Sing$ policy decision in Oct hinges on employment, growth risks

High inflation may give Singapore's central bank no choice but to keep pushing up the currency against the country's trading partners, but just how aggressive it will be is the key question for markets.

The risks of going too hard are clear given that there are increasing signs of a global downturn and the possibility of two consecutive quarters of negative growth here, which would imply the economy is in a technical recession.

The local economy contracted by 0.2 per cent in the second quarter, a reversal from the 0.8 per cent expansion in the first three months of the year.

Some analysts believe growth was negative in the third quarter as well. But the official word on whether the economy is in a technical recession or not will come on Friday when the Ministry of Trade and Industry gives its first estimate of growth in the July to September period.

The Monetary Authority of Singapore (MAS) will release its monetary policy statement on the same day and is expected to tighten the exchange rate-based policy settings, pushing the Singapore dollar further up against other currencies, according to a Reuters poll.

But analysts believe an excessively strong Singdollar, which has risen virtually against all currencies except the US dollar this year, will put the nation's export competitiveness at risk.

A significant decline in exports will hit both economic expansion and the so-far strong employment growth.

Given that the bulk of Singapore's economic growth depends on overseas demand for its goods and services, the importance of the relative value of the Singdollar against its trading partners cannot be overstated.

The currency's strength comes from four monetary tightening moves taken by the MAS since October 2021, as the pace of inflation continued to defy expectations.

Mr Edward Lee, Standard Chartered Bank's chief economist for Asean and South Asia, said the MAS has already tightened monetary policy ahead of and more than most of its trading partners.

"As a result, MAS may have some room to wait and see the effect of its recent tightening and weigh the risk of a global economic downturn," said Mr Lee, who believes the MAS may tighten a bit more in October and assess the situation again in January.

StanChart estimates the Singapore dollar's trade-weighted value - referred to by economists as the nominal effective exchange rate (NEER) - has strengthened by 5.7 per cent since October 2021.

The Singapore dollar's NEER has also appreciated by a cumulative 8.9 per cent against the currencies of all of its trade partners except the US dollar and Hong Kong dollar, which is pegged to the greenback.

Mr Lee said the Government has also noted on a few recent occasions the impact of an overly strong currency on Singapore's export competitiveness at a time of rising global recessionary risks.

Prime Minister Lee Hsien Loong noted in his National Day Rally speech that while a stronger currency makes imported goods cheaper, there is a limit to tightening as a strong currency also makes Singapore's exports more expensive, leading to a loss of competitiveness.

He noted that "we have to be very careful not to overdo things".

This message was recently reinforced by Trade and Industry Minister Gan Kim Yong, who also warned of headwinds to the economic outlook.

Singapore uses its currency as the primary monetary policy tool to cool down import costs - the main contributor to inflation here. That leaves domestic interest rates tracking mainly the rates in the US set by the Federal Reserve.

So local rates on lending, or the cost of borrowing in Singapore dollars, are on the rise and will also have a negative spillover effect on economic growth.

For instance, the one-month Singapore Overnight Rate Average, which is used to calculate home loans, reached 2.5 per cent last Thursday, up from just 0.23 per cent at the start of 2022.

Mr Mohamed Faiz Nagutha, Asia and Asean economist at Merrill Lynch, said the combination of a stronger trade-weighted Singapore dollar and higher domestic interest rates has squeezed the availability of funding in Singapore.

"Our analysis shows that some households in the fifth to eighth decile of income distribution could see their monthly household expenditure - including mortgages - rise close to or beyond 90 per cent of income should mortgage rates move up to 3.5 per cent to 5 per cent," he added.

He noted that given that these households are highly leveraged, higher mortgage payments could have a large impact on disposable incomes.

Dr Chua Hak Bin, regional co-head of macro research at Maybank, said recent manufacturing data from Singapore and other Asian export-driven economies suggests monetary tightening worldwide has sent global demand for the key electronics sector in retreat.

"Services growth will also likely ease due to softer growth in external-oriented services including wholesale trade, water transport, and finance and insurance, which will offset the recovery in consumer and tourism-related services," he noted.

Dr Chua expects that Singapore's gross domestic product growth in the third quarter could have declined by 0.6 per cent on a seasonally adjusted basis from the second quarter, when the economy contracted by 0.2 per cent.

"That would imply that the economy has entered a technical recession," he said.

Mr Nagutha said that while the near-term outlook for jobs and wages remains robust, both are at risk going into 2023 if external demand weakens considerably amid heightened economic uncertainty.

He pointed to the Ministry of Manpower's recent warning that employment growth in external-oriented sectors - such as manufacturing, wholesale trade and financial services - could slow, even as tourism-and aviation-related areas recover gradually while consumer-facing sectors stay robust.