Singapore: A Two-Speed Economy

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By Taimur Baig, Chief Economist for India, and ASEAN, Global Markets Research at Deutsche Bank AG. He is a regular guest on CNBC TV.

Singapore's economy is undergoing a clear soft patch. Consider the following:

1. Industrial production (excluding volatile biomedical goods) has been down by 6 percent year on year or more in recent months
2. Non-oil domestic exports have been down, on average, by 15 percent year on year since December
3. Data on the productivity front is also poor
4. Inflation remains high by historical standards - over 4 percent in recent months despite a tight monetary policy stance for over 2 years

Business sentiment is weak, with the Purchasing Manager's Index exceeding 50 just once since June 2012 (a reading above 50 indicates expansion and below that contraction).

Although gross domestic product (GDP) growth is expected to pick up this year on the back of rising demand in the U.S. and China, the data seen so far this year suggest Singapore will lag the Southeast Asian region in the pace and magnitude of recovery.

But does slow growth really matter? Against the apparently weak data reported above, we need to consider the following context.

The economy is operating at full employment. The rate of unemployment has been around 2 percent for the last couple of years, at the very low end of reported figures since the 1997 Asian crisis.

Wages have been rising steadily, reflecting both a tight labor market and public sector initiatives to raise the standard of living.

While the year-on-year percentage change in real GDP may appear small (1.5 percent in October-December), Singapore's real GDP recovered its lost output from the 2008-09 global crisis rapidly and the present level of real GDP is 29 percent higher than the bottom reached in early 2009. The economy is operating fairly close to its potential level of output.

Asset markets are buoyant, with stock prices up about 11 percent year on year and property prices about 20 percent higher than the previous cycle's peak in mid-2008.

Monetary and financial conditions remain exceptionally easy. Interest rates are at an all-time low, capital inflows are ample, and the appreciating currency has increased the purchasing power of Singaporeans considerably.

It is not difficult to reconcile the first group of negative figures with the second group of positive ones. Singapore's growth depends largely on external demand, which has been weak for a while, affecting exports and production, but the economy's fundamentals remain strong, thanks to low interest rates supporting thriving domestic demand. If anything, some slowdown in growth is desirable as that could relieve some cost pressure on the economy.

Policy Dilemma

With this backdrop I don't expect the authorities to have much desire to support the economy.

Interestingly, the thrust of policy measures lately has been in the opposite direction, with the Monetary Authority of Singapore (MAS) steepening the slope on the nominal effective exchange rate (NEER) appreciation last year and a series of macro prudential measures being put in place since 2010 to cool the property market.

As long as interest rates remain at their floor and global liquidity abundant, there will be only limited traction from steps to cool the property market. As cost of financing remains cheap, money will find its way to the property market and associated activities.

The curious characteristic of the Singaporean economy is that it is compelled to maintain a policy of exchange rate appreciation to fight tradable price inflation, which in turn brings in flows and keeps rates low, and consequently fuels non-tradable inflation (e.g.rent and transportation).

The authorities have taken an array of measures to stem the latter, but the impact has been limited so far. The MAS will likely maintain an unchanged policy stance during its policy review later this month, and more property cooling measures could well be in the pipeline, but I am not convinced if this policy mix will bring about the desired result. Like it or not, Singapore's fortunes will continue to remain tied to the vagaries of global macro-economy and developed country monetary policy for years to come.