1 At the beginning of 2002, MAS announced that it would maintain a zero per cent appreciation path for the exchange rate policy band, centred on the level of the trade-weighted Singapore dollar nominal effective exchange rate (S$NEER) prevailing at that time. Furthermore, as the economic uncertainty arising from the September 11 incident had diminished and financial markets had stabilised, the exchange rate policy band was narrowed.
2 Since then, the S$NEER has largely fluctuated within the upper half of the policy band in H1 2002. (Chart 1.) It initially strengthened over the first two months of the year, as the improved economic outlook led to portfolio inflows into the local and regional equity markets. The S$NEER subsequently eased and fluctuated within a narrow range.
Chart 1 Nominal Effective Exchange Rate (S$NEER)
3 On a bilateral basis, the Singapore dollar strengthened against the US dollar, but depreciated against the Euro and Yen in H1 2002. (Chart 2.) After weakening against the US dollar in February and March, the domestic currency appreciated in the second quarter of the year, to end some 4.9% higher at end-June 2002 compared with end-2001. Against the Euro and the Yen, however, the Singapore dollar fell by 6.1% and 4.5% respectively over the same period. Among the Asian currencies, the Singapore dollar also weakened against the Rupiah and the Won, but remained largely unchanged against the Baht and the New Taiwan dollar.
Chart 2 Singapore Dollar Bilateral Exchange Rate
Against Various Currencies
(a) Industrial Countries
(b) Regional Countries
4 Domestic interest rates continued to trend lower in the first half of 2002, with the three-month interbank rate easing from 1.25% at end-2001 to 1.06% at end-Q1 2002 and 0.88% at end-Q2. (Chart 3.) This was in line with easy liquidity conditions in the domestic money market and the soft global interest rate environment.
Chart 3 Interest Rates
ECONOMIC OUTLOOK FOR 2002
5 The external environment has improved significantly since the beginning of 2002. The strengthening in the global economy was led by the US, reflecting robustness in consumer spending and a reduced pace of inventory liquidation. A turnaround in the global electronics industry also contributed to a pickup in exports and production among the East Asian economies.
6 Against this favourable backdrop, the Singapore economy continued to recover in the first half of this year. The Advance GDP Estimates released by the Ministry of Trade and Industry (MTI) on 10 July 2002 show that the recovery momentum has been maintained, with real GDP growth estimated at 10.3% (quarter-on-quarter, seasonally adjusted annualised rate or SAAR) in Q2 2002, higher than the revised growth rate of 8.4% in Q1. (Chart 4.) As indicated by MTI?s statement, the uptick in growth in Q2 largely reflected the exceptional surge in activity in the chemicals cluster.
Chart 4 GDP Growth
7 The recent volatility in international financial markets, particularly the weakness in global equity markets, has cast some uncertainty on the outlook for the global economy. In our assessment, the recovery in the industrial countries, while likely to continue for the rest of the year, may proceed at a somewhat slower pace than in previous upturns. On current indications, global IT spending is expected to grow modestly by about 3% for the year as a whole, which should provide support for a further improvement in the domestic electronics sector and its related industries. The output of the chemicals sector is likely to remain high although production and exports would continue to be fairly lumpy and volatile. Along with the modest recovery of manufacturing in 2002, the trade-related segments of the services sector are expected to benefit most from the improvement in the external environment. On balance, real GDP growth could come in at the upper half of the official forecast range of 2-4% in 2002.
8 The domestic inflationary environment remained subdued in the first half of 2002, with the CPI registering a decline of 0.8% on a year-on-year basis over January-May. Prices continued to adjust with a lag to the economic downturn last year, and have been held down by the absence of imported inflation and the slack in the domestic economy.
9 Nevertheless, the price declines have begun to level off, and on a seasonally adjusted basis, the index rose by 0.4% in the first five months of this year, since hitting a trough in January. The rise in the price index was mainly on account of higher private road transport costs. Increases in the cost of consumer services and cyclical-sensitive items caused the MAS underlying CPI, which excludes private road transport and accommodation, to also trend up slightly.
10 Looking ahead, imported inflationary pressures are expected to remain low, reflecting the excess capacity that remains even as the global economy gradually recovers. Given the slack in the labour market and rebound in productivity growth, a strong uptick in domestic price pressures is unlikely at this stage of the business cycle. Even taking into account further increases in several cyclical-sensitive items and consumer services, including the recent hikes in public road transport fares and electricity charges, we expect CPI inflation for 2002 as a whole to come in near the mid-point of our forecast range of -0.5% to 0.5%. (Chart 5.)
Chart 5 CPI Inflation Forecast for 2002
11 The domestic economy is expected to continue on its recovery path, although some uncertainty remains over its strength for the rest of the year. Inflationary conditions should, however, remain generally subdued. In view of the benign inflationary environment, and to facilitate continued economic recovery, MAS will maintain its current policy stance of a zero per cent appreciation in the S$NEER for the second half of 2002.