• Exports will decline sharply due to global electronics downturn but industrial production has bottomed out.• Consumer spending and investment will contract. Asset market rally might be temporary due to weak domestic fundamentals and global volatility.
• Fiscal and monetary policies will be accommodative until 2010 due to sluggish recovery in exports and domestic demand.
A high dependence on exports and financial services has pushed Singapore’s economy into a severe recession that is much worse than the 1997‐98 or 2001 downturn. The yearover‐year contraction in GDP growth that began in Q4 2008 will extend through all four quarters of 2009. But the pace of contraction in GDP growth and exports might ease in H2 2009.RGE Monitor expects GDP to contract 5.5% in 2009 after growing 1.1% in 2008. A small consumption base and strong export linkages of investment and industrial production imply these indicators will see a deep U‐shaped recovery. GDP growth will remain sluggish in 2010 at an estimated 1.4%, depending on the pace of recovery in U.S. and China, the savings rate in the U.S. and EU, and improvement in global credit conditions and financial activities. However, accommodative fiscal and monetary policies are a positive amid large job losses and risks of workers' aversion to the political system. Large foreign exchange reserves, strong external positions and credit ratings will cushion Singapore from any revival in global risk aversion.
Export Recession Far From Over
The pace of export contraction has eased since March 2009 but volatility on a month‐to‐month basis implies that export improvement is largely being driven by inventory restocking in export destinations. Improvement in exports is mainly driven by pharmaceuticals while electronics and petrochemicals continue to contract at a sharp pace. Given that demand in the U.S. and EU are unlikely to show a marked improvement at least until late 2009, exports will continue to contract through 2009. Since a large share of exports to other Asian economies (Hong Kong, Malaysia and China) is re‐exported to the U.S. and EU, exports to Asia will also contract. Any recovery in 2010 will largely depend on the revival of global demand and electronics cycle, both of which are expected to be sluggish.
Imports have been contracting sharply since most of the imports are for re‐exports. But trade and current account surpluses have been easing due to Singapore's import dependence. If commodity prices pick up temporarily, external surpluses could come under further pressure. But this will be largely contained as commodity prices will be lower than their 2008 levels and consumer spending will contract.
Investment Takes a Beating
Due to a low domestic consumption base, industrial activity and investment are strongly driven by exports. There has been some improvement in industrial production in late Q2 2009, but mostly due to strengths in sectors such as pharmaceuticals and biomedical. Other sectors such as electronics and chemicals will continue to contract sharply through 2009 due to the global electronics downturn. These exports will also witness a very weak recovery in 2010. The Purchasing Manager's Index (PMI) moved into expansion territory in Q2 2009. But given that a sustained recovery in domestic and export demand is still distant, any improvement in PMI and manufacturing output going forward will be slow. The pace of manufacturing recovery in 2010 will depend on the strength of export growth.
The service sector will continue to contract, led by financial services and a slowdown in retail, tourism and real estate as consumer are aggressively cutting down spending. Consumer spending and exports are expected to recover at a sluggish pace in 2010. Inventories are still high, taking into account demand forecasts for 2009 and 2010. So firms need to aggressively cut down inventories in the coming months. Firms also face tight credit access in capital markets while corporate earnings in 2009 will remain dismal. Therefore, investment is expected to fall sharply in 2009 with a sluggish recovery in 2010 depending on the pace of improvement in global trade and credit conditions.
Labor Market Downturn Hits Consumption
The export manufacturing sector and financial services will continue to shed jobs sharply through 2009 amid demand slack and tight credit conditions. Government stimulus measures have somewhat helped contain lay‐offs but any improvement in hiring prospects will be driven by improvement in global conditions in 2010. Layoffs are expected to continue through most of 2009 so that the total jobs lost in this cycle will exceed the jobs lost during the 1997‐98 or 2001 downturn. The unemployment rate is expected to rise from 2.25% in 2008 to close to 5% by 2010. As most of the immigrants who are laid‐off leave the country, Singapore’s already low consumption base is shrinking. Due to this, the sharp contraction in retail sales and consumer spending is expected to continue through 2009, notwithstanding government tax stimulus measures. This will be exacerbated by negative wealth effects from 2008's correction in equity and real estate markets and tight bank lending standards. Given high import dependence, any taxbenefits spent by households might be leaked via imports.
Asset Market Correction Continues
Singapore's equities have rallied since March 2009, buoyed by capital inflows and surging liquidity. Valuations are some of the most attractive in Asia, especially in sectors most affected by the recession such as exports and real estate. However, another market correction cannot be ruled out given the possibility of revival of global risk aversion and domestic risks. The bleak corporate earnings witnessed in Q1 2009 will continue through 2009 making the export and real estate sectors vulnerable again. A sluggish recovery in exports and domestic consumption will raise investor concerns about the health of the corporate sector.
Low interest rates in the U.S. and EU until 2010 will keep Singapore's short‐end yields low at least until 2010. This will be supported by capital inflows, improving liquidity, deflationary pressures and the central bank’s bias for an undervalued currency. Financing the fiscal deficit and fiscal stimulus package with past fiscal surpluses and foreign exchange reserves implies that fiscal pressures during 2009 and 2010 will not put any upward pressure on yields.
The Singapore dollar (SGD) has been trading above the mid‐point of the exchange rate band set by the central bank in the April 2009 monetary policy meeting. This has been led by capital inflows and U.S. dollar weakness recently. However, there are risks to the SGD in H2 2009, including revival of risk aversion and investor concerns about the weak economy and corporate earnings. Further devaluation of SGD by the central bank is unlikely in 2009. But the central bank will nevertheless intervene to keep the SGD in the lower end of the exchange rate band to support growth. The SGD might get a boost in 2010 as the central bank begins to tighten the monetary policy. Strong external surpluses and foreign exchange reserves will cushion the SGD in the event of any risk aversion.
