Singapore has received some much-needed good economic news of late, with economic growth and exports surprising to the upside. However, the external environment could grow more challenging if protectionism and populism do take root in key markets. Two major policy initiatives by the government were released recently — the report of the Committee on the Future Economy (CFE) and the Budget statement. Here is our take on Singapore’s economic prospects and whether the policy responses will suffice for the country. 

The economy is turning around; upside surprises likely

Singapore’s economy enjoyed its fastest growth in about two years, expanding 2.9% y-o-y in the fourth quarter last year, surging from 1.2% in 3Q2016 as the rebound in external demand boosted manufacturing activity. 

• Manufacturing jumped 11.5% y-o-y in 4Q2016, up from 1.8% in 3Q2016 as the turnaround in global demand powered ­Singapore’s electronics and biomedical manu­facturing clusters. In fact, the January acceleration in exports tells us the trade-led cyclical recovery has legs — exports grew 11.1% last month, up from 9.2% in December. ­Encouragingly, this bounce is broadly based and boosting export-facilitating acti­vities such as transport and storage; 

• Near-term outlook looks good, for now: ­Singapore’s composite lead indicator has been rising in recent quarters, suggesting continued overall economic growth. The forward-looking indicators for global demand, such as the Organisation for Economic Co-operation and Development lead indicator and new orders in purchasing manager surveys, provide strong evidence that the export rebound will be sustained. Interestingly, the latest data from the eurozone shows the economy accelerating nicely, giving global demand more legs to ­depend on than just the US;  

• But some sectors continue to languish: The construction sector actually ­contracted 2.8% y-o-y in 4Q2016, worsening from a fall of 2.2% in 3Q2016, as private construction activity withered. Overall, the ­services sector (which contributes to two-thirds of the economy) disappointed, barely eking out growth of 1% in 4Q2016. Financial and business services are struggling, offset by sectors such as social services, which are benefiting from ramped-up government expenditures on eldercare and healthcare.

In short, the economy has a dualistic nature, with export-oriented segments enjoying a near-term bounce from rising global demand, but other segments being weighed down by a number of structural factors. Overall, since ­external demand makes up about two-thirds of total demand in value-added terms, the ­global upswing can help us overcome the domestic headwinds, at least for now. 

This has two important implications for policy

First, with growth surprising to the upside and tepid non-tradeable inflation telling us there is considerable slack in the economy that will limit upside risks to overall inflation, there is no reason for the Monetary Authority of Singa­pore to further ease the exchange rate policy. 

Second, the improvement in the economy buys Singapore time to address other ­challenges in the economy, some of which are structural in nature. With monetary policy having accomplished what it can, further demand-management policy has to be oriented towards fiscal policy to support the weaker segments of the economy — which, unfortunately, is where most Singa­poreans earn their income. Next, structural ­challenges need to be addressed as well. This is where we need to assess the latest Budget as well as the CFE report. 

Expansionary Budget, with sector-specific measures

We see four broad themes underpinning Budget 2017. 

• Net stimulatory impact: On our measure of fiscal spending, and assuming that the budget balance turns out as estimated, fiscal policy is expansionary compared with the contractionary effect in 2016. However, budget surpluses tend to be bigger than the government’s initial estimates, so the actual fiscal outcome could well be less than intended. Still, it is helpful that S$700 million worth of public-sector construction projects will be brought forward to this year and the next, providing a well-needed boost. Sector-specific measures will also be rolled out to aid some sectors experiencing cyclical headwinds. Rebates on both corporate and personal incomes taxes as well as the GST Voucher handouts will provide (small) fillips to private consumption;

• Preparing the economy for the future: The Budget also fleshed out a number of recommendations laid out by the CFE, including help for Singaporean firms to scale up and internationalise, as well as for workers to equip themselves with skills that are relevant and valuable in new and rising industries;

• Growing emphasis on increasing revenues: Finance Minister Heng Swee Keat spoke about the need to broaden the tax base and control expenditures. Budget caps on ­government ministries will be reduced by another two percentage points to improve spending ­disciplines; and 

• The move towards an inclusive and caring society continues: As Singapore ages and families become smaller, the government seeks to catalyse community efforts to help the needy. The Budget increases funding of charities and voluntary welfare organisations and expands support for the disabled and those with mental health conditions.

Tackling structural challenges — the CFE report

The CFE laid out seven major clusters of recom­mendations to gear Singapore to face the challenging environment it finds itself in. Its aim is to empower Singaporeans to be “pio­neers of the next generation”, leading to an ave­rage annual growth rate of 2% to 3% and ­culminating in good jobs and meaningful ­careers for all ­Singaporeans, while ensuring that manufacturing continues to play a large role in the economy. 

The seven broad and “mutually ­reinforcing” strategies suggested by the CFE focused on (a) deepening and diversifying international connections; (b) acquiring and utilising deep skills; (c) strengthening enterprise capabilities to ­innovate and scale up; (d) building strong digital capabilities; (e) developing a vibrant and connected city of opportunity; (f) developing and implementing industry transformation maps (ITMs); and (g) partnering each ­other to enable innovation and growth. 

Two key questions have been raised: What specific policy changes may emerge from the CFE report, and how can the committee’s ­modest goals be achieved?

