Today, I would like to discuss about USD/SGD exchange rate and inflation in Singapore. As I have mentioned in my previous blogs, inflation is something that I am more worried of as compared to the other crisis. Recently, the authority has announced that CPI went up by 5% in Feb 2011. Correspondingly, USD/SGD exchange rate has dropped to 1.257 these few days. This is something that we have been expecting given that our regulator MAS is more inclined to make use of exchange rate policy as a tool to control inflation.
In the chart above, we can clearly see that the USD/SGD exchange rate tends to depreciate as inflation rate in Singapore goes up. This is evident in the 90s as well as these two years. It shows how MAS controls the inflationary pressure in Singapore with a managed exchange rate policy. Then, the next question that we should ask ourselves will be why is our inflation rate going up?
In the chart above, we compare the real GDP growth in Singapore against its inflation rate. Given our open economy, Singapore's real GDP growth tends to overshoot when we start to recover right after a major economic crisis. Take 1998 Asian Crisis for example. Our real GDP growth ran all the way up to 9.1% after that major crisis. Similarly, we are seeing the same effect now (one year or so after Subprime crisis). When our GDP starts to overshoot, unemployment rate will drop and more people will start buying cars and houses.
Let's take a look at the contributing factors to the increase in the consumer price index for Feb 2011. The major contributors are Transport and Housing. Given that COE (Certificate of Entitlement) forms a major part of the car price, I do not think that a low USD/SGD exchange rate will help very much in alleviating the inflationary pain in this area. Nevertheless, a low USD/SGD exchange rate will help to control the price of petrol in Singapore. As for housing, please take note that CPI only takes into consideration the cost of accomodation (i.e. cost of rental) and not housing price. The escalating housing prices have caused rental cost to go up correspondingly. All in all, inflationary pressures have built up in this country over these two years. To respond to this, our SGD has also appreciated over these two years as well.
Our last question will now be how low can the USD/SGD exchange rate go and how long will it last? Frankly, I do not think the depreciating USD/SGD exchange rate will last long. A lower USD has its side effects to Singapore's economy. It has become more expensive for tourists to visit Singapore and this will hurt our tourism and service industries. And, for your info, this industry includes our Integrated Resorts and Casinos as well. In addition, an appreciating SGD will hurt our manufacturing industry and this sector forms 30% of our GDP. Lastly, in US, QE II is coming to an end and this will bring an end to cheap money soon. If you look at the charts again, you will see that GDP growth will normalize after an initial period of high growth. This goes the same for inflation rate. When inflationary pressure stops rising, it will mean that it does not make compelling reason to maintain a high exchange rate for SGD anymore. And, this day may come sooner than you know. Just my 5 cents worth.
Disclaimer: The content in this blog contains purely my personal opinion and it is in no way a substitute for professional financial advice. You should seek advice from a professional financial advisor with any question regarding your financial matters.
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