Monday, February 14, 2011

S'pore's inflation driven more by domestic demand

SINGAPORE'S tradable price inflation slowed over the last six months, diverging significantly from the rapid pick-up in non-tradable inflation, says RBS economist Lim Su Sian.


This underscores the challenges of reining in inflation with the exchange rate as a policy tool, she says, adding that changes to underlying consumer preferences imply that upward wage pressures may linger longer than the business cycle suggests.


Steadily ratcheting inflation here hit a two-year high in December and has surpassed the regional average since November. But unlike most of Asia and despite its high trade reliance, Singapore's inflation has been driven less by the global hikes in food and energy prices and more by domestic demand pressures.


Many have noted the relatively subdued role of imported inflation in the consumer price index (CPI)'s ascent thanks to the strengthening Singapore dollar. The make-up of imports mattered too, Ms Lim says.


A 5.7 per cent drop in costs of imported machinery and transport equipment (which account for more than half of imports) offset the rise in prices of food and energy (which together make up 20 per cent of imports) last year.


While some say local policy changes like the spreading out of Certificate of Entitlement quota reductions and property market measures should help cool inflation in coming months, Ms Lim thinks the economy's strong growth and the tight labour market will continue to drive this current bout of inflation.


Wage pressures may continue to rise for more reasons than the business cycle too. 'As Singapore's economy has evolved, so have consumer preferences,' Ms Lim says.


She estimates in a recent report that non-tradables - goods and services like accommodation, transport, education and healthcare whose prices cannot be exchanged with those abroad - now account for 57 per cent of the CPI basket, up from 51 per cent in 2004 and 49 per cent in 1997-8.


More worryingly, there has been significant divergence between the non-tradables' and tradables' inflation over the last six months, she says. Non-tradables' inflation accelerated to about 6 per cent while tradable inflation slowed to about 3 per cent.


This higher consumption preference for non-tradables could mean faster wage growth for the sector than for tradables', particularly with promotion of the financial services, hospitality and retail sectors.


'In the face of rising non-tradable inflation, FX-oriented policy is becoming an increasingly blunt tool,' Ms Lim says. But she adds that a shift to an interest rate policy regime is not viable since exports will be the mainstay of economic growth here for a long time to come.


This gives impetus to Singapore's drive to boost productivity growth apace with wage growth, and keep inflation manageable. Ms Lim also thinks the Singapore dollar will have to stay on the path of appreciation to ensure tradable inflation is at least reined in to offset the pick-up in non-tradable inflation.

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