Abstract

On August 11, China’s central bank (PBOC) lifted the central USD/CNY parity to 6.2298 (from 6.1162) and devalued the official exchange rate by 1.82%. More gradual depreciations followed the week after, bringing the yuan’s total fall to about 3% against the US dollar. The move spooked markets across Asia and raised concerns in Singapore, where the economy has been faced with poor growth in the second quarter. Singapore’s GDP fell by 4% (on-quarter, seasonally adjusted rate) in the second quarter of 2015, wiping out the 4% gains made in the first quarter. The main worry today is that the yuan devaluation might tip the economy closer toward a technical recession (two consecutive quarters of negative growth).

The devaluation had an immediate ripple effect on Singapore’s financial markets: the Strait Times Index (STI) fell by about 4% in the course of a few days following the PBOC move, the Singapore dollar correspondingly depreciated by about 2% against the US dollar, and the SIBOR and SOR were up by 6.7% and 17% respectively. The yuan devaluation also raised questions for policymakers. The MAS has maintained a modest appreciation of the SGD NEER policy stance. According to DBS SGD NEER model, the SGD NEER is easing towards the floor of its appreciating policy band amid heightened market volatility. If this continues, the MAS would have two choices: spend reserves defending the band or relax the appreciation policy.

With an economy facing the risk of a technical recession and full-year inflation expected to be negative, currency appreciation becomes a difficult policy to maintain. Challenges are compounded by potential capital flight that could result from higher US interest rates and/or fears of further yuan devaluation. All things considered, risks are rising that the MAS eases policy in October.

□​The yuan devaluation had a ripple effect on Singapore’s financial markets

□​The STI, the Singapore dollar, the SIBOR, and the SOR were all affected

□​Pressure is rising for MAS to ease its policy stance amid external volatility and slow growth