Three things from Thursday's surprise easing by the Monetary Authority of Singapore (MAS). The central bank caught the market off-guard by flattening the Singapore dollar policy band - shifting to a neutral policy stance of zero per cent appreciation of the S$NEER (Singapore dollar nominal effective exchange rate) band. The width of the policy band and the level at which it is centred remains unchanged.
1. Growth, inflation, and the Sing dollar
The latest MAS policy announcement illustrates clearly the interplay of growth and inflation in its policy making - and it's not what's often envisaged by many market watchers. The common reading is one of MAS weakening the Sing dollar to boost growth, by making exports cheaper and more competitive. It's actually the other way round. The subdued growth environment led MAS to lower its core inflation outlook, which then led it to ease its monetary policy stance.
It's worth restating that inflation is the primary target of MAS policy, which manages the Sing dollar to mitigate imported inflation to provide an environment conducive for growth. In the present environment, weaker business conditions will moderate the pass-on of higher costs to prices, helping to contain inflation.
This then allows MAS to take a more accommodative stance. MAS now expects core inflation to come in at the lower half of the 0.5-1.5 per cent range for the year, barring upside surprises to oil prices. Core inflation, which strips out the costs of accommodation and private road transport, is likely to fall below 2 per cent on average over the medium term.
Still, one can read into the MAS policy decision a sober assessment of the Singapore economy. Also on Thursday, the government announced that the Singapore economy grew by 1.8 per cent year-on-year in the first quarter ended March 31, 2016, unchanged from the previous quarter. While this beat market forecasts, growth was flat on a quarter-on-quarter seasonally-adjusted annualised basis, a contrast to the 6.2 per cent expansion in the preceding quarter.
2. Would a weaker Sing dollar help growth?
Expectedly, the Sing dollar weakened in response to the MAS announcement, although the central bank sought to temper reactions. "This is not a policy to depreciate the domestic currency, and only removes the modest and gradual appreciation path of the S$NEER policy band that was in place," it said in its statement. But the Sing dollar slid by almost 1 per cent to S$1.3632 against the US dollar in early trading, its biggest fall since November.
While boosting growth is not the prime target of MAS policy, would a weaker Sing dollar help the economy?
Not really, is the answer, as a BT comparison showed last year. While Singapore's exports will become cheaper, which can serve to boost demand, imports simultaneously become more expensive, which means higher prices for importers. In 2014, exports made up 52.8 per cent of total merchandise trade, while imports constituted 47.2 per cent. Because Singapore imports almost everything it uses, raw materials will become more expensive, and compounded by higher labour costs, the country's total cost base goes up.
So any positive impact on exports from a weaker Sing dollar will be cancelled equally by the negative effects on imports. Interest rates tend to rise too when the currency is weaker, and this raises borrowing costs.
In any case, Singapore will lose out in any competitive devaluation - regional currencies are likely to fall more than the Sing dollar.
For Singapore, the question of long-term growth will have to be addressed by fiscal policies and the restructuring of the economy, as set out in the latest Budget.
3. Some central banks love to surprise
At the last policy review in October, market watchers had called for a major easing move, but MAS more or less stood pat, merely slowing the appreciation of the Sing dollar. Ahead of the latest review, however, the market consensus is for no change - a flattening of the slope was certainly not in the sights of most economists.
While easing was in sight at the start of the year, with sinking oil prices and turbulent financial markets in full force, expectations shifted once conditions steadied. There was no need for "needless policy fussing", as one economist put it. What flat-footed the market was the change in MAS' core inflation outlook - there was little hint of this on the cards, especially when oil prices regained some semblance of stability.
Economists attempted various explanations for the unexpected move, but, if one may say so, what's being offered appears to be driven more by the need to rationalise the development than by any real conviction. It was a surprise.
It could well be down to this: that the MAS decided to take the opportunity to adjust its monetary policy position appropriately when the market least expects. Unlike some other central banks, MAS does not actively guide the market on its future policy direction. In a capital market as open as Singapore's, surprise remains a useful tool in the bag.
This article was first published on April 15, 2016.
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