Singapore: Government, not Exports, Holds the Key to Growth

Posted by Daniel Lian under Policy Watch on 29 January 2001

Data Suggest Economic Picture Has Deteriorated ... The negative growth in December non-oil domestic exports (NODX), and the recent decelerating growth trend observed in retail sales as well as the leading economic indicator raised concerns that the Singapore growth picture may be deteriorating rapidly. Singapore registered strong GDP growth of 10.1% for 2000. Some of these concerns centered on our call of aggressive fiscal expansion in 2001 buoying domestic demand, thus providing a cushion against sharply weakening external demand.

... but Data Provide an Incomplete Assessment

For 2000, Singapore's GDP was composed of private consumption (39.8%), government consumption (9.7%), gross domestic fixed capital formation (33.8%) -- government fixed capital formation accounted for 24% in 1999 -- and net exports (17.2%), on our estimates. A finalized breakdown of GDP is expected sometime in mid-February. We note that growth in GDP in 2001 will likely be both jointly and directly linked to changes in the growth rates of these components (inventory change and statistical discrepancies, the other two expenditure components of GDP, are typically small and exert an insignificant impact).

Monthly NODX provides an accurate picture of Singapore's net export trend. In addition, retail sales, to a certain degree, provide a reasonable gauge of the trend in private consumption. However, there will be no announcement of 1Q01 government consumption and gross domestic fixed investment, which combined accounted for 43.5% of GDP in 2000, until sometime in April. In other words, the monthly NODX and retail sales numbers, plus all the routinely disclosed economic statistics will give market participants a rough guide only on the growth trend of 56.5%, or slightly more than half of GDP. However, our long-held view that a permanent structural shift in the government's saving stance and a cyclical need to cushion growth weakness stemming from external sources means government consumption and gross domestic fixed investment will be primary beneficiaries of fiscal expansion, followed by private consumption.

Revisit Domestic Demand Drivers We expect aggressive fiscal spending to buoy government consumption and investment this year. In turn, the multiplier effect should transform this pump-priming money into income for households and corporates, which should help support the growth trend in private consumption and domestic private investment. We note that our structural consumption boom thesis emphasizes that any spillover effect would mainly be felt by private consumption.

We believe our real GDP growth forecast of 6.6% in 2001 will be attained by double-digit growth in government consumption and gross domestic fixed investment. Indeed, we have allowed for a sharp deceleration in growth of net exports this year, and expect net exports to contribute a negative 6.4% to growth. By our estimates, NODX would need to grow by 4-7% in 2001. Given our assumption of a V-shaped recovery in the US and global demand in 2H01, we could afford to see six consecutive months of negative growth in NODX and flat industrial production in 1H01 without violating our growth assumptions.

Risks to our Growth Assumptions and Forecast? We have identified four categories of risk that have raised investor concerns. A detailed analysis of these risks is provided below to help investors evaluate the risk if they employ our 6.6% 2001 growth projection as the base-case scenario for the Singapore economy:

(1) Domestic demand risk. Is the Singapore government willing to see a rapid decline in the public saving to GDP ratio to below 5% this year? According to our estimates, the public saving ratio has already been trending downwards, moving from 11% on average in 1990-1999 to around 6-7% at present. We cannot gauge precisely the amount of fiscal expenditure affecting domestic demand and the additional income created for domestic demand. Many of these fiscal programs are designed for multiple-year duration and quantifying precise leakage to foreign consumption and investment is extremely difficult.

For our 6.6% GDP growth projection to be achieved while our external demand assumptions remain constant, an extra S$5-6 billion in additional fiscal spending or tax cut would be needed. In our previous reports, we have already extensively documented the need for S$2.5 billion in tax cuts to materialize in the coming budget. So essentially, what we want to see included in the forthcoming F2001/02 budget (scheduled to be presented in parliament in late February) is approximately an additional S$2.5 billion in fiscal stimulus aimed at boosting output and income in 2001.

The government essentially has the resources to pump prime the economy to achieve the upper end of its 5-7% target growth, regardless of the severity of weakness in external demand. However, we would highlight two important considerations: First, the cyclical concern for growth may not outweigh the long-term desire to gradually bring down the public saving to GDP ratio. We have long argued that the government saving to GDP ratio needs to be guided down from double-digit levels in the past decade to perhaps 5-6%, leaving ample room to finance a more gradual buildup of the external economy and to provide a cushion in times of hardship.

As mentioned above, we estimate that the public saving to GDP ratio has already been trimmed from 11% on average in 1990-1999, to perhaps only 6-7% recently. The extra S$5-6 billion worth of spending/tax-cuts that we hope may be forthcoming this fiscal year would trim the public saving ratio to 3-4% of GDP. While such a ratio represents excessive prudence for most governments, it may be too aggressive for the Singapore government in terms of a shift in saving attitude.

Second, the government needs to initiate cost cutting given the rapid rise in wages and business costs in the last two years, especially if other Asian exporters aggressively devalue their currencies. A lower GDP growth rate would put the government in a stronger position to persuade trade unions to restrain their demand for wage increases and CPF restoration. (For a detailed analysis on why domestic cost containment rather than competitive currency devaluation is the appropriate policy response for Singapore, see "Why Trade-Weighted Appreciation Is Pursued?" January 23, 2001.)

