Business Times – 11 Mar 2008
But the biggest problem facing policy-makers is inflation; if it doesn’t stabilise, we may see more drastic steps
SINGAPORE has enjoyed exceptionally strong and stable gross domestic product (GDP) growth in the last few years. For many years after 1997, Singapore’s economy had suffered volatile growth even as it was buffeted by a series of shocks – the Asian crisis, the bursting of the information technology (IT) bubble and then the Sars episode.
None of them was of Singapore’s making but the city-state suffered sharp downturns in each case. It may seem that a small, open economy like Singapore’s cannot avoid being hurt by external shocks.
However, Singapore had enjoyed prolonged periods of high-growth prior to 1997 and had seemed immune to these shocks. What changed after the Asian crisis?
In our view, the big change was in the role of domestic investment activity. Prior to 1997, Singapore relied heavily on high rates of investment that were sustained over decades. This was key to the citystate’s strategy of continuously moving up the value chain – from a British naval base to a low-end manufacturing and shipping hub, and then to a major electronics producer.
The last model broke down in the late 1990s. For many years after the Asian crisis, the city-state floundered for a new strategy and investment activity became erratic. Consumption demand was in no position to compensate, with consumers worried about falling asset values and an uncertain environment.
The lack of a domestic demand dynamic meant that exports became the mainstay and, as shown in the chart opposite (see Chart 1), the economy became susceptible to external shocks.
All this has now changed as Singapore’s government and business leaders have set themselves to the task of transforming it into Asia’s ‘Global City’.
As a result, we are now seeing enormous investment projects that include the two integrated resorts, the Formula One circuit, the Gardens by the Bay, the new business district, additional MRT lines, the Orchard Road upgrade and so on.
Residential investment too has picked up as the city prepares for an accelerated pace of immigration.
Thus, in 2007, we saw fixed investment rise by 20.2 per cent which in turn drove the 7.7 per cent increase in GDP even as net exports slowed.
Note that private consumption plays a passive role with its share continuing to fall (38 per cent of GDP in 2007 compared to 45 per cent in 2001). Thus domestic demand is driven largely by swings in fixed investment.
So what does Singapore invest in? In 2007, residential construction rose 26 per cent, non-residential construction went up by 44 per cent, investment in transportation jumped 30 per cent and machinery rose 10 per cent.
In other words, Singapore is still investing in manufacturing but the focus has shifted towards creating a 21st century commercial/intellectual hub for Asia.
Looking ahead, most of the projects mentioned above are likely to run for at least another two years.
Most of them are fully funded and are likely to continue, irrespective of external events.
There have been press reports that Singapore is facing a credit squeeze that may jeopardise some projects. We see no sign of this with bank credit expanding at over 20 per cent year on year (see Chart 2).
It is possible that some people have not been able to access money but, given the explosive growth in loans, it can hardly be due to the reluctance of banks to expand.
It probably just reflects the strong demand for funds rather than the lack of supply. Thus, we feel that investment momentum will remain strong in 2008.
However, as we also expect exports to weaken due to the faltering US economy, we forecast that GDP growth will slow to 5.8 per cent this year; still a very strong level.
Despite our expectation that growth will slow in 2008, the biggest problem facing policy-makers is inflation. Consumer price inflation jumped to 6.6 per cent year on year in January. As shown in the chart above ( see Chart 3), this is an unprecedented level for this traditionally low-inflation country.
Housing-related costs have jumped especially high, but most other categories are also seeing large increases. This is now a major political issue and is being hotly debated in the media. So, will inflation naturally decline as growth slows?
In our view, slower growth in Singapore and in the world may take off some of the inflationary edge by the middle of 2008, but there is a more fundamental domestic problem. The economy is currently running at full capacity. The unemployment rate is down to 1.6 per cent (see Chart 4) which is the lowest since the Asian crisis.
Similarly, the office occupancy rate has jumped from 82 per cent in December 2003 (see Chart 5) to 93 per cent in December 2007, again levels not seen since 1997.
Thus, a GDP growth rate of 5.8 per cent is good enough to keep inflation on the boil. In a sense, this is the flip side of the investment boom that we are witnessing now.
Singapore’s government is well known for its ‘supply-side’ approach to policy-making.
Characteristically, much of the response to the inflation pressure has been in terms of allowing faster population growth through immigration, encouraging more construction and so on.
Eventually these will expand capacity to keep up with growth. However, there is a more immediate need for a cyclical policy response. This has come in two ways.
First, the postponement of some large long-term public projects. Second and more importantly, the willingness to allow the Singapore dollar to appreciate at a faster pace. At the time of writing, the Singapore dollar stood at 1.39 to the US dollar. We expect it to hit 1.35 in less than six months.
If inflation still does not stabilise, we feel that we may see more drastic steps that may include a lowering of the Goods and Services Tax (GST), which has been hiked to 7 per cent.
The writer is chief economist for Deutsche Bank AG in Hong Kong