The housing sector has witnessed sharp price correction but starting Q2 2009 there has been some improvement in home sales and prices. However, this has been led by rise in home resales, in lower end sections and in sections where prices are now attractive. The entry of buyers has been mostly due to improving sentiment, speculation, rise in capital inflows, liquidity surge and the stock market rally. But all these trends might be unsustainable in H2 2009 and even in 2010 given weak fundamentals for home demand.
Job losses will continue through 2009 with weak hiring in 2010 leading several immigrants to leave the country. Households continue to face wage pressures and wealth erosion. As a result, demand will fail to keep up with the supply of homes leading to further price correction. Commercial real estate may face further downturn in H2 2009 due to bleak corporate earnings, falling business spending and plunging retail sales. Rising vacancy amid oncoming supply of commercial real estate space will cause rentals to follow sharp downward trend.
Bank credit growth has slowed sharply during the current downturn. But there has been some improvement in loan growth in Q2 2009 led by consumer loans and loans to small and medium enterprises under the government guaranteed loan scheme. However, credit to the corporate sector remains under pressure. Declining investment implies that corporate lending will remain subdued. But there are some positives for banks. Interest margins are rising and local banks have the scope to take over lending activity left by retreating foreign banks. Strong capital‐adequacy ratios are helping banks to withstand some deterioration in asset quality from rising nonperforming loans from households, corporates and the real estate sector.
Room for Fiscal Measures
The $13.7 billion fiscal stimulus package was implemented in early 2009, financed in part by drawing from over $3 billion of the country's foreign exchange reserves. The stimulus package includes credit incentives for firms to retain workers, ease taxes and credit access for firms, credit transfers for the poor and unemployed and spending on public services. These measures have somewhat contained lay‐offs and improved credit access for small and medium enterprises. Despite being aggressive, the stimulus will be insufficient to boost growth in 2009 and 2010 as firms face slack demand and households have low propensity to consume. Despite the expected sluggish economic recovery in 2010, there might not be another stimulus package.
High spending and tax cuts in the stimulus package and slowing tax revenues from individuals, corporates and financial activities will push the fiscal balance from a surplus of 1.8% of GDP in 2008 to a deficit of over 4% of GDP in 2009 and 2010. But fiscal discipline, large foreign exchange reserves and external surpluses during boom years will give enough room to maintain loose fiscal policy.
Monetary Policy Takes Cues from Exports and Inflation
Singapore has been in technical deflation since April 2009. Deflationary pressures might continue until early 2010 amid contracting domestic demand, large excess capacity and labor market slack. Inflation in 2010 is expected to remain subdued and will be driven by the pace of recovery in domestic demand. While commodity prices will be lower than the 2008 levels, some strengthening in commodity prices might raise the risk of import inflation.
In April 2009, the central bank moved the exchange rate band to a lower level without changing the width or slope of the band, leading to a devaluation of the SGD. The SGD has actually been trading in the lower end of the exchange rate band since late 2008 due to the central bank's intervention in the foreign exchange market to support exports.
If the sharp contraction in GDP growth and exports witnessed in H1 2009 extends into H2 2009, which seems unlikely, the central bank may further ease the monetary policy by devaluing the SGD. However, this might be limited by the risk of import inflation, especially if commodity prices strengthen. Moreover, the central bank's devaluation bias will make investors averse to Singapore bonds. The central bank's move will also be limited if any revival of risk aversion going forward causes the SGD to depreciate. The central bank has in the past emphasized the limited impact of exchange rate depreciation in boosting exports in the short‐term. But in any case, monetary easing bias will be maintained until sometime in 2010 due to sluggish recovery in exports, economic growth and inflation.
The Way Forward for Economic Policy
Singapore’s ruling party, the People's Action Party (PAP) faces pressure to maintain its popularity amidst the severe recession. As a result, in May 2009 the government proposed reforming the parliamentary system by allowing non‐PAP members to control up to 20% of parliamentary seats in the next elections. Doing so could be seen to give non‐PAP members more say and to promote a debate on the political system and economic policies. In early 2009, the government also implemented a fiscal stimulus package giving transfers to households and unemployed workers and tax and credit incentives to companies. Given that the economy will recover at a sluggish pace in 2010, the government will face pressure to maintain loose fiscal policy and contain public aversion to the political system.
However, the government will limit the extent of voting powers to the non‐PAP members who sit in the opposition. So the government will continue to have a strong hold on the political system, whether in reforming the political or legal structure or voting on economic policies, irrespective of its dwindling popularity among voters in the recent years. The government also recently passed a law to restrict public demonstrations indicating that restrictions on civil liberties will continue.
The government also plans to hold elections before the constitutional deadline of 2010. However, elections in the immediate term might be ruled out as fighting the recession occupies most of the government's time. Moreover, there are risks of calling for an election as voters face rising job losses and reduced spending and aversion to the present political structure grows.
But the biggest challenge for the government will be carving out an economic model for Singapore. This is imperative as de‐leveraging in the U.S. and EU reduce demand for Singapore's exports and competition from Hong Kong and Shanghai and greater financial regulation pose risk to Singapore's edge as an Asian financial center. The government will also have to address high income inequality and Singapore's shrinking population as immigrants leave the country during the recession.
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