SPEX Issue 23

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IN

COLLABORATIONWITH

PROUDLYSUPPORTED BY

ISSUE 23

27 AUGUST 2012

-Japans Lost Decades Continues-Foreign Direct Investment (FDI) in Indian Retail (Part 1 of 2)

-Perils of a Dollarised Cambodian Economy (Part 1 of 2)

The Fortnight In Brief (14th August to 27th August)US

The FOMC has given its clearest indication yet of a strong consensus foraction on its easing policy. Unless the economy turns significantly for the

better, we could possibly expect the Fed to engage in QE3. US trade deficitcontinue to narrow for the third straight month in June to US$42.9 billiondue to higher goods exports and lower goods imports. Consumptionincreased as nominal retail sales bounce back by 0.8%m/m in July.

Asia: A Tale of Faltering Exports and Unsustainable Household Debts

in East AsiaJapan posted a trade deficit of $6.5bn for the month of July due to fallingexports to the EU, a strengthening yen, and large imports of foreign oilneeded to power the country. In Korea, unsustainable household debtlevels have resulted in anemic consumer growth of 1.4% in the first 6

months of 2012. The need to boost growth and reduce high levels ofhousehold debt makes monetary policy decisions especially tricky for theBank of Korea.

EU

France's Constitutional Court paved the way for the acceptance of the fiscalcompact treaty as it ruled that the treaty did not require a change to theconstitution. Latest GDP figures also revealed no surprises the growinggap between the core and periphery nations. German GDP rose 0.3% q/q,France GDP stagnated, while Greece and Portugal contracted 6.2% and1.2% respectively. Due to the weak euro, the EZ recorded its highest tradesurplus of14.9 billion in June. Meanwhile, France's central bank forecastsGDP growth of 0.1% q/q in Q3 and Q4, implying that France wouldofficially join Italy and Spain in recession.

SMU Political-Economic

Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION

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Copyright 2012 SMU Economics Intelligence Club

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Japans Lost Decades ContinuesBy Adam Tan, Singapore Management University

21 years has gone by since Japans asset price bubble first burst in 1991 due to a period ofrapid monetary expansion fuelling unsustainable inflated real estate and stock prices. Theterm lost decade1 was subsequently coined by renowned economists as the aftereffects of

this crisis continue to plague one of the greatest post-industrial economies. With paltrygrowth rate that followed for the past twenty years and the rise of China surpassing Japan asthe worlds second-largest economy, lets examine what near term challenges lie ahead for theland of the rising sun that can prolong this debacle.

Mounting External Challenges

Innovation and cutting-edge technology used to be one of the main drivers of Japans export-oriented economy that allowed companies such as Sony, Toyota and Toshiba to dominatetheir respective industries during the late 20th century. The tide has since turned against theseJapanese conglomerates as the emergence of competitors such as Apple, Samsung and

Volkswagen threatened their position as global market leaders. The dreadful situation isfurther exacerbated by the eroding competitiveness of Japanese exports due to the strength ofthe Japanese Yen () after 2007. The Japanese Yen, being the only free float G10 currencyfrom Asia, is seen as risk-off2 assets at the macro level. The Yen usually strengthens due toglobal demand following uncertainty in the macro growth environment, as observed after theGreat Financial Crisis of 2008 in Figure 1 below.

Figure 1: USDJPY exchange rate from 1998 to 2012

Source: IMF

Earthquakes off the Pacific coast of Tohoku in 2011 resulting in the closure of all nuclearpower plants in Japan add insult to injury at a time when the cost of importing energy is high.This increases production costs for many of these Japanese conglomerates and losses mountas production orders are delayed. However, every cloud has a silver lining; innovativesolutions to these external threats have been put in place by some of these Japanese giantssuch as moving their production facilities to lower cost emerging economies and hedging

against volatile currency movements through currency forwards or options. However, this

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does not solve the underlying issue of surrendering decades of market leadership to emergingcompetitors. Japanese conglomerates need to dig deeper and find new ways to re-establishthemselves ahead of the pack before the gap becomes too big to fill.

