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Introduction

The main purpose of this research project is to explore the extent to which Singapore is being exposed to external economic turbulence given her high level of trade openness. Since the colonial era and its foundational moments as an independent country, Singapore has emerged as a trade and financial hub for the rest of the world, given its geographical location, low tariffs and minimal capital controls.

Singapore is a very small economy with a population of 5 million people and growing, and a land area of 712 km2 (SingStat, 2011).

The city faces three particular constraints, the city can by no means be the producer of all its needs neither can it consume all of its production nor the source of the resources for that production. Thus, the need for an external solution which is trade.

Free trade has been Singapore’s strong bet on its own economic development. But as we know, such openness has its pros and cons. From Modern Trade Theory developed by Adam Smith, David Ricardo and other authors, trade is not a zero-sum game, in the sense that both parties will take advantage of the comparative advantage in production of the other player and enjoy higher outputs.

Since Singapore is trade reliant, this whole framework brings us to the main question: how susceptible is Singapore to external economic shocks?

The global economy has been volatile during the past years. The Global Financial Crises in 2008 brought the developed world into a recession. The Euro Debt crisis in Europe’s peripheral countries such as Greece, Portugal, Ireland, Italy and Spain increased the risk premium of those debt titles to historical levels and has caused the Euro a unprecedented drop since the creation of the Common Currency. Also, during 2011, rating agency Standard&Poor’s downgraded US credit rating from AAA to AA+, and more recently, rumors on an upcoming recession start to become strong as the stock markets worldwide shake on that expectation.

Trade

Singapore’s economy, in terms of trade and investment inflows (FDI), is one of the most open among the world’s economies. With an openness level of 297%, Singapore has the highest openness level as compared to other countries. This is because Singapore rarely imposes any tariffs on trade, and capital inflows into Singapore are free. Openness has been the centre of Singapore’s economic development strategy, due to its small size and extremely limited resources. Comparative advantage over other countries and competitive advantage amongst industries is what maintains Singapore’s success in the long run.

Singapore’s industrial policies are directed towards sustaining growth and competitiveness. In order to avoid head-on competition with more cost efficient countries in Asia (e.g. China), Singapore has, over the years, moved from solely manufacturing industries towards value-adding knowledge-based industries. In addition, Singapore’s financial assistance schemes and other industrial policies are geared towards providing aid to domestic exporters. For instance,

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the total aggregate savings on export tariffs for local exporters amounted to S$700million in 2009 (International Enterprise Singapore, 2010)

Singapore’s high degree of openness, albeit beneficial to its economy and sustainability in the globalized world economy, makes it particularly vulnerable to global economic shocks from time to time. In the following paragraphs, the effect of the 2007-2008 sub-prime mortgage crisis will be used as an example to demonstrate the effect of global economic downturns on Singapore.

FIG T1: Domestic Exports 2007-2009 (Source: (International Enterprise Singapore, 2010)

The 2008 sub-prime mortgage crisis resulted in a fall in global consumption and demand. Figure T1 shows the contagion effect this had on Singapore. From 2008 to 2009, domestic exports of Singapore’s goods experienced a relatively sharp decrease in almost every industry. Exports of services also dropped from S$109 Billion in 2008 to S$100 Billion in 2009. The reason for the relatively gentler decline in services could be Singapore’s higher competitiveness in terms of the service and knowledge-based industries.

FIG T2: Re-Exports and Offshore Trade (International Enterprise Singapore, 2010)

As evident in Fig T2, there was also a decline in almost every industry in terms of Re-exports. Offshore Trade, referring to trade numbers as a result of companies residing overseas which engage in importing from Singapore and re-exporting to other countries, also fell from S$624Billion to S$466 Billion from 2008-2009. (International Enterprise Singapore, 2010)

FIG T3: Overall Trade (International Enterprise Singapore, 2010)

Fig T4( Export + Import Growth Over Previous Year)

The above example

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clearly shows that Singapore is open and vulnerable in terms of trade. In today’s globalized world economy, it is hardly possible for any country not to get affected by external economic shocks, especially ones like the scale of the 2008 sub-prime mortgage crisis. Singapore, especially, would be affected by global economic shifts in demand and consumption.

