The recovery phase from the COVID-19 pandemic has been slowed by several external shocks to the world’s global value and supply chain. Already one of the most expensive cities to live in, Singapore’s headline consumer price index or overall inflation reached 5.4 percent year on year in April 2022. The core inflation (excludes accommodation and transport) also accelerated to 3.3 percent, the highest in a decade when core inflation reached 3.5 percent in 2012. The increase was driven by higher inflationary pressures for food (4.1 percent), retail (1.6 percent), and gas and electricity prices (19.7 percent). This is a global phenomenon as prices are rising the world over.
This article will briefly examine the causes and impact of rising inflation rates in Singapore and policy measures to mitigate their adverse effects. In particular, it will focus on the impact of rising inflation on businesses and households.
RISING INFLATION IN SINGAPORE
There are several contributing factors to rising inflation. The Russia-Ukraine conflict had created new negative supply shocks for the global economy just when some of the supply chain challenges appeared to be receding as economies recover from the pandemic. Russia and Ukraine are major suppliers in the commodity markets. Together, they accounted for 30 percent of global exports in wheat, 20 percent for corn, mineral fertilisers, and natural gas, and 11 percent for crude oil. These caused disruptions to the supply chains that were not able to satisfy the pent-up demand from the market.
In relation to business, Russia and Ukraine are sources of inert gases like argon and neon, used in the production of semiconductors and large producers of titanium sponges used in aircraft. In addition, Russia is a key supplier of palladium used in catalytic converters for cars, and nickel used in steel production and manufacture of batteries. Disruptions to these suppliers will adversely impact the global value chain.
However, prior to the Russia-Ukraine conflict, the global economy was recovering faster than expected partly due to the stimulus measures, but these were not curtailed by governments and partly contributed to inflationary pressures. Then, central banks were more concerned about stagflation, but now drastic measures were required to reduce rising inflation. Singapore’s headline inflation reached 4 percent in December 2021, and in response, the government appreciated the currency and introduced new property cooling measures, to reduce demand for private housing.
In Singapore’s case, being a trade-dependent economy, it uses a monetary exchange rate policy rather than interest rates to maintain price stability and sustained growth. An open trading economy, Singapore’s export to gross domestic product (GDP) is 175.89 percent and import to GDP is 147.63 percent, which highlights its vulnerabilities to external shocks, and renders using interest rates less effective as a tool to mitigate inflationary effects. Instead, managed by the Monetary Authority of Singapore (MAS), the monetary exchange rate is the policy lever used to maintain price stability in the following ways.
First, given that Singapore imports most of what it consumes, and domestic prices are sensitive to world prices, the exchange rate directly acts to dampen imported inflationary pressures. In periods of escalating global commodity prices, the exchange rate acts as a buffer against external price pressures which contributes to medium-term price stability.
Second, indirectly, the exchange rate tackles domestic sources of inflation. A stronger currency moderates the external demand for Singapore’s goods and services, which eases the demand for factor inputs to ensure more modest rises in wages. This, in turn, reduces the domestic demand for non-tradable goods and services and puts downward pressure on prices.
SINGAPORE’S EXCHANGE RATE SYSTEM
In April 2022, the MAS recentred the mid-point of the exchange rate policy band known as the Nominal Effective Exchange Rate (S$NEER) at the prevailing level and increased slightly the rate of appreciation of the policy band. This is the first time since 2010 that the MAS has used both policy tools simultaneously underlining concerns over price instability.
The exchange rate system in Singapore comprises the basket, band, and crawl (BBC) system as described below.
First, the Singapore dollar is managed against a basket of currencies of its major trading partners. This feature reflects Singapore’s diverse trading patterns and makes its currency less volatile than if it was to be pegged to a single currency.
Second, the Singapore dollar is managed by a floating regime where the trade-weighted exchange rate is allowed to fluctuate within a policy band. This mechanism enables the MAS to accommodate short-term fluctuations in the foreign exchange markets and permits flexibility in managing the exchange rate.
Third, the slope of the exchange rate policy band is reviewed regularly. This is to ensure that it remains consistent with the economy’s underlying fundamentals. This crawl feature enables the exchange rate to be adjusted by the MAS.
These features in the monetary framework have provided stability for Singapore’s incredibly open economy and enhanced confidence in the Singapore dollar.
MITIGATING IMPACT OF INFLATION
Industry
Business opportunities could also mitigate the impact of inflation. In existing contracts where prices have not been indexed, besides front-loading the spending, companies should request a clawback on unindexed contracts that cover periods when commodity prices fell.
Using digital tools and analytics, spreadsheet analysis could be enhanced to ascertain the true costs of large purchases which enable managers to quantify how inflationary prices are affecting prices. Supplier and buyer collaboration could also drive joint efficiencies to look beyond price such as changes to quality or specifications or using fewer materials. Companies could also increase collaboration between the pricing and procurement teams to evaluate inflation’s impact on prices that the company charges to its customers.
Other technical levers to mitigate inflation include adjusting batch sizes, accelerating value-added engineering, and addressing the volatility in the short-to-medium-term. Optimising supplier footprints could also have better control over coordination, costs, tariffs, and inventory. Longer-term measures to mitigate volatility include strategic inventory stockpiling, relying more on vendor-managed inventory, and expanding cross-industry collaboration to share commodity exposures.
Companies, as buyers, could prepare for negotiations by using short-and long-term commercial and technical levers. Price increases could be considered but only after cost and other fact-based tools had been utilised to determine its fairness. In the event a price increase is necessary given prevailing market conditions, alternatives could be made available to minimise the cost increase’s effect. New suppliers could also be explored by reassessing the vendor matrix and opportunities. This shift in companies’ response will have an immediate impact, and a review process could help to identify non-incumbent suppliers or suppliers for other areas that might be able to provide better costing or service.
Businesses
First, companies could transfer inflationary risks upstream by employing a range of sourcing and contracting techniques to reduce exposure to increased costs. It could be possible to collaborate with suppliers to share supply-chain risks by using a long-term fixed-price contract.
Second, transfer some risks downstream by including in the contracts certain terms and conditions to adjust the timing of contract expiration and risk exposure. Price collars could be used to restrict price changes to a specified range or match contract terms with those of suppliers’ contracts to help structure risks and allocation fairly. In exchange for reduced prices and or other concessions, customers might be willing and or able to absorb some degree of risks.
Third, companies could collaborate with other companies on shared objectives and transfer risks externally. For example, if a manufacturer could gain access to raw materials overseas through a contractual swap or by sharing this source with another manufacturer, this enables both to reduce costs and provides them with the flexibility to reduce supply chain risk. The government has also brought forward measures such as the disbursement of the Small Business Recovery Grant which provides up to S$10, 000 for SMEs most affected by the pandemic.
Households
For households, the government has brought forward the disbursement of several household support measures such as vouchers totalling $100 for each household for groceries and rebates for utilities equivalent to a month’s cost for those living in four-room HDB flats. In the past, lower-income families have also been provided transport vouchers and Goods and Services Tax (GST) Vouchers. The government has also ensured the diversification of food import sources that helps to maintain the price competitiveness of food items and reduces its vulnerabilities to large price fluctuations globally.
With rising prices, it gets even harder to save and invest. In a survey among Singaporeans by SJP Asia in 2021, just over half (52 percent) considered inflation in their financial plans and its impact on their savings.
Individuals
For individuals who are investing, rising inflation adds to the increased costs of living which impact savings and investments. To mitigate inflation risks, investors could consider investments that could be hedged from rising inflation. For example, on equities, examining data on historical returns for high and low inflation periods from 1992 to 2021, it indicated that the S&P 500 (S&P Dow Jones Indices) had posted an annualised return of 8.1 percent after adjusting for inflation.
While it has been shown that the annualised inflation-adjusted return on stocks had outpaced the rate of inflation, it is also prudent for investors to manage risks by diversifying across different sectors. This strategy helps to reduce overexposure to areas that are out of favour with investors. In addition, investors could also reduce their portfolio volatility by investing in assets that are uncorrelated or having low correlation with inflationary pressures.
CONCLUSION
Singapore imports nearly all its required resources and has an open trading regime. Rather than leveraging on interest rates, the monetary policy is the main policy tool used to stabilise prices during strong inflationary pressures. Rising inflation leads to higher borrowing costs, wages, and materials which in turn compels businesses to raise their prices and pass these onto their consumers. Increases in the GST will worsen the impact of rising inflation and if the inflation rate keeps increasing, other measures such as a Supplementary Budget may be required to mitigate its adverse impact on businesses and households.
Dr Faizal Yahya is senior research fellow at the Institute of Policy Studies, National University of Singapore.
This piece was first published in The Karyawan on 15 July 2022.