Brewing Domestic IssuesAn aging workforce seems to be one of the mega trends that Japan has yet to find a solution toand it poses a serious problem in the near term. Looking at Figure 2 below, pension costs havebeen increasing consistently over the past decade to as high as 15% of national income. Inaddition, the ratio of retirees (over 65 years old) to the current workforce (between 15 to 64years old) seems to be on a worrying uptrend.

Figure 2: Japanese National Income Spending for Pension and Population Ratio

StatisticsSource: Japan Ministry of Health, Labour and Welfare

This is just the start of the cycle of Baby Boomers3 retirements with the first batch retiring in2011, and an estimated 7 million more in 2012. The time bomb for health care is set for 2017,when the Baby Boomers enter their seventies. This will soon put unbearable pressure on thefiscal foundations of the welfare system that was instituted at a period when demographicswere completely different. The near term solution by the Japanese government to boost salestax4from 5% now to 8% in 2014 and 10% in 2015 to rein in Japans huge public debt andrising welfare costs was only made possible through promising early elections by the rulingDemocratic Party of Japan (DPJ). The short term solution was politically costly for the ruling

coalition with 50 lawmakers leaving DPJ in protest. This leads to increasing politicalinstability, and comes as no surprise to many political analysts. After all, Japan remains theonly country that is notorious for having 5 different Prime Ministers over the past 5 years.

What Lies Ahead for Japan

The challenges highlighted above have been echoed by professionals and renownedeconomists such as Paul Krugman over the past years. Structural reforms to tackle thesepressing issues through a top down approach in both the public and private sectors willdetermine how the current and next decade will pan out. A stable ruling coalition that mayemerge after early elections coupled with inflation targeting monetary policies in the near

term could inject much needed confidence and stability. Only a stable, business-friendly

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environment can help the muted Japanese corporations re-evaluate their faltering strategiesand regain the pole position through what they are best known for - Innovation.

Sources: Bloomberg, Forbes, Reuters, the Wall Street Journal

1Lost Decade: The Lost Decade is the term coined to describe the period from 1991-2001, in which

the Japanese economy grew very slowly despite extremely low interest rates

2 Risk-off: A general term to describe a bearish period when investors in aggregate feel pessimistic about

the global economy and do not want to take risks

3 Baby Boomers: A person who was born during the demographic Post-World War II baby boombetween the years 1946 and 1964

4 Sales Tax: A tax paid by the consumer for goods and services that contributes to the overall tax

revenue of the government

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Foreign Direct Investment (FDI) In Indian Retail

(Part 1 of 2)By Rounak Agarwal and Tejas Kumar Ahir, Entrepreneurship Development

Institute of India

Part 1 of this article gives readers an introduction to the Indian retail scene and

analyses the pros and cons of introducing FDI into this sunrise industry. Part 2 willgive readers a deeper look into policies and changes put in place to regulate and

encourage FDI in Indias retail industry.

Opening the gates for FDI in Indian retail raises the expectations of generating

immense employment opportunity in organised retailright from procuring the goods

to marketing. But the possibility of hitting the domestic sectors by the above measure

may compel the government to watch their steps before unlocking gates.

In India, the retail industry marks its presence in both the organised and unorganisedsectors. Organised retailing involves trading activities undertaken by licensed retailers whopay sales tax, income tax, value-added tax, etc. The unorganised sector includes retailers likethe kirana shops (traditional family-owned stores), corner grocery stores, and small shops onthe small and big roads or at the complexes of residential areas. Currently the organised retailconstitutes only a small share, while the kirana shops hold almost 95 per cent of retail trade.Retail turnover in India is estimated at Rs.4000 billion, accounting for 10 per cent of IndiasGDP. Interestingly, although with very few players in the organisedretail sector, the sector isstill expected to grow five per cent per annum. In total, there are approximately 12 millionorganised and unorganisedretail outlets in India.

