The world is not going to be a kind place for small, trade-dependent countries such as Singapore. Geopolitical stresses, financial market turbulence, economic policy uncertainty in the big economies and trade frictions will make sure of that. The regional hinterland may offer some upside, but only so long as political and financial risks can be contained. As domestic demand in Singapore itself has been steady but lacklustre, the economy is vulnerable to shocks to external demand, which it depends on disproportionately. Fortunately, inflation is benign and the external surpluses remain large, giving the country considerable buffers to protect against a rough environment.
Modestly slower external demand with downside risks
The key drivers of the Singapore economy point to a slower pace of growth next year, at around 2.5%, compared with this year’s likely outcome somewhere in the region of 3.5%. This is seen in how the composite lead indicator — which predicts the course of the economy over the next year or so — has fallen for two quarters in a row. A look at the main international drivers of the economy supports this view:
• G3 economies will slow but still raise global demand: The US economy is set to continue growing well above its long-term potential growth rate of just below 2%, but it will decelerate as the year progresses because the fiscal stimulus provided by President Donald Trump’s expansionary budget reforms will fade in the later part of the year. Similarly, the European and Japanese economies are also likely to lose momentum, but continue to grow in line with their long-term trend. So, the big three developed economies will add to global demand for Asian exports, but not as vigorously as in 2018. There is an important silver lining, though — US orders for electronic components are rising, which is positive for Asian exports, given the large footprint of the electronics industry in the region. Not only will our manufacturing sector benefit, as it is highly export-dependent, but our export-import sector will also enjoy greater demand, as we are a hub for sourcing electronic components for the region.
• Global financial conditions will tighten further. Markets are at the moment hoping that the US Federal Reserve will shift to a more dovish stance and avoid aggressive rate increases next year. This is, however, premature. The US economy is growing above its sustainable rate, and there are incipient signs that inflation will perk up. The Fed will raise rates at least twice in 2019 and continue to cut back on its quantitative easing. Similarly, the European Central Bank has made it clear that the slowing eurozone economy will not stop it from ending its quantitative easing policy in January. As global liquidity tightens, investors will continue to cut back on risky assets and become more rigorous in how they price assets. In a world full of political shocks and economic uncertainties, risk aversion is likely to prompt even more withdrawal of capital from emerging markets back into developed markets. So, global equity and bond markets will be volatile, while emerging market currencies will come under continuing pressure.
• What happens in China will matter a lot. The economic data for November confirmed that the headwinds to growth are strengthening even in the face of an ongoing stimulus. Retail sales grew at the slowest rate since records started, while industrial production lost momentum, and investment did not accelerate as much as it should have, given the government’s ramped-up infrastructure and social housing construction.
† Growth is not the issue: The authorities will turn more aggressive in further easing lending restrictions, cutting taxes and making it easier for local governments to raise investment spending. Consequently, economic growth will slow only a little from this year’s 6.5% to around 6.2% in 2019. Since the Chinese are responding to the US trade war against them by opening the economy up to more imports, there will be a better spillover of Chinese demand into demand for Asia’s goods and services than before.
† The risk to Singapore and the region is from the side effects of policy stimulus: We think that there will be more speculative pressures on the Chinese renminbi. There will be knock-on effects if policy succeeds in boosting credit growth, raising household spending and improving investment. China’s current account balance, already in a small deficit after decades of surplus, will weaken further. Since China is no longer providing capital to the world but rather importing capital now, that changes the dynamics of the local currency for the worse. Credit-fuelled growth will also cause some financial imbalances to worsen, adding to concerns about the Chinese economy.
Against this cautious outlook, the Asean economies that form Singapore’s hinterland seem to be in a better position; economic growth may be as robust as in 2018, or decent, at least. The series of interest rate increases in Indonesia will slow business and consumer spending, though government spending on infrastructure and election-related spending in the early part of the year will partially offset that. Malaysia’s new government is gamely working hard to clean up the scandals and resulting fiscal challenges that the previous government left it. Uncertainty over how the clean-up goes and over political succession is causing businesses to hold back expansion plans. The necessary reforms of subsidies and other support measures for the poorer people could slow consumer spending first before their benefits begin to flow in the longer term. Still, the economy can grow around 4.5% in 2019. Thailand faces a watershed election, the first since the military coup of 2014 — but the military junta’s seeming keenness to hold onto power through military-backed political parties could cause a popular backlash and prolong the uncertainty, which would deter investment. This is a pity because the economy is in good shape, with sound plans for the long term and massive infrastructure projects being implemented.
Domestic demand remains unexciting
The internal dynamics of the economy are a bit more mixed, however.
