WASHINGTON, July 23, 2010 (AFP) - The Singapore dollar is expected to strengthen as the island's economy rapidly expands, the IMF said Friday.

Singapore, unlike many other economies, uses the exchange rate rather than interest rates to conduct monetary policy.

In a report after annual consultations with the Singapore authorities, the International Monetary Fund (IMF) said the Singapore dollar "would likely strengthen in real effective terms over time as reforms promote faster productivity growth and the domestic economy continues to expand."

The Singapore dollar "appears to be somewhat weaker than its medium-term equilibrium level although considerable uncertainty clouds this assessment," said the report by the fund's board.

In a surprise move in April, Singapore unexpectedly revalued its currency and said it would seek further strength to contain inflation.

The Monetary Authority of Singapore (MAS), the de facto central bank of the city state, revalued upward its targeted trading band for the currency and said it would now allow a "modest and gradual appreciation" of its currency, shifting from "zero appreciation."

Analysts described the MAS policy move as "aggressive" but the central bank said it was necessary to curb inflationary pressures.

Singapore's monetary policy is conducted via the local currency, which is traded against a basket of currencies of its major trading partners within an undisclosed band known as the nominal effective exchange rate.

The IMF report forecast the Singapore economy would expand a rapid 9.9 percent in 2010 before slowing down to 4.9 percent next year.

The government last week upgraded its 2010 growth forecast to a blistering 13 to 15 percent, setting the stage for Singapore to become the world's fastest-growing economy this year.

The new estimate, up sharply from an earlier prediction of 7.0 to 9.0 percent, outstrips forecasts of around 10 percent growth in regional powerhouse China and comes despite lingering worries over the US and European economies.

The IMF said Singapore's exchange rate regime "remains appropriate" and that the exchange-rate centred monetary framework was an important source of stability in challenging times.

The fund also said that while building strong foreign exchange and fiscal reserve buffers was a central element of Singapore's economic strategy, "a slower pace of reserve accumulation could be expected given Singapore's demographic profile going forward."

Singapore has foreign exchange reserves worth hundreds of billions of dollars, including those in one of the world's largest sovereign wealth funds. The city-state is Southeast Asia's wealthiest economy in terms of gross domestic product per capita.

But its dependence on trade makes it sensitive to economic disturbances in developed nations such as key European and United States markets.