Currently in Indian national laws, FDI is not permitted in multi-brand retail outlets, but

allowed in 100 per cent foreign-owned investment in wholesale cash- and-carry operations,and 51 per cent in single-brand retailing. Recently, the Indian retail sector has been identifiedas the sunrise sector by economists and retailers alike, and India has been identified by USmanagement consulting firm A T Kearney, in its 2012 Global Retail Development Index, as thefifth most attractive retail investment destination in the world. The government is alsogradually allowing FDI in the retail sector, as per Indias international agreements.

Much investment opportunities have arisen in India port-liberalisation in the retail-industry.On the political front, there has been constant opposition in India from various politicalparties towards FDI in retail. This could be mainly attributed to myopic reasoning on thegrounds of profit sharing interests. On the other hand, there has been a constant push from

international retail agencies world-wide to invest in India.

The following points, gathered by the writers of this article, highlight the advantages anddisadvantages of FDI in retail for India:

Advantages:

1. Development of efficient supply chain management skills.2. Eradicating the role played by the middlemen and the extra cost they impose on

businesses.3. Benchmarking of local product to international products, ensuring higher quality.

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4. Increase competition between domestic and international companies, therebyimproving efficiencies and competitiveness of the economy.

5. Transfer of technology, so as to increase the efficiency or labour.6. Increase in employment.7. Availability of variety of products.

Disadvantages:

1. Higher handling & storing costs at the multinational chains may pass on to higherprices for consumers. As shown in the graph below, Indias inflation rate is at a 5-yearlow period and risking this could upset the countrys economic growth prospects.

2. If foreign retailers captures 20% of the Indian retail market, displacement of existingsmall retailers will occur, creating a situation of joblessness for them around 8million jobs could be lost.

3. Unfair trade practices may result if regulations are not made proper.4. Due to an influx of FDI, real estate prices may spike, rendering it difficult for private

entrepreneurs to break into retail market.

Thus, in order to foster a FDI-friendly Indian retail sector, the government should have anunbiased view towards organised and unorganised retailers and seek to foster and regulatethem as a whole. As India is a vast country with a huge population, there stands a noticeabledifference in terms of the regulation and efficiency between organised retail market andunorganised retail market. With such a huge market and economic potential, the governmentshould recognise that FDI in retail can be a winning situation for all, and possibly usher in anew period of economic prosperity for the millions of retailers in India.

Sources: Tradingeconomics.com, A T Kearney and Indian Express

Foreign Direct Investment: Investment made by a foreign entity into a local company in order to enablesome control over the company to realise improvements in the company in order to generate greater

economic returns.

Sunrise Industry: An industry that is expected to see a high rate of growth and has a growing body of

start-up companies.

Wholesale cash-and-carry: A form of wholesale operations that involves customers (usually retailers

and professional companies) visiting the premises of the wholesaler and purchasing products using cash

and arranging for their own delivery of their purchased products.

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Perils of a Dollarised Cambodian Economy (Part 1 of

2):The vulnerable and precarious position of the poor in

CambodiaBy Eugene Lim, Singapore Management University

Part 1 of this article shall look at an introduction to the Cambodian economy, the

growing trend of using United States Dollars (USD) in its everyday transactions as well

as what is driving this trend.

Cambodia Real GDP Growth Rate (%)

Source: Indexmundi.com

As seen in the graph above, between 2003 and 2007, the Cambodian economy has beengrowing at an average rate of around 10 percent on the back of political and macroeconomicstability. Runaway inflation has been contained to an acceptable average of 3.5% over thesame period, although showing signs of rising levels in recent times. As Cambodia opens up itsdoors to foreign investors and trade, its economy is also increasingly dollarised. Ironically, asmuch as the dollarisation of the economy provides a stable anchor to other parts of theeconomy, it can adversely affect the poor and vulnerable. In terms of reduction in poverty,Cambodias poverty level fell from 47 percent in 1994 to 30 percent of GDP in 2007 (Menon,2008). Nonetheless, one third of the four million Cambodians remain stricken with poverty(the poor is defined as people who have an income of less than US$1.25 (2005 prices) a day

and are vulnerable due to exposure to high risks and lacks the ability to cope with them).

