How is our neighbour, Singapore really doing?

Rising risks to Singapore’s growth

First Read Written by Manu Bhaskaran Wednesday, 03 October 2012

DESPITE the optimistic tone in financial markets, the economic news flow for Singapore has been getting gloomier. Data on economic activity, exports and retail sales all point to a sharp loss of momentum, and the likelihood of further deterioration. Given that the global economy is slowing and that Singapore tends to follow the global cycle, such a deceleration is not surprising.

The key question is how much worse it might get and what implications follow for investors and businesses. It is quite clear that an across-the-board slowdown is taking shape.

First, manufacturing, accounting for more than 25% of our economy, is slowing. Not only was the Purchasing Manager’s Index (PMI) below 50 in August, indicating that manufacturing was contracting, but the new orders component of the PMI suffered one of its sharpest two-month contractions in recent times, suggesting that manufacturing could well decline further.

Second, external demand is clearly hurting Singapore. Non-oil domestic exports fell 10.6% year-on-year (y-o-y) in August after rising 5.7% in July.

Third, domestic demand is also losing strength. Retail sales have sunk deeper into contraction, falling 2.9% y-o-y in July after falling 0.8% in June.

Fourth, while unemployment remains very low at 2% in the second quarter (2Q), net job creation is easing while the ratio of job vacancies to unemployed persons has fallen to 0.91 in 2Q from 1.05 in 1Q, the first time the ratio has fallen below 1 in more than two years.

Finally, the corporate sector is beginning to feel the effects of a slower economy, with commercial payments slowing — the incidence of occasions when more than half of total bills due are paid later than the contracted date hit a record high of 53.8% in 2Q, up from just 11.9% in 1Q.

But we have had periods when the economy appeared to slow, only to rebound fairly quickly thereafter. To ascertain how bad this might get, we need to look at the global and domestic forces, which are operating on the economy.

While global business confidence has appeared to steady following the aggressive moves by the European Central Bank (ECB) and the US Federal Reserve Bank to step up monetary easing, the fact is that these measures will do little to prevent the weakening in global demand that is already underway.

What these measures can do is to reduce the risks of extreme events such as a default in one of the larger eurozone economies.

Even if these monetary measures do boost demand, the effects will take at least six months to appear. Thus, in the near term, the global demand for Asian and Singaporean exports will continue to weaken.

The direction of the OECD lead indicators is abundantly clear: Virtually all the major developed and developing economies are heading for slower growth, with the eurozone particularly at risk. The larger emerging economies are also slowing significantly.

The JP Morgan PMI New Business Index (a measure of new orders) is at its lowest point since the global crisis bottomed out in mid-2009.

Capital spending in the US, eurozone and Japan is desultory. This is worrying for us as orders in the US for computers and related items are a good lead indicator for Asian exports.

The poor outlook for weak export demand in this part of the world is not surprising.

In the US, there is growing uncertainty over the outcome of the November presidential and congressional elections as well as the “fiscal cliff” (the risk that political disagreements might result in a massive contraction of fiscal support for the economy early next year). This uncertainty is already causing businesses to defer or cut back on planned hiring and capital spending.

Similarly, the eurozone is in the throes of a massive fiscal consolidation that is taking demand out of the economy at a ferocious pace, no matter what the ECB does in terms of monetary support. In Japan, the expected rebound from the earthquake disaster in March 2011 has been undermined by slower global demand, an overly strong yen and uncertainty over the elections that are likely in the next few months.

The other global engine is of course China, whose gargantuan stimulus programme in 2009 helped save the global economy then. As we argued earlier, the Chinese economy is also facing headwinds. In fact, conditions in the Chinese economy are even more worrying than we had expected.

There are signs that Chinese companies are suffering much weaker cash flows as accounts receivables mount while profits at listed companies are weakening. There is also growing concern that the stimulus programmes that local governments have been announcing are far from implementation and that a political consensus for a major stimulus has yet to form.

Given this dim outlook for global demand, Singapore is fortunate that the economic resilience of its neighbours will provide some support:

While Malaysia is bound to take a hit from weaker exports and lower commodity prices, its Economic Transformation Programme is stepping into high gear, allowing the ratio of investment to GDP to rise to a decade high. The budget to be announced on Friday is almost certain to provide a strong stimulus to the economy. Thus, while the Malaysian economy may well lose momentum, it should hold up reasonably well.

Indonesia continues to grow strongly, given its relatively low exposure to exports. Foreign and domestic investments remain strong.

Like Malaysia, Thailand is hurting from slower demand for its exports. But it is also benefiting from reconstruction spending following the flood disaster a year ago. In addition, while the government’s ambitious infrastructure programme is not being implemented as rapidly as hoped, it will still provide strong support to the economy.

There has been a sizeable pick up in net investment commitments with the total for the first half of 2012 (1H12) at around S$10.5 billion (RM26.28 billion), well above the S$6.3 billion in 1H11. As these investments mature into actual factories and production, economic growth will be supported.

Investment in infrastructure is growing rapidly, with several mass transit rail lines being constructed simultaneously.

Public housing construction is also being ramped up.

With the labour market remaining tight, wage growth is likely to remain well-supported, which will feed through to consumer spending.

All this will provide some offset to the global headwinds. However, given our preponderant dependence on the major economies and the relatively small role played by domestic consumer spending and local investment, the net effect will be that the Singapore economy will weaken further.

The current context of the economy is quite different from that in 2008 and this will influence how the economy moves. First, the currency in real trade-weighted terms is at its strongest level ever. Given that inflation is still higher than desired, it is unlikely that the policymakers will allow the Singapore dollar to weaken significantly. So, the strong currency is here to stay, certainly for the next few months.

Second, following several years of above-potential growth and the substantial rise in population since 2004, business costs in Singapore have risen markedly relative to its neighbours and trading partners. This has undermined our competitiveness.

Third, costs may not adjust down as quickly as before in the early phase of the downturn. The need to curtail the rise in foreign workers means that the supply of foreign workers will now be more restricted. As a result, wage costs will not adjust down as flexibly and as quickly to give businesses the respite they need.

So, what happens when an economy whose costs have risen and whose currency is strong enters a period of slow growth or near recession? The economy will have no option but to restructure itself and, possibly, to do so in ways which will detract from economic growth in the short term.

Consequently, as the economic slowdown deepens, businesses will have to take stronger measures to survive. Costs have to be crunched down through downsizing, relocation, squeezing suppliers to reduce costs and through changing business lines. We are already seeing the first signs of some regional operations moving activities out of Singapore. This will certainly accelerate, particularly as Iskandar Malaysia is gaining critical mass this year and becoming a much more attractive place for activities where labour and land costs are important.

In short, investors have to prepare for Singapore to undergo a period of rough adjustment similar to what it experienced in 2001-03. Growth will be mediocre and inflationary pressures will diminish sharply. This may sound pessimistic but there is a silver lining — eventually, costs will come down and a base will be laid for another phase of growth. — The Edge Singapore

Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy. This article is appeared in The Edge Financial Daily on Sept 25, 2012.

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