Cautious policy approach that emphasises ongoing initiatives 

The CFE report carefully adheres to existing policy approaches, with few groundbreaking new initiatives. The emphasis was on expanding implementation of ongoing strategies, based on the view that the highly complex and unpredictable world limited policy options on building capacities and improving the enabling environment, instead of picking winners or being more targeted or specific: 

• No change to key growth sectors: The government will take on a more active role to support growth and innovation in sectors such as finance, hub ­services, logistics, urban solutions, healthcare, the digital economy and advanced manufacturing;

• Retaining a large manufacturing base of about 20% of total economic output. The core of CFE’s strategy involves the ITMs announced last year. These are industry-­specific platforms to integrate planning and implementation in 23 industries and about 80% of the economy. Six have been launched so far;

• No change to economic openness: Singa­pore will focus on progressing ­negotiations for the Regional Comprehensive Economic Partnership. No new initiatives for ­regional integration appear to have been contem­plated nor was there an indication of what it would do now that the Trans-Pacific Partner­ship initiative has floundered; 

• The most substantive measures in the CFE report related to deregulation to spur innovation, digitisation and entrepreneurship: First, the government will redesign the regulatory environment to make it more supportive of innovation and risk-taking, such as through regulatory sandboxes and by ­issuing “no action” letters assuring disrupting companies that they would not be penal­ised if, in pushing the envelope with new ideas, they brush against Singapore’s infamously rigid regulations. Second, the govern­ment is also committed to act as a source of “lead demand” for up-and-­coming industries, particularly those that intersect strategic national needs. Third, the government will simplify the regulatory framework for venture capitalists and encourage the ­entry of private-equity firms to provide smart and patient growth ­capital. Fourth, it will also set up a Global Innovation ­Alliance to link Singapore’s institutes of higher ­learning and companies with overseas partners in major innovation hubs and key demand markets; and 

• Scaling up and internationalising: The govern­ment will support the scaling up of high-growth local enterprises as well as the commercialisation of research findings and ­intellectual property of research institutions. The govern­ment will make a big push for agglomeration gains through enhanced international connectivity as well as by devel­oping districts such as Jurong and Punggol into ­synergistic and vibrant clusters.

Can the objectives outlined by the CFE be achieved?

Much has been written about the CFE report, so our comments are confined to two big issues. 

First, Singapore faces overarching ­challenges requiring a more fundamental rethink of its economic model if the CFE’s goals are to be attained. 

The average annual 2%-to-3% growth target is a marked downshift from the 3%-to-5% ­posited by the 2009 Economic Strategies Committee. It is difficult to see Singapore ­hitting 2% to 3% growth, given that: 

• Long-term economic growth is constrained: Growth is a function of productivity and labour force growth, but productivity performance has been lacklustre and demographic headwinds can only grow as the population ages; 

• Moreover, a more hostile global trading environment beckons: US President ­Donald Trump is following through with his protectionist bent, while Congress is contem­plating a border adjustment tax that will hurt imports into the US and potentially spark a trade war; 

• Singapore’s status as the premier regional hub challenged. Bangkok is emerging as a rival to hub services that Singapore has focused on as a high-growth industry, while Hong Kong is widening its lead in many ­areas. Some elements of the ­regional hub are already at risk. The local stock market’s turnover volumes have plummeted since 2013, with average daily trading volumes declining, while those on other regional exchanges have grown. A lack of liquidity and weak valuations are deterring ­regional and local firms from listing here. Yet, it is the stock market that provides growth companies with viable exit strategies and, without that, the government’s pursuit of smart and patient capital from venture capital and ­private equity will struggle; and

• High-cost structure inhibiting entrepreneurship and growth of small and medium-sized enterprises: Costs in terms of rents, wages and compliance have mounted, resulting in a loss of cost-competi­tiveness. High costs are also stifling entrepreneurial spirit and inhibi­ting the growth of local start-ups.

Second, the push for a large manufacturing base needs better under-girders. 

Several advanced economies such as ­Germany, Japan and South Korea have remained production powerhouses, showing that ­maintaining a robust manufacturing base in a mature economy is feasible and rewarding. But Singapore’s manufacturing share of GDP has been on a downtrend — from 26% in 2000 to 19% in 2015 — while Germany and South Korea’s have remained largely unchanged, and Japan’s has ticked down only from 23% to 20% over the same period. The reason is Germany can count on its world-class Mittelstand group of SMEs while Japan and South Korea have strong national champions to undergird their respective manufacturing bases. However, Singapore has an unhealthy reliance on MNC-led growth and foreign direct investment, and has not been making great inroads into nurturing a strong core of SMEs. 

A big worry is that in the pursuit of this 20% target, the government will ramp up its big-ticket giveaways and sweeteners to entice MNCs to remain in or come to Singapore. This would mean more investment incentives and tax breaks, pointing to a higher cost of attracting foreign investment and potentially skewing the cost-benefit analysis against Singapore’s favour. 

The bottom line: The economic cycle is turning around, giving Singapore breathing space to address the larger structural challenges it faces. The latter is an evolving process, which the CFE has helped accelerate. It is hoped that, over time, the government will feel its way to a pragmatic mix of policies that comprehensively address long-term challenges. 

Manu Bhaskaran is a partner and head of ­economic research at Centennial Group Inc, an economics consultancy 

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