VZCZCXRO4065
RR RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHGP #0853/01 1230517
ZNR UUUUU ZZH
R 030517Z MAY 07
FM AMEMBASSY SINGAPORE
TO RUEHC/SECSTATE WASHDC 3007
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUCNASE/ASEAN MEMBER COLLECTIVE

UNCLAS SECTION 01 OF 03 SINGAPORE 000853 
 
SIPDIS 
 
STATE PASS TREASURY FOR JCIORCIARI AND ABAUKOL 
FEDERAL RESERVE SAN FRANCISCO FOR DFINEMAN AND TCURRAN 
FEDERAL RESERVE NEW YORK FOR MHILDEBRANT AND MCHOI 
OFFICE OF THRIFT SUPERVISION FOR RGAFFIN 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON ETRD EINV SN
SUBJECT: MONETARY AUTHORITY DOWNPLAYS INFLATION RISK 
 
¶1.  Summary:  The Monetary Authority of Singapore (MAS) 
downplayed possible domestic inflationary pressures such as 
the upcoming two-percent increase in sales tax, double- 
digit rental increases, and a tight labor market during an 
April 24 briefing for analysts ahead of the release of its 
biannual Macroeconomic Review.  MAS reiterated its stance 
that use of the exchange rate is the best tool to combat 
inflation.  MAS asserted that Singapore's economic 
prospects hinged on a pick-up in demand for electronics 
exports expected in the second half of the year.  While 
officially "unconcerned" and "puzzled" by the recent 
volatility in interbank interest rates, MAS highlighted the 
role that non-resident deposits played in driving down 
interest rates and welcomed a "two-way bet" again on the 
currency, which had appreciated to the strong end of its 
intervention band.  Private sector analysts expressed 
concerns during the briefing that MAS was slowly losing its 
policy flexibility and ignoring what they perceived to be 
structural shifts in inflation expectations, balance of 
payments trends, and sources of economic growth.  End 
Summary. 
 
Cautious Tone 
------------- 
 
¶2.  In its Macroeconomic Policy Review released April 24, 
MAS left unchanged its current GDP growth forecast for 2007 
of 4.5 percent to 6.5 percent Q compared to a 7.9 percent 
actual growth rate in 2006.  At a meeting with economic 
analysts just before the Review's release, MAS's tone was 
not optimistic: they stated that the risks were to the 
downside, driven by concerns about the electronics export 
cycle and U.S. demand/property price correction, with the 
former causing the most consternation.  MAS conceded that 
Singapore's electronics exports had been lagging the region 
and noted that only South Korea had a worse electronics 
export performance in 2006.  MAS's sectoral analyst 
attributed this underperformance in part to a 
reorganization of the domestic disk drive industry after 
Seagate Technology took over rival Maxtor Corp; and in part 
to restructuring by Hewlett Packard's Singapore operations 
to emphasize services over production.  MAS expressed 
optimism that the sector's exports would turn around in H2 
¶2007. 
 
Inflation Pressures and Interest Rate Drops 
-------------------------------------------- 
 
¶3.  MAS dismissed concerns about domestic sources of 
inflation.  First, echoing sentiments expressed in its 
March inflation forecast announcement, MAS argued that the 
two-percent increase in the Goods and Services Tax (GST) to 
7 percent starting in July would result in a 60 to 80 
percent pass-through rate, or only a 0.2 percent increase 
in the rate of inflation in each of the four to five 
quarters after the hike.  Second, despite the tight labor 
market and the high labor diffusion index (indicating that 
the tight labor market was not limited to one or two 
sectors), MAS said it was not concerned about wage 
increases.  (Note:  Press reports have highlighted MAS's 
analysis about the role of foreign workers in keeping wage 
pressure under control and in providing a buffer for 
employment in downturns. End Note.)  Finally, MAS said it 
was not worried about the effect on inflation of recent 
double-digit increases in commercial rentals since such 
expenses comprised only 10 to 14 percent of average unit 
costs for production for businesses.  MAS asserted that 
external and not domestic factors remained the more likely 
drivers of inflation. 
 
