The Singapore economy is in trouble. Virtually every economic indicator we look at is signalling weakness. From a bottom-up perspective, there is more and more anecdotal evidence of companies facing difficulties. The stock market is trading near three-year lows and the currency has also weakened. Although there is some hope that falling oil prices and an upturn in the US economy could revive demand, external and domestic headwinds limit the upside.
In other words, the economy is now reaching a point at which a turning point in policy should be approaching: Additional help for small businesses and a step up in fiscal spending might need to be considered as well as longer-term strategies to improve cost competitiveness.
State of the economy: highly vulnerable to external shocks
The flow of reports on the economy is a litany of bad news and weak data:
- Activity indicators weakening. Not only is the purchasing manager index down but its forward-looking components such as new orders have also fallen. Manufacturing output has been contracting for six consecutive months. Export growth has been lacklustre since early last year. Container volumes at the port fell 12% to 13% in July/August, the worst performance since 2009. Tourist arrivals have been edging up a tad since May but only after falling for more than a year. Only in the financial sector (outside bank lending) are there signs of reasonable growth;
- Corporate sector in pain, restructuring. The Singapore Business Federation-DP SME Index of small and medium-size enterprises’ confidence has fallen in the third quarter to its weakest level since early 2013. This is particularly evident in the retail sector, where several large chains have been shutting down outlets in recent months. Even successful companies are moving more aggressively to cut costs — many global technology firms that set up shop in prime office locations are now shifting to cheaper locations outside the city. Others, such as several banks, are consolidating their operations to reduce rental costs;
- Employment growth losing momentum, hurting consumer spending. If one excludes foreign domestic workers, the first half of this year saw total employment actually fall (by 1,000 compared with expansion of more than 52,000 in the same period in 2014). Worse still, there was a decline of almost 9,000 in local employment in 1H2015. While there may have been some one-off or seasonal factors at play, we believe the labour market has basically weakened. This could be hurting consumer confidence, which would explain the virtual stagnation of retail sales volumes (if one excludes sales of motor vehicles);
- Real estate market — unmistakable signs of weakness. As at August, HDB resale prices had fallen 3% from a year ago — prices are estimated to be 11.3% below the peak in April 2013 as measured by the SRX Price Index. Retail rentals in the Orchard area are falling, while residential and office rents are under pressure as well; and • Credit market also suggesting build-up of problems. Banks have reported that 2.3% of their loan book is in the special mention category, signifying a potential for turning bad. This is the highest level since the global financial crisis of 2009. The increase in activity in property auctions we have seen in recent months probably reflects distressed borrowers cutting their losses by selling off their speculative purchases of property as well as a rise in foreclosures by banks.
Looking ahead, the indications are still tilted to the downside
First, the good news. One potential upside is the incipient turnaround in US capital spending — Singapore’s exports are highly correlated with capital expenditure, so if this turnaround is indeed real, our exports should see an uptick in time. However, the large fall in retained imports of intermediate goods, which are used to manufacture export goods, tells us that a near-term recovery in exports is not on the cards yet. The significant fall in oil prices should also be positive — but recent experience teaches us that the boost to global demand takes time to emerge while the immediate impact in terms of cutbacks in oil sector capital spending are felt immediately: Unfortunately, Singapore’s offshore and marine sector gets hit quickly from this.
In addition, domestic interest rates have spiked in recent weeks. Once the US Federal Reserve starts raising rates, we will see even more increases in local rates, which will then spill over into higher borrowing costs for businesses as well as individuals. Our estimate is that every one percentage point rise in mortgage rates will raise the monthly repayments by 3% of a typical young couple’s income — not huge but enough to slow consumer spending.
In the meantime, events in Malaysia also pose a risk. First, the sharp depreciation of the ringgit makes it even more attractive for Singaporeans to hop over to Johor to shop, putting ever more pressure on our retail sector. Second, companies will find the case for relocating more activities to Malaysia even more compelling. Even if there is some political risk, most would say that there are ways to mitigate it. Third, as Malaysia’s economy slows as a result of the falling confidence and as the ringgit remains weak, demand for Singapore’s now more expensive services will fall, hurting our regional hub activities.
In short, the economy is losing its oomph and, while there may be some recovery in export demand, this is still uncertain and some way off. The bottom line is that the composite lead indicator for the Singapore economy is falling, pointing to further loss of momentum.
How should policy respond?
Singapore’s current predicament is the product of both cyclical as well as structural forces. Policy action is needed to tackle both.
First, from a cyclical perspective, the best that the government can do is to mitigate the downward pressures:
- The government could signal that the forthcoming budget will be more expansionary to support business confidence. Infrastructure spending that has already been planned could be brought forward as well; and
- There could also be more measures to alleviate the financial pressures on SMEs. For example, the government could reintroduce some of the risk-sharing measures it used successfully during the global financial crisis, when it shared the risk of loan losses with financial institutions, thereby helping to ensure a continued flow of credit to the business sector.
Second, measures to tackle the structural challenges that the economy faces are needed. The fundamental problem is that Singapore has lost competitiveness because its costs have escalated far more quickly than its ability to create value: For many years until recently, our inflation rate was higher than those of our trading partners, resulting in a huge loss of competitiveness. Unit business costs in manufacturing and unit services costs rose 3.1% and 2.7% a year, respectively, from 2010 to 2014.
We cannot continue with a situation in which prices of many goods and services are so much more expensive in Singapore than in other top-tier cities of the world. The reasons for the cost escalation are not fully understood, but there are several possible causes, each of which requires counter measures:
- Rising property prices and rentals are clearly a cause. In our view, Singapore has no choice but to bite the bullet and allow a significant fall in real estate prices. This is not a popular thing to say, but this is the reality. While easing some administrative measures to cool the property sector can be considered once the fall in property prices escalates, the important ones such as the total debt service ratio restrictions should remain;
- Create a more competitive marketplace. While some sectors such as F&B as well as retail are quite competitive, others are not. Exemptions from the Competition Act should be reviewed so that all sectors of the economy, particularly those providing input into production, are subject to the Act;
- Create more opportunities for local companies to gain economies of scale. Although the evidence is not conclusive, it is possible that Singapore’s small market size means that unit costs are higher. Singapore’s trade negotiators should perhaps focus more on how free trade agreements can provide Singapore- based businesses with greater scope to leverage off larger markets; and
- Reconsider our macroeconomic policy framework. On hindsight, it appears that policy settings — particularly foreign worker inflows, supply-side incentives to attract businesses to Singapore — were set at levels that produced too rapid a rate of growth: When the economy grows faster than its underlying potential, costs tend to escalate. This seemed to have been the case from 2004 to 2011, resulting in the cost escalation that the economy suffered from.
In other words, there are some hard policy choices ahead. But Singapore has shown in the past that it is capable of making tough decisions and enduring the short-term pain needed to drive long-term success.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy.
This article appeared in the Personal Wealth of Issue 695 (Sep 21) of The Edge Singapore.
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