Slowing growth to contain inflation is easier said than done

A global economic slowdown is not just a risk anymore, with policymakers expecting tighter financial conditions to dampen growth.

In his remarks at the Monetary Authority of Singapore's (MAS) 2021/2022 annual report press conference on Tuesday, managing director Ravi Menon said that a good scenario as a result of the slowdown is a mild and short-lived global technical recession: Two consecutive quarters of negative growth that tame inflation.

The strategy of slowing growth to contain inflation is as old as the institution of the central bank itself.

But it always carries the threat of pulling the economy into a recession, costing jobs and incomes.

By raising interest rates, central banks hope to tame inflation by discouraging too much spending.

Obviously, governments and central banks worldwide are so frustrated at their inability to restrain the pace at which prices are rising and destroying their citizens' purchasing power that they are prepared to sacrifice economic growth.

But this policy shift is also quite an abrupt U-turn from where things were just two years back and undermines their credibility to maintain the balance where income growth continues to outrun inflation.

Fearing Covid-19 would snuff growth, governments opened their coffers wide to compensate for incomes lost to lockdowns and central banks became super-accommodative - a move equivalent to pumping interest-free money into the financial system.

Ironically, that largesse is why inflation is so persistent now.

The problem is that the MAS' preferred scenario depends on the central banks of major economies such as the United States and the European Union that were completely blindsided by the brewing storm of inflation, even as consumer prices started to rise above their forecasts in mid-2021.

Singapore relies on what policymakers do elsewhere.

The small size of the economy means growth is a function of how much Singapore can export.

Scarcity of resources means it imports almost everything it consumes, making it a price-taker.

This is why MAS has an exchange rate-based monetary policy - it allows the Singapore dollar to strengthen - which is quite effective in keeping imported inflation at bay by making imports cheaper.

But that also means interest rates are virtually benchmarked to rates set by the US Federal Reserve.

The Singapore central bank has tightened its policy stance four times since October last year.

MAS said the Singapore dollar has appreciated on a trade-weighted basis by 4 per cent since then, keeping inflation here lower than the four-decade high of 9.1 per cent in the US.

Most of the criticism of not acting against inflation early on is directed at the Fed, since the US economy posted the strongest recovery from the pandemic-induced 2020 recession and was the first major economy to show signs of underlying inflationary pressures.

Now the Fed has moved rates up at the fastest pace in decades, raising the risk of a recession.

Meanwhile, Singapore interest rates have risen in tandem. Both the stronger currency and higher rates in the Republic are apparently starting to make an impact.

Gross domestic product (GDP) growth in the second quarter on an annual basis was not only lower than what most private economists had expected, it was nil when compared with the previous three months on a seasonally adjusted basis.

The GDP data was consistent with growth in non-oil domestic exports (Nodx), which have been losing steam since the beginning of this year. The annual three-month moving average for Nodx, a more telling measure of the strength of export growth, came in at 9.1 per cent last month, down from 19.9 per cent in January.

Nomura International said real exports - adjusted for inflation - have been on the downtrend, not only in Singapore but across most export-driven Asian economies.

Morgan Stanley said the drop in real exports means goods inflation in Asia is already on the retreat and, along with it, capital expenditure - investment in plants and equipment - has started to shrink.

The US bank says the twin declines are in response to slowing demand from major economies, a fact echoed by business leaders in Singapore such as Mr Ang Yuit, vice-president of the Association of Small and Medium Enterprises.

Mr Ang said if demand for exports from the US and Europe continues to ease, the strength of the Singdollar may start to hurt export competitiveness at some point in the coming months and push businesses here to cut operating expenses, which include payroll and hiring costs.

While MAS said the currency appreciation so far is not a problem, the differentials between currencies on a nominal basis is much wider than in previous business cycles.

For example, the Singdollar is about 3 per cent lower than the greenback, which has risen this year against almost all its trading partners. But the Japanese yen has dropped by almost 17 per cent against the US currency this year, while the euro and the British pound are down about 11 per cent.

This means the Singdollar strengthened relative to the yen, euro and pound, and hence is less competitive in comparison.

The market will be watching out for data to be released on July 28, when the US announces second-quarter GDP numbers.

The Atlanta Fed's GDPNow gauge sees the second quarter running at negative 2.1 per cent which, coupled with the first quarter's decline of 1.6 per cent, would fit the definition of a technical recession.

Mr Irvin Seah, senior economist at DBS Bank, said the slowing economy amid still-high inflation will be a dilemma for central banks worldwide.

"It will be a delicate balancing act ahead for the MAS," he said, adding that the extent of growth slowdown may tilt policy at MAS' next meeting set for October.

Bank of America believes policymakers worldwide would shift their policies to defend growth as soon as the end of this year.