The Dollarisation of Cambodian Economy

The origin of dollarisation in Cambodia can be attributed to many historical events, namelythe destruction of economic and financial institutions after the 1970s and the large US$1.7billion inflow during the United Nations Transitional Authority in Cambodia (UNTAC) in the1990s (Menon, 2008). To further develop its economy and not be too reliant on foreigncurrency risk, a partially dollarised economy such as Cambodias should rely more on its owncurrency (the Cambodian riel) as it grows. However, this isnt happening in fact, the

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opposite is. This phenomenon is due to two factors: an increasingly open Cambodian economyand an urban economy that is growing faster than the rural economy.

As the economy and society develop, Cambodia is becoming increasingly integrated into theglobal economy. Attracted by the economic prospects and potentially high rates of return,large amounts of inflow of foreign investment and currency (predominantly USD) has foundits way into Cambodia,. In essence, the dollarisation occurs because of the absolute increase inthe amount of USD, termed as volume effects. This means that the USD did not substitute theriel but is preferred in the transactional flows. This preference can be due to convenience orperceived lower risk. In essence, the USD is seen superior to the riel in terms of purchasingpower and investment potential.

With its accession into the World Trade Organization (WTO) in 2004, Cambodias tradeboomed. Exports share rose from 30 per cent in 1998 to 70 per cent in 2008 and total trade

flow amounted to 122 per cent of Gross Domestic Product (GDP) (Hill & Menon, 2011). UsingUSD for trade accounts hence became more rampant because of the dollars ease ofexchangeability.

Also, after UNTAC, increasing numbers of non-governmental organizations (NGO) andinternational aid organizations poured large amounts of aid denominated in USD intoCambodia to help in the reconstruction efforts of the country which are to be spent on variousprojects directly. In addition, most of these organizations also pay both foreign and local staffin USD.

The Cambodian economy can be best described as one with two different path projections:one is an urban economy that predominantly uses the USD and the other is the agrarian ruraleconomy that utilizes the riel. The former flourishes under the thriving garments and tourismsectors, as well as foreign direct investment and international aid. In the cities, the USD isused as the main medium of exchange, store of wealth and the unit of account in bookkeepingand trade. More than 90 percent of banking deposits in Cambodia are in foreign currencies,mainly USD (Economist Intelligence Unit, 2008). Unsurprisingly, due to the strength andstability of the USD, Cambodians high growth figures can be attributed mainly to the urbaneconomy. On the other hand, the rural population (which contains of the majority of the poor)is largely agrarian and does not witness growth as rapid as the urban economy. With the mainmedium of transaction in the rural areas being the riel, the rural economy remains relativelystagnant and the ratio of USD to riel widens.

Effects of Dollarisation that Threaten the Poor

Due to the stability and strength of the USD, this has conferred onto the urban population anoverwhelming advantage, enabling them to accumulate wealth. The rural population thatconsists of over 90 percent of Cambodias poor, undoubtedly, is being marginalized and leftout of economic growth. As such, there can be three repercussions of dollarisation that affectsthe poor: the loss of autonomy to conduct monetary/exchange rate policy vis--visdollarisation, the lack of development of financial, banking and monetary systems and theunavailability of microfinance.

Firstly, as a result of a highly dollarised economy, the central bank, the National Bank ofCambodia (NBC) has very limited monetary instruments to intervene and fine-tune theeconomy. The steering of the economy via monetary policies is effectively surrendered to

external players, i.e. the U.S. Federal Reserve that is in charge of U.S. monetary policy. Since

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the predominant currency used in the economy is USD, the NBCs control over money supplyis weak because it can only vary the amount of riel, which accounts of a small part of themonetary base in the country. This places the authorities under an extremely untenableposition with limited capabilities to manage the economy and shield its people from financialrisks.

