportive of economic activity as growth came off its cyclical high and moderated to a slower pace.
3 Economic activity slowed much more in the first half of 2001 than was expected. This caused market sentiment to shift against the Singapore dollar. Strong demand for US dollars to fund merger and acquisition activities by domestic corporates, and a strengthening of the US dollar against the major currencies, exerted further downward pressure on the Singapore dollar. MAS intervened in early May, to prevent this exceptional demand for US dollars from pushing the exchange rate beyond the policy band.
4 The S$NEER has therefore weakened over the period, from the top of the policy band at the start of the year to the lower half of the band at end June. This trend was consistent with the change in underlying economic and market conditions. On a bilateral basis, the Singapore dollar depreciated against the US dollar but strengthened against the Yen and Euro and most regional currencies. (Chart 2)
5 Overall monetary conditions have eased since the beginning of this year, reflecting both the easing of the S$NEER as well as lower interest rates, influenced by interest rate cuts by the US Federal Reserve. The domestic 3-month interbank rate eased from 2.81% in December 2000 to 2.25% in June 2001. Interest rates in the retail market have also stayed low. (Chart 3)
GROWTH PROSPECTS TO WEAKEN FURTHER THIS YEAR
6 The global economic environment has deteriorated sharply. The extent of the slowdown has exceeded what was expected at the beginning of the year, and so has the risk of a more protracted downturn. The US economy slowed markedly, while Japan recorded negative growth in the first quarter. In Europe too growth has weakened more than expected. The forecasts for many regional economies have also been revised downwards following weak first quarter exports and GDP growth rates. The aggregate GDP growth for Singapore's major trading partners is expected to moderate sharply to 2.5% this year, down from the 5.5% recorded last year.
7 Given the openness of the Singapore economy and its dependence on external demand, it is not surprising that we have been hit hard by the external downturn. GDP growth is estimated to have fallen to 1.8% (year-on-year) in H1 2001, from 10.7% in H2 2000, led by a sharp slowdown in manufacturing and weakening domestic demand. Measured in terms of a seasonally-adjusted quarter-on-quarter annualised rate (SAAR), growth has been negative for two consecutive quarters and the economy is technically in recession.
INFLATIONARY PRESSURES ARE SUBSIDING
8 The labour market remained tight in the first quarter of the year, with the seasonally-adjusted unemployment rate declining from 2.9% in December 2000 to 2.4% in March 2001. However, the labour market is now showing clear signs of easing.
9 CPI inflation averaged 1.8% in Jan-May 2001, down from a peak of 2.0% in Q4 2000, although the MAS measure of underlying inflation was still relatively high at 2.3% in Jan-May 2001. (Chart 4)
10 CPI inflation is expected to trend down for the rest of the year, coming in within the 1-1.5% range for 2001 as a whole. (Chart 5) Foreign inflationary pressures are expected to be benign this year, especially with the softening in oil prices. Domestic sources of inflation will also be more muted with a softer labour market going forward, significantly slower growth in nominal earnings, and more cautious consumer sentiments.
11 Against the backdrop of a weaker external economic environment and a more protracted global electronics downturn, near term growth prospects for the Singapore economy have turned significantly weaker. Real GDP growth is expected to slow sharply to 0.5-1.5% this year. Recovery in 2002 will depend on an upturn in external demand, particularly of the global electronics industry. At the same time inflationary pressures are subsiding. However, the slowdown reflects a decline in demand, not an erosion of competitiveness. There is no reason for any persistent weakening of the Singapore dollar.
12 MAS has therefore shifted to a neutral exchange rate policy stance, with a policy band centred on a zero percent appreciation of the S$NEER. MAS will continue to guide the S$NEER within this exchange rate band, and stands ready to intervene to dampen excessive volatility should this become necessary.