Consumer Price Index (2004=100) 
Percentage change (year-on-year) 
-------------------------------- 
 
                CPI       % Change 
                ---       -------- 
1997            96.2        2.0 
1998            95.9       -0.3 
1999            96.0        0.0 
2000            97.2        1.3 
2001            98.2        1.0 
2002            97.8       -0.4 
2003            98.3        0.5 
2004           100.0        1.7 
2005           100.4        0.5 
2006           101.4        1.0 
 
SINGAPORE 00000853  002 OF 003 
 
 
2007 March     101.7        0.7 
 
Source: Department of Statistics (www.singstat.gov.sg) 
 
¶4.  Economic analysts who attended the MAS briefing were 
most concerned with recent volatility in interest rates. 
MAS reiterated that its monetary policy only targeted the 
exchange rate, keeping a neutral liquidity stance that 
enabled the interest rate to be determined by the market. 
While MAS maintained that interest rates were a "market 
phenomenon" and that they were "just as puzzled" as the 
analysts about what was driving the rates, it offered two 
possible explanations for the drop: 1) a large inflow of 
non-resident funds, particularly non-resident "quasi fixed 
deposits" and "transactional accounts"; and 2) lower 
interest rates in those countries whose currencies comprise 
the basket of denominations MAS uses to peg the Singapore 
dollar, assuming that the theory of interest parity held. 
(Note: The one-month Singapore Inter Bank Offer Rate 
(SIBOR) -- the interbank interest rate that is usually the 
reference rate for pricing loans in Singapore dollars -- 
has fallen 100 basis points, i.e., one percentage point, 
since the beginning of the year to 2.44 percent.  See chart 
below.  End note.) 
 
Domestic Interest Rates 
----------------------- 
 
End of Period      Interbank 1-Month 
-------------      ----------------- 
2007 
Jan 05             3.44 
Jan 12             3.41 
Jan 19             3.38 
Jan 26             3.38 
Feb 02             3.38 
Feb 09             3.38 
Feb 16             3.38 
Feb 23             3.38 
Mar 02             3.31 
Mar 09             3.13 
Mar 16             3.00 
Mar 23             3.00 
Mar 30             2.94 
Apr 05             2.88 
Apr 13             2.75 
Apr 20             2.44 
 
Source: MAS (www.mas.gov.sg) 
 
¶5.  Despite MAS'S professed neutrality, one official 
conceded that it was not inherently undesirable to have 
"more symmetrical risk" in the currency market as was the 
case currently.  One analyst explained that lower interest 
rates meant that expected returns for holding Singapore 
dollars were roughly on par with expected returns for 
holding U.S. Treasuries, and thus this shift to a more 
balanced outlook would reduce speculative pressures on the 
Singapore dollar. 
 
 
FX Reserves Build-Up 
-------------------- 
 
¶6.  One analyst questioned the rate of increase in 
Singapore's FX reserves, noting that MAS had heretofore 
maintained that its current account surplus, which ran to 
US$37 billion or 28 percent of gross national income in 
2006, was not a concern as it was "recycled" outward 
through the capital account by parties re-investing the 
funds overseas.  He pointed out that this recycling had 
ceased recently, resulting in a rapid accumulation of FX 
reserves, especially reserves plus net forward positions. 
According to the analyst, the current account surplus plus 
net forward position is 25-30 percent of GDP and foreign 
exchange reserves are 130 percent of GDP. He asked if this 
was an issue for monetary policy, and whether MAS 
considered this to be a "permanent shock" or a cyclical 
issue.  MAS responded only that money had to be flowing 
back out, perhaps through the net foreign assets of the 
banking sector or through corporate investment overseas. 
(Note: MAS data show that the official foreign reserves 
increased by US$10.5 billion to US$136.6 billion in 2006, 
an acceleration from the US$5.9 billion increase in 2005. 
End note.) 
 
 
SINGAPORE 00000853  003 OF 003 
 
 
 
Comment 
------- 
 
¶7.  To its credit, MAS has a respectable track record of 
keeping inflation below 2.0 percent on an annualized basis. 
However, there may be some merit to analysts' concerns 
about domestic sources of inflation and unease about MAS's 
monetary policy choices.  MAS's belief that external shocks 
pose the biggest inflation risk to the economy drives its 
use of the exchange rate rather than the interest rate as 
its monetary policy tool to manage inflation. However, too 
much allegiance to this monetary policy regime may be 
leading to an excessive focus on old drivers of the economy 
(such as electronics exports) at the risk of ignoring new 
threats that would challenge MAS's monetary policy 
paradigm.  In particular, the risks of domestic sources of 
inflation (GST, property prices, wages, falling interest 
rates) might be hard to mitigate using only the exchange 
rate as a tool, especially when the Singapore dollar is 
near the strong end of its band, as it has been until 
recently.  The contrast between MAS's gloomy outlook and 
the higher than expected 7.2 percent first quarter GDP 
growth figure also announced on April 24 only highlighted 
the disconnect that worries analysts.  End Comment. 
 
 
FERGIN