That being the case, Singapore has to be prepared to ease the impacts of such economic shocks and downturns. In its defence, Singapore’s government and government-related organizations actively seek to aid Small Medium Enterprises (SMES) and trade-related industries in terms of financial assistance and actively promote overseas business operations. At the same time, it is also pro-active in seeking Free Trade Agreements with countries in order to promote trade with less restrictions and risks.

In summation, government and trade policies may as a whole act as a protective measure for Singapore, in the event of a global economy shock. However, being competitive to the highest extent can only serve as easing the threats but not preventing them. This is because in the current global economy, countries like Singapore, practice high interactivity in terms of trade and financial activities(which will be elaborated on in the next section). In this regard, there is no way Singapore would be able to prevent economic downturns from affecting its domestic economy. Looking into the future, for Singapore to sustain its growth, it should look into domestic consumption, in order to further ease fluctuations in global demand and supply. This way, Singapore would not be extensively vulnerable to external shocks. A good example would be to increase its population through promoting immigration or internal population growth.

The Singapore Financial Sector

With a correlation of 0.61 in stock market returns compared to the United States S&P 500 from year 2000 to 2007, it is not difficult to tell that Singapore’s financial sector is very much affected by the United States. This is due to fundamental reasons such as the high financial exposure Singapore has to the United States. As of June 2006, Singapore’s financial exposure to the United States stands at 129.2% of Singapore’s GDP (International Monetary Fund, 2008)

Other than the high financial exposure that Singapore has to the United States leaving Singapore vulnerable to the United States, measures taken by their Federal Reserve (FED) also affects us. This can be seen from the quantitative easing measures taken by the FED from January 2009 to April 2010 and November 2010 to June 2011. During these 2 periods, the Singapore Interbank Offer Rate (SIBOR) as well as the Swap Offer Rate (SOR) fell constantly, reaching negative territories most recently. The cause of the falling SIBOR and SOR is due to the excess liquidity overflowing from United States into Singapore. Both the SIBOR and SOR can be seen in the chart below.

Source: http://smp-consulting.com.sg/smpc/?option=com_content&view=article&id=62

Not only does the excess liquidity cause the falling of the SIBOR and SOR, it also causes asset prices in Singapore to escalate as capital inflow increases. With a lower SIBOR and SOR, domestic investors would be more willing to invest in the various asset classes, thus further

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inflating asset prices. This can be seen by the following charts, which show the increase in both the stock market and property prices in Singapore during the period of quantitative easing.

Source: Urban Redevelopment Authority

Such increases in asset prices is very likely to form an asset bubble and is by no means healthy to the Singapore economy. Should the asset bubble burst, both foreign and domestic investors would pull out of the market, causing asset prices to free fall. Investors who borrowed money would not be able to finance their loan, and as a result default on their mortgages. This would result in banks having a higher number of non-performing loans that would hit their balance sheet. With banks reporting lackluster performances, investors’ confidence is bound to drop further causing yet another round of a fall in asset prices.

Monetary policySince 1981, Singapore's monetary policy has been centered on the management of the Sing Dollar exchange rate. The ultimate target of monetary policy can be defined as price stability or low inflation. The monetary policy instrument used most commonly is the exchange rate. In the context of Singapore's open capital account, the choice of the exchange rate as the focus of monetary policy would imply that domestic interest rates and money supply are endogenous (refer to next section on MAS’ exchange rate policy for Singapore). This is based on the principle underlying the Theorem of the Impossible Trinity, also known as the Open-Economy Trilemma, which states that a country cannot concurrently manage its exchange rate and maintain an open capital market while pursuing a monetary policy (interest rate or money supply) oriented toward domestic goals.Apart from that, MAS money market operations are also aimed at ensuring that there is sufficient liquidity in the banking system to meet banks' demand for reserve and settlement balances. Interest rates volatility may occur overnight as banks attempt to meet reserve requirements or settlement balance requirements by trying to fund account deficiencies or dispose of account surpluses. For example, the banks in Singapore are required to maintain reserve requirement or MCB with MAS equal to 3% of their liabilities base. In addition to the demand for reserve balances, banks would also set aside additional fund as buffer to facilitate settlement of interbank transactions.

