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Suppressing currency strength and tolerating higher inflation for better growth has not helped. It is time to try the opposite
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Singapore held a by-election on 27 January to elect a member of parliament from Punggol East constituency. The by-election was necessitated by the resignation of Michael Palmer, the ruling party MP, in December over his admission of an improper relationship with a party staff member. He was the speaker of Parliament. The by-election resulted in a big defeat for the ruling People’s Action Party (PAP). Overall, the margin of victory for the opposition Workers Party candidate was around 10.8%, a rather big one. The margin of victory has surprised both the victor and the loser. The next general election is not due until 2016. The Singapore government has its task cut out for the next three years.
Many have cited the rise in the cost of living, the unaffordability of homes and the immigration influx and overcrowding as the reasons. They are not new. They were cited in the 2011 general election too. Since then, the government has curbed inflow of workers heavily. It has raised the levy on domestic workers brought from overseas. The result is that Singapore’s unemployment rate has remained very low even as economic growth has slowed and productivity has suffered. Inflation remains high. In December, the inflation rate was 4.3%, up from 3.6% in December and against expectations of an inflation rate of 3.8%.
The election result raises the risk that the government may resort to populist measures. Targeted distribution of accumulated fiscal surpluses to needy households is clearly needed. However, responses that pander to the undefined and vague existential angst of the Singapore public would aggravate the problem. Bare Talk reckons that the real issue is that the monetary policy could be a lot tighter.
Singapore runs a current account surplus of around 15% of gross domestic product (GDP). This should result in a sustained appreciation pressure on the currency. Further, the rise in the reported liabilities of Singapore banks to all external counter-parties in all currencies since 2003, published on a quarterly basis by the Bank for International Settlements, has coincided with the rise in foreign exchange reserves that Singapore holds. This suggests that Singapore has thus prevented the currency from appreciating a lot further than it has, as a natural consequence of the current account surplus and inflow of deposits into Singapore-based banks from overseas.
No doubt, the currency has strengthened in nominal terms. But, it has appreciated more in real terms due to the higher inflation rate in Singapore. This could still be a price worth paying if the policy of holding back or managing the currency appreciation helped with economic output. Not quite. Many small businesses in Singapore are struggling with rising input costs—land, rentals, transportation, etc. For all the exuberance in global financial markets, Singapore exports are contracting because global economic conditions are weak and uncertain. A weak currency is not of much help in boosting exports in such an environment.
At the same time, Singapore’s tighter immigration rules have stifled productivity gains resulting in the paradoxical situation of a low unemployment rate coinciding with stagnant growth in the real economy. Another paradox is the rise in the cost of living amid the economic slowdown. Advanced economies are vainly trying to restore growth through unconventional monetary policies whose gains are uncertain but the costs are clear for the rest of the world. They are importing inflation. Smaller economies like Singapore are especially vulnerable because of the impact of global capital flows on prices of domestic assets, goods and services. Suppressing currency strength and tolerating higher inflation for better growth has not helped. It is time to try the opposite—allow currency strength and tolerate weaker economic growth for a lower cost of living.
A working paper published by the International Monetary Fund in June 2011, titled exchange rate pass-through over the business cycle in singapore, recommended that Singapore allow the currency to rise faster during global boom times because retailers pass on the rise in import prices much more readily in such periods. They try to sustain demand in times of slow growth by absorbing most of the cost increases themselves. Therefore, in order to manage inflation better and keep it low, the authors recommended that Singapore allow the currency to appreciate rapidly in good times and let it weaken more in bad times. In hindsight, Singapore did not that in the boom times between 2002 and 2008. The euro price of the US dollar dropped 43.6% in the six-and-half-year period from January 2002 to June 2008 whereas the Singapore dollar price of the US dollar dropped only 26.4% in the same period. In other words, Singapore followed other East-Asian countries in sticking to the de facto US dollar standard (Bretton Woods II). The time has come for Singapore to ask if that policy is serving it well.
Going forward, Singapore should target subsidies at the lower income quartile, continue to welcome skilled immigration, allow the currency to appreciate to raise service sector productivity, communicate its policy to the public better and hope for the best.
V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at baretalk@livemint.com. To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk
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