What’s ahead

With new political developments and economic policies forming in certain emerging markets, the near term futures of these currency pairs should be very interesting.

Singapore. Although economic growth in Singapore slowed in 2006 after peaking at 10.8 percent in the first quarter, expansion in Southeast Asia’s fourth-largest economy nonetheless grew at a higher-than-expected 7.1 percent in the third quarter.

Manufacturing has been a major contributor to Singapore’s economic expansion; demand for the country’s products has led to booming export growth, accounting for nearly a quarter of Singapore’s $118 billion economy. This strength has helped drive the unemployment rate down to 2.7 percent. As a result, wages have edged high enough to potentially improve consumer spending, which has declined in five of the past eight months as of December 2006.

Another major source of Singaporean economic strength is an influx of Asian investors. Singapore’s financial regulations are generally less cumbersome than those in other Asian countries, such as Japan. For example, according to an annual survey by KPMG, Japan’s corporate tax rate is 40.7 percent, more than double Singapore’s 20 percent rate, which reduces operating costs and boosts corporate profit margins.

Given the vitality of the economy, the Monetary Authority of Singapore (MAS) surprised no one in maintaining its SGD hawkish bias at its semiannual review in April and October of this year. This means policy makers will keep a relatively watchful eye on the economy and its currency as inflationary pressures rise. They will likely make near-term adjustments to the SGD’s pegged band. Although definitively unknown, the band on average has fluctuated between +/- 0.03 percent and +/- 0.06 percent of the current rate dictated at the semiannual reviews. Central bankers will opt to adjust the currency’s band through monetary intervention (rather than by adjusting a benchmark interest rate) to quash speculation in the market. Subsequently, the bias will remain a mainstay until fundamentals shift and policy makers alter their views at a following review.

Hong Kong. Sluggish growth in global exports could continue to plague economic expansion in Hong Kong. In the second quarter of 2006, the Hong Kong economy grew 5.2 percent from Q2 a year earlier, with exports gaining 6.4 percent the smallest increase in four years — after jumping 14.4 percent in Q1.

Nonetheless, Q3 GDP is expected to accelerate to 5.8 percent, as private consumption may be able pick up the slack. Households have started to spend more as the jobless rate dropped to a five-year low of 4.5 percent in the third quarter and the benchmark stock index, the Hang Seng, made anew all-time high during the same period.

As the economy expands, labor demand is increasing and companies have added workers to cope with increasing business. This has resulted in more competition for skilled talent, boosting employee incomes and leaving people with more money to spend. Meanwhile, the same rising corporate earnings that are paying for more workers will also underpin investment expenditures.

Consumer prices in Hong Kong only emerged from deflation two years ago. However, the economic rebound pushed up rents in the city, and this inflationary pressure has spread to other areas, including clothing and food. Hong Kong’s consumer price index (CPI) reached an eight-year high of 2.5 percent in August. Although inflation eased slightly to 2.1 percent in September (because of shifts in volatile fresh food and oil prices), the Hong Kong Monetary Authority still anticipates inflation will accelerate to 2 per cent this year from 1 percent in 2005.

South Africa. In what might be considered a paradox, consumer spending has become the thorn in the side of the South African economy. Retail sales are driving economic growth, rising 8.7 percent in August and pushing GDP to 4.9 percent in the second quarter of 2006.

Although this would be seen as an encouraging sign of growth in many countries, in South Africa consumption has led to a record current account deficit. The current account balance hit an all time low of -103.14 billion rand in Q1, and while the deficit narrowed to 101.67 billion rand in Q2, at 6.1 percent of GDP the figure is still a far cry from being remotely balanced.

The primary concern is the government will struggle to attract the foreign investment needed to finance this deficit, which has caused the rand to drop more than 20 percent against the dollar since May 1. The surge in spending and a weaker rand have also fueled inflation, which jumped to a three-year high of 5.1 percent in September. The South African Reserve Bank (SARB) has tried to discourage excessive consumer spending on imports and curb price pressures by hiking rates three times since June 2006 (to a three year high of 8.50 percent). Nonetheless, the SARB forecasts CPI to hit the top of the 3-6 percent target range in 2007.

Also, the central bank may not be done with monetary policy tightening yet, as credit growth has continued to surge. Higher interest rates have yet to discourage borrowers, and consumer debt hit a record 69.8 percent of disposable income in Q2.

Mexico. Growth in Mexico, which is largely dependent on export demand from the U.S., could continue to slow after peaking at a five-and-a-half year high of 5.5 percent in Q1 2006. The country’s GDP slipped to 4.7 percent in Q2, but the figure was still encouraging as consumption, investment, and external demand performed well. Mexico’s expansion was mainly the result of the boom in oil, its biggest export, as prices rose to record highs and growth in the U.S. fueled demand for Mexican manufactured goods, such as cars. However, with Q3 GDP in the U.S. falling to a tepid 1.6 percent, growth in Mexico could be endangered in coming months as well.

The main determinant of future performance is likely to be the political environment. In the aftermath of a bitterly contested election, president-elect Felipe Calderon plans to adjust many aspects of the economy. Calderon’s predecessor Vincente Fox was known to concede to labor unions to ensure economic and social stability, but Calderon has indicated he will take a different route. His plans include major reforms to the state oil and electricity companies, public school systems, and the labor code. Unions are expected to oppose efforts to adjust labor law, much of which dates back to the 30s and has been a major deterrent to foreign investment and job creation. Additionally, Calderon is under pressure to generate more tax revenue to increase the government’s credit rating, which Moody’s currently rates at level Baa1, the third-to-lowest investment grade category.

As a result, Calderon has vowed to introduce a flat-tax for corporations, a change that will simplify the tax code and encourage more people to pay taxes. While major reforms would create instability in the short term, the long-range outlook for the economy would improve by leaps and bounds, a good sign for the Mexican peso.