After the Dire Data, Singapore Risks Another Contraction

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The outlook for the wealthy island nation of Singapore is turning increasingly grim with a recent mix of downbeat economic indicators pointing to a contraction for the economy in the current quarter.

ING downgraded its growth forecast for the city state on Tuesday, calling for a contraction of 2.1 percent year on year for the three months to March, from an earlier forecast of a 3.4 percent expansion.

Credit Suisse also revised its numbers downwards; it now expects Singapore's economy to shrink one percent over the same period, compared to its initial forecast of a 0.5 percent contraction.

Singapore, which last suffered an economic contraction back in the third quarter of 2012, will release its first quarter gross domestic product (GDP) flash estimate next week.

Economy watchers cited concerns over a key set of data released on Tuesday - industrial output - which slumped 16.6 percent in February against expectations for a fall of 10.5 percent, with weakness seen across a range of industries including electronics, precision engineering and biomedical. While softness in output is partly tied to the Lunar New Year holidays, the significant drop is enough to signal underlying weakness in the industrial sector.

"The data are not good -- where industrial production goes, GDP goes. Based on the revision of first quarter estimates, full year GDP is likely to come in at the low end of the 1-3 percent official target," Tim Condon, head of research for Asia with ING Financial Markets told CNBC. Industrial output accounted for over 19 percent of GDP in 2012.

Last week's export figures, which showed a 30.6 percent slump in February compared to expectations for a decline of 16 percent, is also worrying. Michael Wan, economist at Credit Suisse, expects exports to remain under some pressure given declining competitiveness of goods produced in country, due to Singapore dollar's elevated exchange rate and rising cost pressures as a result of tighter foreign labor laws.

On top of the slowdown in economic activity, inflation in the country spiked in February, with the country's consumer price index (CPI) rising by a higher-than-expected 4.9 percent, breaching the central bank's 2013 forecast of 3.5-4.5 percent. The rise in inflation was driven by a range of domestically driven factors including private rose transportation costs, food prices and household services, after the government implemented new regulations to improve working conditions and compensation for domestic workers.

Singapore, which has historically enjoyed stable prices, now faces a dual challenge of supporting growth while keeping inflation - which has exceeded growth - in check.

"Policymakers have painted themselves into a corner. With sticky inflation and weak activity - the MAS' (Monetary Authority of Singapore) accommodation during the growth years has boxed them in," Condon said, referring to the country's defacto central bank's move in recent years to allow the Singapore dollar to strengthen. The MAS sets monetary policy by allowing the Singapore dollar to rise or fall against an undisclosed basket of currencies.

(Read More: Singapore Firms Hit by Foreign Labor Laws)

"We are stuck here, it's not exactly stagflation but it's very weak activity," Condon added.

Economists expect the MAS officials, who will meet in mid-April to review monetary policy, to prioritize controlling inflation over growth given that there has been growing discontent among Singaporeans regarding the rising cost of living in the city state.

"We expect the MAS to maintain the current slightly steeper Singapore dollar NEER (Nominal Effective Exchange Rate) appreciation bias at the April policy meeting, despite poor manufacturing and export readings," wrote Hak Bin Chua, ASEAN economist at Bank of America Merrill Lynch.

Growth Slowdown: So What?

While the economy is expected to witness a sharp growth slowdown from the fourth quarter of 2012, when it expanded 1.5 percent from a year earlier, Taimur Baig, chief economist at Deutsche Bank said this is not a grave concern.

"It is a bit troubling that Singapore's data has been lagging a regional trend, but headline growth is not always a good indicator. The country is close to running full employment, wages are rising. For a Singaporean, the job market has never been this good," he said.

In 2012, for example, Singapore's unemployment rate stood at a desirable 2 percent - significantly lower than developed market peers such as the U.S. where the jobless rate came in at 7.7 percent in February.