MAS also provide many facilities to reduce interest rate volatility. An example would be the End-of-Day Liquidity Facility, which is a late-day refinancing facility, allowing banks to cover their net debit positions that may arise at the end of the day. On a bank's request, MAS may provide lending via overnight sale and repurchase agreements of SGS. Other facilities include Intra-Day Liquidity Facility to ensure adequate liquidity for settlement purposes. This facility allows MAS' appointed Primary Dealers to borrow intra-day funds from MAS via intra-day repos at a rate determined daily by MAS.

Such a refinancing facilities offered has the effect of making the supply curve less steep or more interest rate-sensitive, thereby leading to less interest rate volatility. These MAS functions are carried out with the broader macroeconomic objectives in mind, including sustained medium-term noninflationary economic growth, financial and monetary stability, and development of financial services sector.

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Currency exchange policySince the 1981, the SGD exchange rate has been on an appreciating trend against both the main global currencies and regional Asian currencies. This has curbed both imported and domestic inflation. A basic philosophy underlying this policy is to preserve the purchasing power of the SGD while maintaining confidence in the currency and preserve their value of workers’ savings (e.g. CPF).There are four main features of the exchange rate system in Singapore.

1. The Singapore dollar is managed against a basket of currencies of our major trading partners and competitors. The composition of this basket is periodically revised.

2. The MAS operates a managed float regime for the Singapore dollar, allowing it to fluctuate within an undisclosed policy band.

3. The band is periodically reviewed to ensure it is consistent with the underlying fundamentals of the economy.

4. This policy implies that the domestic interest rate is not under the control of MAS.

Following MAS’ policy of keeping inflation under control, MAS will intervene in the FX market as and when needed, to bring the S$ trade-weighted index (S$ TWI) within an undisclosed policy band. When the S$TWI breaches the policy band on either side, or when there is undue volatility or speculation in the S$, MAS will step in to intervene. Intervention operations may take the form of a purchase of S$ against the US$ to stem the depreciation of the S$, or alternatively a sale of S$ against the US$ to moderate its appreciation. As it affects the economy with some lags, monetary policy has to be pre-emptive and forward-looking, with a medium-term focus on low inflation and sustained economic growth.Given that Singapore is such a small and open economy, the exchange rate is the most effective policy instrument for maintaining domestic price stability. To add on, the government’s avoidance of fiscal deficit (a strong surplus) has allowed MAS to be effective in its course of control.

Fiscal Policy

Source: MAS Macroeconomic Review, Volume X, Issue 1, April 2011

The ‘Domestic Liquidity Indicator (DLI)1 and Fiscal Impulse (FI)2 chart illustrates that the shifts in Singapore’s macroeconomic policy have been fitting with the cyclical developments in the economy.

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The chart above indicates that Singapore’s macroeconomic policy has been expansionary during the economic downturns. It also shows that, in 2010 the output gap turned positive as the economy recovered decisively from the recession to post record growth. Appropriately, in 2010 the macroeconomic policy bearing was contractionary as the temporary fiscal policies (‘Special Risk-sharing’ and ‘Jobs Credit Scheme’ expired in 2010) were withdrawn. The policy setting was progressively restored to that conducive to price stability and sustainable growth in the medium term. (MAS Macroeconomic Review, Volume X, Issue 1, April 2011)

This shows that the policies rolled out have quantifiable effects on our economic performance and that MAS has been managing it well.

MAS-guaranteeAmidst the uncertainty in the global economy, in October 2008, the government took the necessary step in providing guarantee on all non-bank deposits in banks, merchant banks and finance companies licensed by the MAS. Though the guarantee, expired on 31 December 2010, it was still being views as an extraordinary measure that provided the much needed assurance that has saved the banks from failing. (Monetary Authority of Singapore, 2011)

Due to such strong and decisive policies, MAS has proven that it will provide the necessary support in developing Singapore as an international financial centre, and evidently, Singapore’s financial centre has continued to grow in prominence, as the financial services expanded by 12% in 2010. (SingStat, 2011)

Singapore’s fiscal policy has a primary focus at promoting long-term economic growth, rather than cyclical adjustment or distributing income.

