Most analysts are bearish on the short-term prospects of the Singapore dollar. A number of factors have combined to lead to a situation where further depreciation is expected in the SGD's value on top of the slide that has already taken place.
The Singapore dollar is already at a six-year low against the US dollar. It is also highly susceptible to a depreciation in the yuan because of its volume of trade with China.
Some of the major determinants of the value of the SGD are:
Performance of the US dollar
The American economy has been performing well in the recent past. Consumer spending, which provides a major portion of GDP growth, is robust as the drop in oil prices has left more money in the hands of the consumer.
Employment figures have improved for the last two years. In 2015, nearly 2.7 million jobs were added in the country, according to data released by US Bureau of Labor Statistics.
This strong showing was almost as good as the 3.1 million jobs that were added in 2014. The jobless rate is now at almost half of what it was at its peak.
These developments led to the US Federal Reserve reversing an almost decade-long policy and raising interest rates as it anticipates that the hot jobs market could spur a pickup in inflation and wages.
As a result, the US dollar has appreciated against a number of currencies including the Singapore dollar. Currently, 1.44 SGD equals one US dollar. A year ago the comparative rate was 1.34 SGD to a US dollar.
Slowing of the local economy
Although Singapore's economy grew by a better than expected 2.1% in 2015, the manufacturing sector actually contracted.
DBS senior economist Irvin Seah points out that overall GDP growth in 2015 was at its slowest in six years. According to him, both cyclical and structural challenges are negatively impacting manufacturing activity with electronics, transport engineering, and precision engineering being the worst casualties.
In the fourth quarter of 2015, the manufacturing sector contracted by 6%, replicating the 5.9% decline in the previous quarter.
An important reason for the slump in manufacturing activity is the declining demand for the country's goods by overseas buyers. In December 2015, non-oil domestic exports fell by 7.2%, according to International Enterprise, a Singapore government body.
The resultant declining demand for the SGD serves to further depreciate the country’s currency.
Local economy is tied to oil and commodity sectors
Singapore's economy is inextricably linked to the oil and commodity sectors, both of which are seeing a sustained downturn.
The country’s economy, and the SGD's exchange rate, in turn would improve once these areas see a turnaround.
Impact of the yuan's devaluation
The yuan’s recent devaluation has raised fears that the Chinese economic slowdown is worse than anticipated. China's November 2015 exports dropped 6.8% year-on-year, the fifth straight month of decline.
China's decision to devalue the yuan is prompted by its desire to strengthen its exports. This step will put Singapore's exporters at a disadvantage as they will face a price disadvantage vis-à-vis their Chinese competitors.
Singapore's currency is highly vulnerable to a decline in the yuan as its exporters have a high degree of exposure to China. It is important to remember that China is the world's biggest user of energy, metals, and grain and the yuan's fall will impact the economies of the countries that have strong trading links with it.
Singapore's companies are important suppliers of components that go into smartphones that are made in China. The country’s shipping industry has a large share of the world market for transporting raw materials and finished goods.
Singapore's economy will be negatively impacted by the decrease in China's growth rate, leading to further pressure on the SGD's value.
Weak SGD makes import expensive
Singapore's export-led economy relies almost entirely on imports for raw materials. As the SGD depreciates, imports become expensive, making the country less competitive.
The weakening of the Singapore dollar over the last year has come at a time when the demand for the country's exports is slowing.
These factors have combined to result in a situation where the country faces rising import costs coupled with declining demand for its exports, a combination that has already contributed in no small measure, to a fall in the SGD's value.
Rising interest costs
The US Fed's raising of interest rates will lead to an increase in the interest rates in Singapore over a period of time.
This will impact the country's businesses and its economy negatively as borrowing costs rise and make Singapore's companies less competitive.
The depreciation of the SGD in the last year is a cause for concern for the economy but it does have certain advantages.
It makes the country's exports competitive as buyers need to pay less. But the flip side is that imports become more expensive. As the country does not have natural resources of its own, most of its imports are destined for re-export.
This may prove to be a bigger disadvantage as it pushes up costs to an extent that Singapore's industries lose their competitive edge. Considering the current global economic scenario, the SGD would probably continue its downward slide.
The importance of the value of the SGD against other currencies is apparent when the fact that Singapore has one of the highest trade-to-GDP ratios amongst all the countries in the world considered.
The scenario is aptly summed up by Associate Professor Lee Boon Keng of the Centre for Applied Financial Education at Nanyang Business School who says, "With the Chinese trying all means to prevent a hard landing and the Federal Reserve perhaps rather behind the curve in raising interest rates, Asian currencies could be entering a perfect storm in 2016."
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Singapore Business Review. The author was not remunerated for this article.
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Istvan Loh Wye Lung is a professional FX trader. He spends his free time researching relevant investment opportunities and analysing the markets.