The languishing U.S. dollar has resulted in unprecedented gains for other currencies. The Singapore dollar, for one, hit a record high against the greenback on Wednesday, as the latter scraped three-month lows versus a basket of currencies.
While this may spell cheer for investors long on the Singapore dollar [SGD= 1.2037
0.002 (+0.17%) 
], it paints a less rosy picture for the nation’s economy, say financial experts.Wei Zheng Kit, an analyst at Citi, notes that while Singapore remains competitive on many measures, the appreciation of the Singapore dollar could erode its advantage in the near term.
"While SGD appreciation can eventually curb domestic inflation, it may exacerbate the loss of cost competitiveness in the short run, because of the lag needed for a stronger exchange rate to bring down inflation," Wei said, in a report.
Singapore's June consumer price inflation (CPI) rose to it's fastest pace in six months, to 5.2 percent, driven by rising housing and food costs.
"Since 2008, Singapore has seen inflation outpace foreign trade-weighted inflation, reversing the pattern for the past 20 years," according to the Citi report.
The Singapore dollar is among the best performing currencies in Asia this year, since the state's de-facto central bank – the Monetary Authority of Singapore (MAS) – said in April it would allow further appreciation to tame price gains. The currency has gained over 6 percent versus the U.S. dollar so far this year, and 24 percent in the last five years.
There are already signs the stronger currency has been crimping competitiveness. According to the 2011 World Competitiveness Index report compiled by Swiss business school IMD, Singapore slipped from the top spot to third, overtaken by the U.S. and Hong Kong. Citi says the effect may be most pronounced in the labor market.
"The supply shock from tightening of foreign worker inflows will likely imply wage growth could be structurally higher than the 3 percent annual average of the 2000s,” the report stated. “More importantly, wages have risen faster than Asian competitors, especially once FX appreciation is included.”
Meanwhile, as wages climb, productivity has not kept pace. The report predicts growth in Singapore's unit labor costs to “likely outstrip those of its Asian competitors in 2011, similar to the overheating period in late 2006-2008."
The spillover from a stronger Singapore dollar is also being felt in the property sector. Citi observes that while Singapore's office rents were lower than Hong Kong's, the gap is narrowing as its currency appreciates.
Losing its competitive edge may sting the most during the next economic slump, but Citi says Singapore has the ammunition to lessen some of the pain.
"The loss of cost competitiveness could prove to be a double whammy once the economy is in recession, though this could at least partially reversed via monetary easing."
© 2011 CNBC.com
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