Secondly, as exogenous factors steer the monetary aspect of the Cambodian economy, there isa lack of emphasis in developing the financial sector in the country. The entire financialinfrastructure was obliterated during the Khmer Rogue regime and attempts to rebuild ahome-grown financial sector have been undermined by the dollarisation of the economy. Therole of banking has since been taken up by foreign-owned financial institutions that areconcerned with the commercial transactions carried out in USD, and not with riel-based loansfor long term constructive purposes. Rampant corruption and weak rule of law in Cambodiafurther discourages the development of this sector that requires transparency andenforceability of contracts. Without a developed financial infrastructure with long-termdomestic interests protected, the poor are deprived of adequate shelter to protect them fromexogenous economic shocks.

Thirdly, loans in the form of microfinance that have proven to be relatively successful inalleviating poverty levels in many countries (i.e. Grameen Bank in Bangladesh), are relativelyunavailable to the Cambodia poor. Microfinance loans are relatively small amounts of creditgiven to the poor (at low interest rates) to generate self-employment and income. These loansalso help the poor in consumption smoothing, asset building, investment in human capitalthrough education and also tackle health/welfare problems (Latifee, 2003). In Cambodia, thissector of microfinance has not been sufficiently developed to serve the needs of the poor. Thedollarisation of the economy has caused a physical lack of riel. The NBC is not willing to putmore riel in circulation due to fears of rapid depreciation vis--vis the USD. To make mattersworse, commercial banks (mainly based in the urban areas) mostly have their deposits indollars and not riel. Since riel is the predominant currency used in the rural economy, themicrofinance institutions (MFI) are chronically deprived of riel and this inhibits them fromlending to the poor. Paul Luchtenburg, chief executive officer of Angkor Microfinance, amicrofinance institution in Cambodia claimed in the light of increasing demand, the industryneeded around 120 billion riel in 2011, which is much more than the amount available in themarket (Postlewaite, 2010).

In conclusion, the travails facing the Cambodian economy is not a lack of growthopportunities, but a lack of long-term planning and execution of economic development plansthat enable equitable growth across its population, and a gradual phasing out of reliance onthe USD in favour of a more stable and well managed riel.

Sources: Economist Intelligence Unit, World Bank, indexmundi.com, aforementioned

quoted papers.

Dollarisation: A situation where citizens of a country increasingly rely on the United States dollar (USD)

as legal tender for conducting transactions and not its local currency.

Exogenous economic shocks: Economic events that happen outside the country but also have effects

(adverse or beneficial) on the country itself.

Microfinance: The provision of loans (often in a small amount) to people living in poverty and who

dont usually qualify for standard bank loans.

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The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in

the United States. It has been widely regarded as a gauge for the large cap US equities market

The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market countryindices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand.

The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization

companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy,Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents

Ben Lim (Vice President, Publication)[email protected] Management UniversitySingapore

Herman Cheong (Vice President, Operations)[email protected] Management UniversitySingapore

Tan Jia Ming (Publications Director)[email protected] Management UniversitySingapore

Fariha Imran (Marketing Director)[email protected] Management UniversitySingapore

Vera Soh (Liaison Officer)[email protected]

Singapore Management UniversitySingapore

Randy Lai (Editor)[email protected]

Singapore Management UniversitySingapore

Seumas Yeo (Editor)[email protected] Management UniversitySingapore

Adam [email protected] Management UniversitySingapore

Eugene [email protected] Management UniversitySingapore

Tejas Kumar Ahir

[email protected] Development Institute of IndiaAhmedabad, India

Rounak [email protected] Development Institute of IndiaAhmedabad, India

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