Singapore: Staff Report for the 2007 Article IV Consultation Supplementary Information

Singapore’s recent economic performance has been impressive, underpinned by prudent macroeconomic management. Economic activity remains strong despite a softening in external demand. On the demand side, domestic demand strengthened driven by private consumption and investment while net exports were broadly unchanged during the first half of 2007. It has been noted that the exchange-rate-based monetary policy framework has served Singapore’s small, open economy well. As inflation expectations are well anchored, they agreed that the present monetary policy stance of targeting a gradual nominal effective exchange rate appreciation remains appropriate.

Abstract

Singapore’s recent economic performance has been impressive, underpinned by prudent macroeconomic management. Economic activity remains strong despite a softening in external demand. On the demand side, domestic demand strengthened driven by private consumption and investment while net exports were broadly unchanged during the first half of 2007. It has been noted that the exchange-rate-based monetary policy framework has served Singapore’s small, open economy well. As inflation expectations are well anchored, they agreed that the present monetary policy stance of targeting a gradual nominal effective exchange rate appreciation remains appropriate.

I. Introduction

1. In line with the 2007 Decision on Bilateral Surveillance, this supplement to the staff report (6/15/07) elaborates on the staff’s assessment of Singapore’s exchange rate level and presents the authorities’ views. This assessment does not change the overall analysis and policy recommendations contained in the staff report. Paragraphs 5–8 below should be considered part of the staff appraisal.

II. Recent Developments

2. Economic activity remains strong despite a softening in external demand. Real GDP grew by 8.6 percent (y/y) in the second quarter, bringing growth during the first half of 2007 to 7.6 percent (y/y). On the supply side, the strong expansion was led by the services, construction, and selected industrial sectors (pharmaceuticals and transport engineering). On the demand side, domestic demand strengthened driven by private consumption and investment, while net exports were broadly unchanged during the first half of 2007. In light of strong momentum, real GDP growth in 2007 is now projected to reach around 7½ percent. Inflation remains subdued, with consumer price inflation of 1 percent (y/y).

3. The current account surplus continued to rise in U.S. dollar terms, despite a slowdown in export growth, partly due to the shifting of the income balance into positive territory.

4. Asset markets have generally remained fairly orderly, notwithstanding recent disturbances in world markets. Similar to other markets in the region, equity prices have risen further over the past few months, with the Singapore’s Straits Times Index up by around 34 percent (y/y) despite a drop of around 10 percent in recent weeks. Currently available information indicates limited exposure of Singapore banks to the U.S. subprime market. The property market continues to strengthen; private residential prices rose by 21 percent (y/y) in the second quarter of 2007, but remain well below pre-Asian crisis levels. In response to rising demand, the authorities have recently increased land sales and raised the rate charged on land development.

III. The 2007 Decision on Bilateral Surveillance

5. As explained in the staff report, the authorities intervened heavily in the foreign exchange market in response to large capital inflows in 2006. However, in previous years and subsequently in 2007, they have not engaged in protracted large-scale intervention in one direction. More recently, as Singapore dollar interest rates declined, capital inflows appear to have eased and the nominal effective exchange rate has depreciated and moved toward the center of the staff-estimated policy band. These developments, together with a significant decline (US$ 7.5 billion) in the sum of gross official reserves and the MAS’ forward position since March 2007, suggest that the authorities have refrained from sterilized intervention.

6. As noted in the staff report, Singapore is a small open economy with few natural resources and thus is highly vulnerable to external shocks. The large build-up in official and quasi-official foreign assets reflects Singapore’s prudent policy to safeguard against adverse shocks, rapid population aging, and geopolitical uncertainties.

7. Although Singapore has run large current account surpluses in recent years, they can be explained mainly by structural (including fiscal surpluses, income relative to that of trading partners, and the working-age dependency ratio) and cyclical factors as indicated in Box 2 of the staff report. Furthermore, the recent increase in the current account surplus reflects changes in private saving and investment. Over the medium term, even in the absence of a real effective exchange rate appreciation, the ratio of the current account surplus to GDP is projected to narrow by about 5 percentage points to 22 percent in 2012 as the recovery in private investment (especially in the construction sector) continues and corporate savings decline due to more modest profit growth. Over the longer term, the current account surplus is expected to narrow further as structural reforms continue to strengthen Singapore’s resilience to shocks, reducing the need for maintaining large fiscal reserves, and as the savings rate declines with population aging.

8. As stated in the staff report, the monetary policy framework, which targets the nominal effective exchange rate, has served the Singapore economy well as evidenced by sustained low inflation and high growth. Net foreign assets relative to GDP will continue to grow strongly, although the rate of increase is expected to diminish as the current account surplus begins to narrow over time. Nonetheless, Singapore’s external position and its prospects suggest a misalignment at present in the real effective value of the currency relative to its long-term value and that the Singapore dollar is likely to appreciate as part of the adjustment process. Estimates prepared by the mission team based on models estimated specifically for Singapore suggest that the deviation in Singapore’s real exchange rate from its medium-term equilibrium level ranges from an overvaluation of 7 percent to an undervaluation of 16 percent. However, estimates of the equilibrium exchange rate vary widely. For example, those based on the CGER methodology (which also relies on models estimated from panel data) suggest an undervaluation of 15–20 percent from a medium-term perspective.

9. In responding to the above, and consistent with what is reported in the staff report, the authorities agreed with the staff assessment regarding structural factors contributing to the large current account surplus, which is expected to narrow over time. However, the authorities disagreed with the staff’s assessment that Singapore’s exchange rate is “misaligned”, stressing the lack of evidence of exchange rate misalignment. They cited the sustained low inflation against the high degree of wage and price flexibility, and the considerable statistical uncertainty associated with estimation of the equilibrium exchange rate.

Singapore: 2007 Article IV Consultation: Staff Report; Staff Supplement; and Public Information Notice on the Executive Board Discussion
Author: International Monetary Fund