Stronger Sing$ May Weigh Down Interest Rates

Source : The Business Times, April 15, 2008

Inflows may increase, but stronger currency could hurt exports

Amid the clouds of uncertainty hanging over some sectors, there is good news for home loan borrowers. Interest rates are poised to fall to levels last seen in 2003 following the move to let the Singapore dollar appreciate strongly in an effort to fight imported inflation.

The Monetary Authority of Singapore (MAS) will be busier than ever - intervening in the banking system to mop up some of the extra liquidity in order to moderate the pressure on interest rates.

Low interest rates might negate some of MAS's anti-inflationary measures by helping fuel domestic growth. But economists say MAS will stick to its guns of using the exchange rate as a tool to fight inflation given Singapore's open economy.

Last week, data showed that the economy grew a stronger than expected 7.2 per cent in the first quarter against 5.4 per cent in Q4, 2007. Inflation rose to a 26-year high of 6.6 per cent.

Analysts expect the three-month Sibor to fall to between 0.75 and 1.00 per cent by the fourth quarter of this year as capital flows are attracted here by a rising Singapore dollar.

The record low for three-month Sibor was 0.56 per cent reached in August 2003, when the US Federal Funds rate was at one per cent, said Citigroup economist Kit Wei Zheng.

Since last Thursday when the MAS decided to reset the Singapore dollar higher, the key three-month Sibor, which is the interbank interest rate, has fallen some 19 basis points to 1.25 per cent.

'Foreigners are betting the Singdollar will appreciate ... the band re-centring would reinforce the market perception that MAS wants the exchange rate to appreciate and increase investor expectations of returns on Singapore dollar assets,' said Mr Kit. This would exert downward pressure on short-term interest rates.

The Singapore dollar is now expected to rally to $1.31 by the end of the year against the US dollar. It was $1.36 yesterday.

It is not clear if MAS's move last week will ease inflation significantly given the persistently high commodity prices, record rents and higher transportation charges.

But the more immediate impact of a stronger local dollar could weaken the demand for exports and hurt the profits of foreign companies operating here, given that their costs are in local currency terms, said some economists.

'There will be a slowdown in exports, likewise for foreign companies, their profit margins will be impacted,' said Mr Kit.

United Overseas Bank's Suan Teck Kin thinks there would be a margin rise in inflows by investors to pick up some gains on the appreciating Singapore dollar, but 'overall, we might not see a wholesale rush of capital inflows'.

'This is because from a foreign investor's point of view, currency return is only one component of total return,' said Mr Suan. 'So if an investor believes there is more upside to the equity/ bond/property market and the upside is better than other parts of the region, then the capital will follow.'

Still, the market is bracing for more MAS interventions and sterilisations.

'Investors should expect the MAS to continue sterilising aggressively, so as to moderate the fall in domestic interest rates as a result of its forex interventions,' said Mr Kit.

MAS has been sterilising in unprecedented amounts.

In February, data showed that MAS sterilised or removed about US$8 billion from the banking system, the second largest amount since May 2006 when it was over US$9 billion, said Mr Kit.

This means that Singapore's reserves will continue its climb to record levels.

At the end of March, spot reserves reached S$245 billion, up S$18.8 billion from October, he said.

'Our reserves are always climbing, the same for many Asian countries,' he said.