1 In July 2001, MAS shifted to a neutral exchange rate policy stance, with the policy band reflecting a zero percent appreciation of the trade-weighted nominal effective exchange rate (S$NEER). Prospects for the Singapore economy had worsened significantly in the second half of last year, dragged down by the deterioration in the external economic environment, especially the sharp downturn in the global IT cycle. Inflation also trended down in 2001, reflecting the fall-off in domestic spending and the lack of external inflationary pressures.
2 With the heightened uncertainty in the external environment following the terrorist attacks in the US, MAS decided to widen the policy band in October, so as to allow greater flexibility managing the exchange rate.
3 The trade-weighted S$NEER trended up initially in H2 2001, reflecting in part a marked weakening of the US$ as data showed a sharper-than-expected slowdown in the US economy. (Chart 1) In addition, sentiments for the S$ were boosted by the relatively smooth political succession in Indonesia. There was a further up-tick of the S$NEER towards the upper range of the band in mid-September, partly due to the plunge in the US$ as concerns over the US economy deepened following the September 11 terrorist attacks. However, with the release of economic data in October showing the continued sharp deterioration in the Singapore economy, there was a downward revision in the short-term outlook for the year, and the S$NEER depreciated before stabilising at around the levels prevailing 18 months ago (2000H1).
Chart 1 Nominal Effective Exchange Rate (S$NEER)
4 On a bilateral basis, the S$ weakened against the major currencies as well as most of the Asian currencies in the second half of 2001. (Chart 2) After some initial strengthening, the S$ depreciated against the US$ through mid-November. The S$ weakened further against the US$ in the last few weeks of December reflecting the depreciation of the Yen, although on a trade-weighted basis the S$NEER has continued to remain relatively stable.
Chart 2 Singapore Dollar Bilateral Exchange Rate
Against Various Currencies
(a) Industrialised Countries
(b) Regional Countries
5 As global monetary conditions have eased, domestic interest rates have fallen significantly. (Chart 3) The 3-month interbank rate has fallen since the September 11 attacks, declining to a low of 0.88% at end-October, before rising slightly in November. However, because the 3-month US$ SIBOR fell even further, the differential between the two interest rates narrowed to 90 basis points at end-November. Retail interest rates experienced a similar decline, with the average prime lending rate sliding to 5.35% in November, after remaining at 5.80% for the first eight months of the year.
Chart 3 Interest Rates
ECONOMIC OUTLOOK FOR 2002
6 The Advance GDP Estimates released by the Ministry of Trade and Industry today, show that real GDP in Singapore contracted further by 7.0% in Q4 (year-on-year) resulting in a contraction of 2.2% for 2001 as a whole. The export-oriented manufacturing sector bore the brunt of the slowdown last year, reflecting the downturn in the global electronics sector. This in turn had negative spillovers on the trade-related services sectors, which were affected by the drop in transport and travel receipts and the slowdown in entrepot activity. Nevertheless, there are some signs that the economy may be bottoming out. Real GDP, seasonally adjusted, is estimated to have increased at an annualised rate of 4.3% in Q4 (quarter-on-quarter), after declining at the rate of 10% for three consecutive quarters.
7 Given the openness of the Singapore economy, our recovery hinges critically on the strength of the turnaround in the electronics industry and the improvement in the external environment. The global electronics sector remains in a prolonged adjustment phase, characterised by inventory adjustment and weak demand, though some tentative positive signs have emerged in recent weeks. Inventories in the electronics industry have continued to shrink, while semiconductor prices have risen recently, suggesting some strengthening in demand conditions and a bottoming out of the inventory cycle. On the domestic front, the decline in manufacturing exports and production appears to be levelling off. With a steady pick up in global IT demand through the year, the domestic electronics sector could pick up by the middle of 2002.
8 However, we remain cautious about whether this is the start of a sustainable improvement, or merely a year-end seasonal pick-up in demand. Given the uncertainties, the Ministry of Trade and Industry is maintaining its forecast for real GDP growth of 2% to 2% in 2002.
9 The synchronised slowdown in the global economy has muted inflationary pressures in most of Singapore's major trading partners. At the same time, world commodity prices have generally weakened, led by a decline in oil prices.
10 Imported inflation in Singapore fell to 2.2% in July-November, compared to 2.8% in H1 2001. This, coupled with the fall in domestic production, excess capacity in the economy, and lacklustre consumer sentiments, caused CPI inflation to trend down to 0.8% in Q3 and further to 0% in October-November, from an average of 1.7% in H1 2001. Similarly, all core inflation measures have moderated, with the MAS underlying inflation falling below 1% in October. For the whole of 2001, CPI inflation is expected to average around 1%.
11 Weak demand conditions are expected to exert more downward pressure on prices of cyclical-sensitive items such as clothing, cars and miscellaneous items, while services inflation should be subdued as wage growth moderates further in the months ahead. As inflation typically lags GDP growth, a turnaround in economic activity in H2 2002 is unlikely to lead to an immediate uptick in inflation. Overall inflation is expected to come in lower this year, between 1.0% to 0%. (Chart 4) This forecast takes into account the cost-cutting measures announced by the government to cushion the effects of the recession, which will directly reduce the prices of various consumer goods and services.Aside from the price cuts by NTUC, which have been extended to December 2002, and the reduction in petrol excise duties, other measures include holding local university and polytechnic tuition fees unchanged for academic year 2002, and a freeze in the maid levy. A further reduction in electricity tariffs has also been implemented as part of the October 2001 off-Budget measures.
Chart 4 CPI Inflation Forecast for 2002
12 Despite recent tentative signs of a bottoming out, downside risks remain in the external environment. Furthermore, the initial stages of the recovery in the US and global economy will in all likelihood be modest and hesitant. We therefore expect the Singapore economy to remain subdued in the near term, and to start picking up only in the second half of 2002. Inflationary pressures are likely to be absent this year.
13 In our assessment, the current level of the S$NEER is supportive of economic recovery and growth in a benign inflationary environment. The MAS will therefore maintain a zero percent appreciation path for the policy band, centred on the current level of the S$NEER. We are also restoring a narrower policy band, as market and economic conditions have become less volatile.