May 29, 2003
Singapore enters third consecutive year of recession. Downgrade, weak, conservative & ineffective Government Fiscal Policy. Bleak 2Q Economic Outlook
Recession is looming in Singapore, in our view. Real GDP grew 1.6% YoY in 1Q03, and the economy appears to be decelerating significantly in 2Q03 as domestic demand is hit hard by SARS and services exports, chiefly tourist receipts, are impacted negatively by SARS. Tourist arrivals dropped about 70% for the period April to May 19. Based on the correlation between tourist arrivals and consumer confidence and retail sales, we think it is reasonable to assume a double-digit decline in retail sales over the same period.
The deceleration has also spread to the goods sector. Both manufacturing and merchandise export sectors have lost momentum in April and May, a phenomenon that we also observe elsewhere in Asia. Latest figures suggest that manufacturing production fell 5% YoY in April, and there appear to have been disruptions to the supply chain. The negative impact on the goods sector does not bold well for an economy that is already hard hit by the weakness of its services sector. We believe both goods and services sectors will contract to the tune of 3% or more in 2Q03.
Therefore,despite our recovery scenario for 2H03E, we expect GDP growth to weaken to a mere 1% in 2003.
Near-Term Growth Prospects Clouded by Policy Choice and Uncertain Global Outlook
Singapore has probably entered its third year of recession, with a significant rise in unemployment, relative stagnancy in labor and income,and a significant loss in household confidence dealing blows to domestic demand. Beyond SARS, the cyclical prospects are clouded further by the following two factors, in our view.
1. Policy choice. We believe the Singapore government is quite settled on its long-term policy objectives. The ultimate policy objective is a large external economy through acquisition of real and portfolio assets abroad, accompanied by a knowledge-intensive and export-oriented domestic economy that thrives on high-value-added manufacturing and bio-technology, and exportable services sectors such as education, healthcare and tourism.
These objectives require a high level of savings and globalization through EAEM strategies. High savings means preserving the savings flows and the stock of wealth for the build-up of the external economy. This suggests to us that the government would be very reluctant to pursue an expansionary fiscal policy aimed at salvaging domestic demand.
Globalization through the EAEM strategy means undertaking measures to keep the Singapore supply curve competitive, so that the high-cost economy can be competitive in the global marketplace, in terms of both capturing foreign investment and promoting manufactured exports and newly identified services exports. This suggests to us that Singapore will proactively address cost and competitiveness (supply curve) issues by tolerating structural job shedding and cyclical unemployment, as well as cost containment through cuts in labor income and business costs. While these are necessary steps to address the supplyssues, the bulk of these measures conflict fundamentally with a cyclical revival of the domestic economy.
In fact, if the latest round of wage cuts taken by the Cabinet and senior civil servants were to spark a round of wage cuts (or restraint) across the board, this would make it even more difficult for domestic demand to revive in the near term.
While the government has stated recently that it will stimulate the economy if recession looms, we believe this would involve limited measures with marginal impact. In our view, the bottom line is an unwillingness to tolerate fiscal deficit. After recording a fiscal deficit ratio of 0.5% in 2001-02 (the first deficit in more than 15 years), the government has stated clearly that its objective is to restore the fiscal balance. The fiscal deficit ratio was a moderate 0.1% in 2002-03, and is projected by the government to be a moderate 0.6% for 2003-04. We doubt the government would be willing to raise the projected deficit to anything substantially more than 1% of GDP. Singapores fiscal posture is very conservative relative to its neighbors.
The recent fiscal response to SARS in the region once again demonstrates the fiscal conservatism practised by Singapore, in our opinion. Malaysia’s economics package announced on May 21 provides support equivalent to some 2% of GDP. Hong Kong and Taiwan unleashed packages amounting to some 1% and 0.5% of GDP, respectively. In comparison, Singapores SARS package is equivalent to a meager 0.1% of its GDP.
2. Uncertain global outlook. The policy choice outlined above leaves the Singapore economy pretty much at the mercy of global demand, in our view. Fiscal expansion and prolonged monetary easing in the US, together with the end of the Iraq War and the new policy of US dollar weakness may have brightened the US growth prospects, but its aggregate impact on the global demand picture is uncertain. Europe and Japan’s growth outlook seems dimmer because of the US dollar policy. This, coupled with the negative impact of SARS on the region, suggests that the global outlook on Singapore is far from certain.
Government Should Compromise on Its Strategy in the Short Term
While we still believe Singapore should pursue a more balanced growth strategy emphasizing structural domestic demand on the one hand, and exports and ownership of the external economy on the other, we still view building a large external economy and an export-oriented domestic economy via a competitive supply structure as a sensible long-term strategy. (See our report Dont Forget the Domestic Economy dated April 17, 2003.) We also admit that boosting domestic demand structurally in Singapore is more difficult, given its small domestic demand and high leakage to imports.
However, we take issue with what we believe is the governments perception of a fundamental conflict between the pursuit of its long-term strategy and the need to provide temporary cyclical support. Policy is all about trade offs, in our view. We think the government should temporarily trade off its long-term objectives with a well-thought-out fiscal expansion plan aimed at providing cyclical support to the economy. Prolonged weakness in the domestic economy would continue to incur significant economic costs. For example, over a three-year period, an additional 30,000 working Singaporeans being left without jobs, even at a moderate average annual income of US$30,000, would translate into lost labor income of some US$2.7 billion, plus a substantial multiplier on jobs and income on the part of the US$2.7 billion household income that is being spent.
We are not advocating indiscriminate salvation of the domestic economy through fiscal means. Given the relatively small size of Singapores domestic economy and its high propensity to import, we believe fiscal pump-priming would yield better results if it were provided to the poor and unemployed (a high multiplier, as their propensity to consume is high) with a well-thought-out plan to keep as much as possible of the initial and extra spending generated thereafter onshore. We believe coupons for education, food, rent, mortgage payments, utilities and basic transportation are available avenues to structure such an income support plan to help tide Singapore over a prolonged domestic recession. A more aggressive and comprehensive paid retraining program for the unemployed, as well as a social welfare scheme for the structurally unemployed should also be considered in our opinion. We believe also that it does not make senseto retrench civil servants and state enterprise workers at this difficult time, unless alternative jobs can be created.
Bottom Line: Don’t Pin High Hopes on a Policy Shift
There is no doubt in our minds that the Singapore economy is in need of cyclical support from the government, as it is going through a volatile and prolonged period of uncertain external demand, domestic asset deflation and economic restructuring, which combined is resulting in fewer jobs, reduced income and lower confidence. However, the government has been reluctant to use fiscal means to support the domestic economy because, we believe, it sees a fundamental conflict between the pursuit of its long-term strategy and the need to provide temporary cyclical support. We believe the government should temporarily trade off its long-term objectives with a well-thought-out, albeit temporary, fiscal expansion plan aimed at cyclically supporting the economy, as the prolonged domestic recession is incurring significant economics costs.
However, we doubt the government would abandon its long-term objectives of a large external economy and an export-oriented domestic economy. The former requires high savings, suggesting that policy makers would probably be very reluctant to pursue an expansionary fiscal policy aimed at salvaging domestic demand. The latter requires aggressive globalization through EAEM strategies, which means undertaking measures to keep the Singapore supply curve competitive. Both are fundamentally at odds with cyclical policies aimed at reviving the domestic economy. Given the track record of Singapores policy makers, we believe they are likely stick to the long-term path.