BudgetThe long-term objectives of the government budgetary polices are:

● to promote and support sustained, non-inflationary economic growth;● to maintain a balanced budget, i.e. to finance total operating and development

expenditures from operating revenue over the course of the business cycle; and● to focus government expenditure on delivering essential public goods and services, e.g.

education, health care, infrastructure, housing and programmes to protect the environment.

(Inland Revenue Authority of Singapore, 2011)

The objectives of the budgetary policies recognize the market forces that drive the economy and its financial prudence. It also places an emphasis on human and infrastructure investment for the long term good.

The national budget responds both to the immediate and future needs of the country by adapting and shifting its fiscal strategy. This can be seen from the measures put out in the budget of 2008, 2009, 2010 and 2011 respectively.

FY2008, the budget’s focus was on innovation, business competitiveness, growing financial services and developing the maritime hub. While FY2009 budget’s focus was on surviving and helping Singapore through the crisis. It was also the year in which Singapore tapped on her past reserves to fund part of the ‘Resilience Package’. The tides changed and so did the 2010

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budget’s focus. FY2010 Budget marked a shift of a policy focus from crisis-containment to investment; aiming at enhancing productivity over the medium to long term.

ReservesAs of August 2011, Singapore has S$300 billion in her reserves (MAS, Official Foreign Reserves, September 2011, From URL: http://www.mas.gov.sg/data_room/reserves_statistics/Official_Foreign_Reserves.html). Singapore’s deep reserves act like an immediate air bag to cushion Singapore from an economic crash by providing a deep pool of reserve monies to fund any immediate stimulus packages needed for the short-term crisis management as seen in 2008. The government drew S$4.9 billion from her reserves during the 2008 financial crisis, a first time of such a draw in all years of being an independent nation

(NASDAQ, 2011).

It was used to fund two temporary measures, the ‘Jobs Credit’ and a ‘Special Risk-Sharing Initiative’; which has helped Singapore through the financial crisis.The reserves also provide the funds to pay off any overall budget deficit. For example, the overall budget deficit for the financial year of 2010 was $3.0 billion, which was 1.1% of the GDP and it was funded by the reserves. (Popatlal, 2009) Though, the reserves are a source of confidence that Singapore can weather any crisis, it is only the last viable option and the government has to continue to implement fiscal policies that will protect her economic health.

FY2011 Budget

The FY2011 Budget’s focus was to share the fruits of the 2010 growth with Singaporeans, address the rising inflation and to further supplement the longer-term measures that were introduced in previous budgets.

The FY2011 Budget contains both endogenous and exogenous measures but with the bulk being exogenous; which is in lined with the long term objectives of the budgetary policies. (Inland Revenue Authority of Singapore, 2011)

Conclusions

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Source: MAS Macroeconomic Review

Singapore’s trade openness and financial exposure to the US attest that Singapore is in no economic isolation from the rest of the globe. Her economy has undergone several stages of recovery since its rebound from the trough in Q1 2009. In Q1 2011, the domestic economy transited to a more stable stage of recovery.

The increase in economic activity in the first quarter of this year indicates a growth in Singapore’s key export markets. Despite the headwinds from the uncertainty arising from the spike in oil prices, the calamity in Japan and the financial cracking in US and Europe, the MAS Economic Policy Group’s assessment concluded that there is adequate momentum for the

global economy to grow at a moderate pace in 2011 despite these headwinds.(Monetary Authority of Singapore, 2011)

Although infrastructure and strategic location has given Singapore some advantage, what has propelled Singapore onto the international financial services arena and remains as one of her core strength is her ability to create sound far-sighted policies and the ability to execute them seamlessly. It was the relaxation of monetary regulation that brought the Asian Dollar Market onto our shores. Her policies on education, large expenditure and the industry relevance continue to churn skilled efficient workers for the economy.Her stringent monetary regulatory framework ensures the quality in her banking system. Economic development board continues to plan and execute economic strategies to promote Singapore as a business and financial hub.

In a nutshell, Singapore’s pragmatic approach to policy making and implementation, has been and will continue to complement our advantages gained through sound infrastructure and strategic location. Thereby, assuring Singapore’s protection from sudden economic shocks that we have no control over.

References

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