Singapore Devalues Currency After Record GDP Fall

Singapore's central bank eased monetary policy by effectively devaluing its currency to counter a record economic slump while also keeping a lid on domestic interest rates.

The currency is Singapore's main policy instrument, and the central bank on Tuesday repeated what it had done in previous downturns in 2002 and 2003. It shifted the centre of the secret trade-weighted band for the Singapore dollar to the existing weak level of the exchange rate basket in an actual one-off devaluation.

Based on their estimates of where the currency had been trading before the move, economists said the Singapore dollar might have been devalued by 1.5 to 2 percent. The currency's rally on Tuesday suggested market participants had expected a bigger move.

"There had been some expectation that the re-centering would be as much as a 400 basis points depreciation," said Claudio Piron, a strategist with JPMorgan Chase.

Faced with slumping exports, the deepest recession on record and growing speculation of Singapore dollar depreciation, devaluing the currency had been the Monetary Authority of Singapore's best option for the trade-dependent economy.

Other options such as gradually steering the currency lower or widening the width of the trading band would have stoked speculative selling of the currency, thereby pushing yields higher.

"A more radical policy action may have been viewed as counter-productive in terms of operational policy band management and foreign exchange reserves preservation," Piron said.

Those moves could stir further market expectations for currency depreciation, which would have led to withdrawal of local currency supplies from the system, he said.

Tuesday's monetary easing came as Singapore's economy contracted a record 11.5 percent from a year earlier in the first quarter of 2009, more than a market median forecast of an 8.8 percent slump. The government expects the economy to shrink 6-9 percent this year.

"Given all these horrendous numbers, this policy change is not a big surprise. It is reflecting the free fall in external demand," said Song Seng Wun, economist at Malaysian bank CIMB in Singapore.

The Singapore dollar, which has been emerging Asia's second-worst performing currency this year, strengthened to a two-month high of 1.497 against the U.S. dollar, from 1.515 before the announcement, and was trading at 1.5036 in the afternoon session Tuesday.

"The market was expecting a more aggressive easing policy and it did not come about. The bet on the Singapore dollar will be less aggressive," said Irene Cheung, currency strategist at Royal Bank of Scotland in Singapore.

Nearing Bottom?

The country's gross domestic product in the first three months of the year fell at a seasonally adjusted, annualized pace of 19.7 percent, the ministry of trade said. The central bank said the economy is likely to remain below its potential growth rate until a decisive recovery in exports.

"MAS will therefore re-centre the exchange rate policy band to the prevailing level of the S$NEER, while keeping the zero percent appreciation path," the central bank said in its twice-yearly monetary policy statement, referring to the currency's nominal effective exchange rate.

The Monetary Authority of Singapore sets policy by managing the Singapore dollar in a secret trade-weighted band against a basket of currencies, instead of setting interest rates.

The bank has to tread a fine line between allowing its currency to weaken to help exporters while avoiding giving its neighbors the impression that it is seeking to make its currency more competitive in export markets. Vietnam has depreciated its dong, while central banks in Thailand and Taiwan seem to be tolerating weakness in their currencies.

Central banks from Wellington to Bangkok have slashed interest rates sharply in recent months and some central bankers said they intend to wait and see how much good their rate-cutting had done to their battered economies before taking more action.

Singapore eased policy at its last policy review in October for the first time since 2003 to support an economy that was the first in Asia to fall into recession last year.

Economists said the economy could be nearing a bottom as its non-oil exports (NODX) fell 17 percent year-on-year in March after a record 35 percent plunge in January and a 24 percent fall in February. Shipments to China jumped 14 percent in March.

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"Although we are seeing some faint heartbeats in the Singapore economy with better-than-expected March NODX numbers, we have not seen the bottom yet. With inflation easing and external demand fragile, the shift in policy remains appropriate," said CIMB's Song, calling for the Singapore dollar to weaken to 1.60 by the end of the year.

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