However, the above twin considerations arguing against using more fiscal ammunition should be balanced with the fact that the government needs to pay attention to cyclical unemployment caused by this unexpected slowdown, and the ongoing challenge of managing structural unemployment as Singapore moves rapidly toward the New Economy. We also believe the government is clearly contemplating calling an election as early as 1H01 and cyclical concerns must be weighed against structural worries. We assign a 40% probability to the government's not bringing the fiscal saving ratio down from 6-7% to 3-4% this year. This eventuality would pose downside risk to our 6.6% 2001 growth forecast.

(2) External demand risk. Our external demand assumption is a 1H01 recession in the US, and a V-shaped US/global demand recovery in 2H01 culminating in dramatically reduced growth in the US of only 1.1%, global of 2.9%, and Asia/Pacific of 5.8% for 2001. A more severe deceleration in these external demand forecasts could render net exports a bigger, i.e., more than a 6.4%, negative contributor to growth. This invariably would lower our projected 6.6% growth, with domestic demand remaining unchanged. We assign a 20% risk to external demand failing to even live up to our already pessimistic conjecture.

(3) Asian currency competitive devaluation risk. Many investors advocate such risk, especially for the Malaysian ringgit, either through another repeg to a fixed rate or an outright conversion to a floating exchange rate regime. It is important that these are part-and-parcel of the external demand risk we have contemplated in (2) above. Such risk has already been incorporated in our growth forecast together with our assumption of continued trade-weighted appreciation in the Singapore dollar. Given that our external demand assumption and the concomitant result of net exports' negative 6.4% contribution to GDP growth has already incorporated such risk, we do not see the need to assign a probability to such a risk or alter our growth assumptions and forecasts.

Fear of a weaker ringgit is an initial negative response on the part of the Singapore market, in our view, given the erroneous perception that a more competitive ringgit would crowd out Singapore exports in the international market, and lead to a more severe contraction in external demand for Singapore. We believe this view to be false and based on a naïve assumption that Malaysia and Singapore are competitors in the international market. In reality, there is a complementarity between Malaysian and Singapore exports. Electronics account for more than 60% of merchandise exports (in the case of Singapore, NODX) in both countries. However, more than 35% of Malaysian goods exported pass through Singapore, either using Singapore as an entrepot, or such Malaysian goods become part of the inputs utilized by Singapore manufacturers.

Singapore, in addition, is a main service provider for the Malaysian economy. These earnings are mainly derived from financial services, transportation, telecommunication, commerce and trade, and IT services. If Malaysia, through a weaker currency, is better able to preserve export earnings and growth, we believe this would benefit the Singapore real economy rather than harming it.

Singapore's exchange rate response to a ringgit downward adjustment would be one of a managed trade-weighted depreciation, in our view. The Singapore dollar would have to depreciate more versus the US dollar, but appreciate against the ringgit in order to reduce the imported cost of Malaysian goods. On the other hand, the more inelastic services rendered by Singapore to Malaysia should ensure that Singapore preserves service export earnings despite the Singapore dollar's appreciation against the ringgit.

(4) Risk of a sharply slower first half in the Singapore economy. While keeping our growth projection for 2001 at 6.6% in our last analysis ("Stay Focused On Domestic Demand," January 9, 2001), we assumed a 5-6% YoY growth rate in the first half, accelerating to 7-8% YoY in the second half. There are some risks to this forecast, however, as the V-shaped recovery could prove to be lengthier on either of the slopes. We are now adjusting our intra-year forecast to reflect the risks of a more severe contraction in external demand in the first half. Our intra-year forecast now calls for 4.5-5% YoY growth in the first half, accelerating to 8-8.5% YoY in the second half.

Conclusion: Government Spending Is Key to Growth Watching export growth and other manufacturing and production-based numbers will not produce an accurate picture of growth in Singapore, in our view. The government holds the key to growth, as we believe that the magnitude of fiscal expansion will determine the ultimate growth rate. We believe, based on double-digit growth in government consumption and domestic fixed investment, and a robust private consumption growth trend, that the Singapore economy is capable of delivering 6.6% growth for 2001.

However, we recognize four categories of risks that concern investors. (1) A domestic demand risk in the event the government fails to bring the public saving to GDP ratio down to 3-4% in the forthcoming February budget. (2) External demand weakness might be more severe > than the sharp V-shape we envisage. (3) Competitive devaluations of Asian currencies. (4) Sharply slower economic growth in the first half. We assign 40% and 25% probabilities to the first two risk categories, respectively. The last two risk categories have no bearing on our growth projection for the year. Risk (3) is part of the same set of external demand risks, and Singapore's expected trade-weighted appreciation response to competitive Asian currency devaluation is already incorporated into our external demand assumptions and growth forecast. Last but not least, while keeping our 2001 growth forecast at 6.6% in anticipation of a stronger fiscal expansion, we recognize the V-shape nature of the recovery and have adjusted our intra-year forecast to reflect a slower first half and a sharper acceleration in the second half.

Jan 23, 2001


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