• Households seem to be holding back spending. In nominal terms, compensation of employees has been growing more slowly than total national income in the first three quarters of this year — in other words, the distribution of income is moving away from workers to corporations. Moreover, in the same period, household spending has been growing more slowly than incomes — or put another way, the savings rate has gone up. The reasons for these trends are not clear but seem rooted in the structure of the economy, so they are likely to persist. One key issue could be concerns over retirement adequacy and whether the savings most Singaporeans have locked up in their homes can be monetised when needed to pay for old-age needs. How the value of 99-year leasehold public housing will diminish over time is now a big concern for the average citizen — it could be that Singaporeans are now saving more because they realise that they will not have enough from their current savings to fund a comfortable retired life.
• Another concerning trend is how lacklustre investment has been, especially investment in plant and equipment. That means that businesses are not confident enough about future demand to build capacity in Singapore for the future. Again, it is not clear why this is so — the economy has enjoyed decent growth for almost two years now and while there are global uncertainties, regional demand has been good.
What are the structural changes that will affect Singapore in the longer term?
Apart from these near-term drivers of Singapore’s prospects, there have also been some structural changes in recent times that will have an important effect on Singapore over time:
• The growing threat of ‘de-globalisation’: Singapore was one of the biggest winners from the massive expansion of trade, investment and people movements in the past 40 years. So, any sign that this globalisation movement is faltering must be of great concern. While we expect some progress in the talks between China and the US to resolve their trade disputes, we think that this will mark a temporary pause rather than a fundamental resolution. The dispute between the two powers extends beyond trade to a struggle for global influence, with hawks in the US determined to press for restrictions on technology transfer and investments involving China. Moreover, the pressures against trade go beyond the US and China. Data from the G20 shows that restrictive trade measures have grown persistently in recent years, with many large emerging economies also imposing more barriers to trade. Nationalism is growing, as well as disenchantment with the open-market policies of the past few decades. There is nothing Singapore can do except to plan measures to buffer its economy against these threats.
• Regional economic integration will start releasing synergies: At the end of this year, the Comprehensive and Progressive Trans-Pacific Partnership will come into force, with many cuts to tariffs across the 11 countries that have signed the agreement. Another round of tariff cuts will follow in January. The CPTPP is not perfect, but we believe it will be on balance positive for Singapore. We will not be surprised if Thailand and South Korea also apply to join the pact, boosting the benefits it will bring. Negotiations over another large trade agreement, the Regional Comprehensive Economic Partnership, are scheduled to be concluded in 2019. These talks have made slow progress, as it has been difficult to reconcile the demands of such a varied group of nations, but we believe some form of agreement will emerge once elections in India and Indonesia are over. Singapore will need to expand its involvement in such multilateral agreements, as well as broaden the ambit of its existing free trade agreements to mitigate the ill-effects of de-globalisation.
• Production relocation to Southeast Asia is another positive: As a result of the trade frictions that are directed at China, more producers are relocating their facilities out of the country, with Southeast Asia gaining a good portion of this, especially Vietnam, Thailand and Malaysia, with all of whom Singapore has strong trade, financial and investment links. Singapore will thus benefit indirectly from this new trend of production relocation.
• Southeast Asian economies are set to accelerate: Production relocation is only one of several positive drivers of the Asean economies. Governments are also deregulating their economies and accelerating infrastructure improvements. Regional integration in the form of the Asean Economic Community is slowly but steadily helping as well. All this has boosted Asean’s competitiveness, which is resulting in more flows of direct investment. Once-laggard economies such as the Philippines and Myanmar are set to enjoy higher growth as well.
In other words, there are some positive trends in the regional environment that can help Singapore.
How will policy respond to this scenario?
First, it is clear that Singapore cannot depend much on domestic demand unless there is an expansionary budget. However, we are coming to a point, more than three years into the government’s term, when under the current fiscal rules, it has built up enough surpluses to be able to share some of them with the citizenry. As the global economy slows and downside risks build, it would make sense for the government to increase spending. Thus, the budget in late February will be a nice one, and will strengthen domestic demand. However, the government is likely to be cautious in doing so, since it makes sense to hold back some bullets in case of a major global shock.
Second, as the economy will continue to grow and the labour market remain relatively tight, wages are likely to pick up a tad and contribute to modestly higher inflation. In this scenario of uncertainty and modest inflationary pressures, there is no hurry for the Monetary Authority of Singapore to step up the pace of Singapore dollar appreciation against other currencies — its favoured way of managing monetary conditions. However, barring more severe global or other stresses, we suspect that the MAS will act in October.
Third, the government needs to clarify its policy on public housing leases and how it will mitigate the impact of the falling value of 99-year leases. Prime Minister Lee Hsien Loong has already outlined a path; what is needed is to flesh out the details. That will help stabilise the public housing prices and provide comfort to the 79% of the population that resides in public housing.
Conclusion: A tough year but Singapore has buffers to protect itself
The coming year will be marked by unpleasant political, economic and financial developments at the global level. Singapore’s mix of strong economic fundamentals and effective policy responses has provided it with resilience to external stresses in the past. There is no reason why it will not be the same in the coming year. Once it weathers the near-term storms, it can look forward to longer-term developments, especially in Asean, that will be more supportive of its prospects.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy