Negative swap rate signals Singapore rethink on SGD rise

SINGAPORE Wed Aug 17, 2011 12:04am EDT

SINGAPORE Aug 17 (Reuters) - Singapore is attracting an unwelcome flood of U.S. dollars that has caused a key interest rate to turn negative, complicating efforts to dampen inflation and prompting speculation the central bank will tweak its policy to slow the rapid rise in the country's currency.

While Singapore prides itself on having a highly globalised and open economy, the stream of investors seeking refuge from international market turmoil in recent weeks could fuel price pressures on the tiny island, adding to fears of a potential property bubble, even as the economy shows signs of slowing.

That could persuade the city's central bank to reconsider its policy on allowing further appreciation in the local currency.

Authorities have allowed the Singapore dollar to gain 6.5 percent against the U.S. dollar so far this year, the most among Asian currencies, to curb imported inflation and as investors shy away from the United States and Europe where governments are struggling to resolve debt issues.

As global markets plunged last week, the Singapore dollar swap offer rate (SOR) fell below zero for the first time due to inflows into the Singapore dollar. The rate reflects lending costs as well as the expected forward exchange rate between the U.S. dollar and Singapore currency.

The three-month SOR was fixed at minus 0.06 on Tuesday, widening from Monday's minus 0.01. It fell below zero on Aug 10.

Singapore's current policy stance is to allow a gradual appreciation of the local dollar against a basket of currencies to curb price pressures.

That stance, however, has attracted even more safe-haven inflows into the AAA-rated Southeast Asian city-state, threatening to magnify existing price pressures and hurting local banks by reducing their already low loan margins.

"A case could be made to argue for a slower pace of appreciation in light of the recent (downward) revision in the city-state's non-oil domestic exports," said Maybank head of FX research Saktiandi Supaat.

Several traders speculate that the fall in SOR to negative levels, due in part to the Monetary Authority of Singapore's (MAS) failure to mop up excess liquidity, was an attempt by the central bank to discourage inflows.

Some said the fall in SOR could even be a signal that MAS might ease monetary policy to a slower or even zero percent Singapore dollar appreciation stance, since the strong inflows have had the adverse effect of fuelling inflationary pressures.

"We currently also have a parallel, but not identical, situation in the Swiss franc, where the Swiss National Bank, is attempting to engineer negative interest rates to discourage strength in the franc," Oversea-Chinese Banking Corp said in a note to clients.

Asian countries such as South Korea have already taken steps to discourage hot money inflows while other AAA-rated nations such as Switzerland are trying to force down the value of their currencies, fearing big gains may threaten their export competitiveness even as global demand slows.

MAS reportedly intervened in currency markets earlier this week to prevent the U.S. dollar from falling below S$1.20.

Lorraine Tan, director of research for Asian strategies at Standard & Poor's, said MAS will continue to maintain an appreciating currency bias as it was its main tool against inflation.

"But inflationary pressures have come down and there is less reason for MAS to let the Singapore dollar appreciate so much," she added.

Reflecting global weakness, Singapore's economy is also slowing. Data on Tuesday showed non-oil domestic exports registering a surprise fall in July as electronics shipments contracted for a sixth consecutive month.

The weak trade figures raise the odds of the city-state sinking into a technical recession in the third quarter, after activity contracted in April-June, economists from Bank of America Merrill Lynch and CIMB said.

Citigroup economist Kit Wei Zheng said "in the event that MAS decides to steer the NEER (nominal effective exchange rate) lower, the initial reaction would probably be a lower/negative SOR fixing in the first instance to deter inflows".

"Once the NEER has depreciated and market expectations shift towards a neutral or weaker Singapore dollar, the SOR could then rise. This two-step process was also observed in July/August 2008" when Singapore let its currency fall, he added.

BANK MARGINS

Singapore's three banking groups posted higher second quarter net profits as loans grew by 20-plus percent and interest margins stabilised, but the fall in SOR to negative levels shows lending margins remain under pressure.

DBS , Oversea-Chinese Banking Corp and United Overseas Bank , along with foreign banks in the city-state, price some of their loans at a premium over SOR, which is fixed daily by the Association of Banks in Singapore.

Nomura analyst Anand Pathmakanthan said that while banks typically have provisions within their loan agreements to reset the reference rate to zero, "this nonetheless still implies a 20 basis points-plus decline in total yield as compared to just two weeks ago."

The three-month SOR traded around plus 15 to 25 points during the month of July.

Singapore borrowing costs are already among the lowest in world, thanks to its high savings rate and safe image that helps it attract inflows from around the world.

Speaking to reporters last week, UOB Chief Financial Offier Lee Wai Fai said UOB had invoked "market disruption clauses" in most of its loan agreements that will allow it to either reset the benchmark to zero for mortages or use another reference in the case of corporate loans.

But he acknowledged Singapore's third-largest bank by assets had in the past priced some housing loans as low as SOR plus 75 basis points, which meant some lenders may soon be paying as 0.75 percent per annum on their morgages -- well below inflation which is running at 5-plus percent.

"Until safe haven flows subside or we see broad U.S. dollar strength, SOR fixings will probably staying low or negative in the near term," said Citi's Kit. (Reporting by Kevin Lim; Additional reporting by Saeed Azhar)

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