Budget 2016: Greater dependence on the reserves

By Chris Kuan

One of the things that jumped out in Budget 2016 was the huge increase in the projected Net Investment Return Contribution (NIRC) to $14.7b from the final figure of $9.9b for previous year, itself a large upward revision from the initial estimate of $8.9b. The NIRC is the amount of expected long-term real returns on financial assets managed in the main by GIC, Monetary Authority of Singapore (MAS) and Temasek Holdings which the government is permitted by the Constitution to spend, subject to a maximum of 50% of said returns.

For 2016, the $14.7b projected NIRC kept the overall budget in surplus by $3.45b (excluding land sales revenues and the remaining 50% of the NIRC). That means without such a large input from the NIRC, the government would be running a budget deficit of $11.255b or 2.6% of projected 2016 GDP. The table below shows the overall budget surplus or deficit position, the amount of NIRC and the budget position without the NIRC since 2011.

This clearly shows that the government in recent years is heavily dependent on the returns from the reserves to plug the spending gap in the budget. Recent increases in social expenditures has made the spending gap larger, requiring ever more NIRC.

But what explains the huge jump in the 2016 estimate of $14.7b, a 48% jump from 2015’s final NIRC of $9.9b? Did the reserves increased by 48% or did the expected long term rate of return by which the NIRC is calculated been revised upwards by 48% from 4% to 5.9%? The answer would be No; the reserves could not possibly increase by 48% in a single year neither could the expected long term real rate of return jump by that much in a single year even if inflation has declined. The reason is that the NIRC framework of spending 50% of the expected long term real rate of return on assets has now been applied to Temasek (formerly its contribution was its declared dividend which is significantly lower than the expected real returns). The interesting thing to note is that this change was supposed to be implemented in 2017, not 2016. This begs the question as to whether this change is now brought forward to plug an increasing gap in the government finances.

Overall, the increase use of the returns from the reserves points to the following

• There is substantial room for increased social expenditures because the NIRC is subject to a cap of 50%. Removing the cap does not prevent the reserves from increasing because of land sales revenues and land can be recycled due to 99 year lease.
• Some Ministers and PAP MPs have warned that increased social expenditures will require tax increases for the general population. Budget 2016 showed this to be a false premise, not withstanding the marginal tax increase in 2015 for the rich which is fair given the large income inequality.
• In the Budget 2015 debate, some PAP MPs voiced their concerns about the spending gap and the application of the long term real rate of return spending framework on Temasek. These concerns are misplaced and may be due to the MPs’ insufficient understanding of government finances. As shown in the above table, the NIRC has increased year on year even before the framework application to Temasek and despite global investment returns remaining depressed. Moreover, most social expenditures are in the form of budgetary transfers into funds and endowments such the Pioneer Generation Fund, in which large expenditures are expensed in a single year but monies are disbursed over considerably long period of time. There are no year on year recurring budgetary transfers on the same scale or even at all, e.g. there has been no additional transfers to the PG Fund.

That the government has made increased use of the reserves should be lauded since the reserves were derived from selling public housing at elevated prices to citizens and from excess returns earned on CPF savings.

However this is tempered by the fact that social expenditures are still too low, defence spending continues to exceed healthcare spending, the government continues to aim for a surplus in the overall budget (excluding land sales and unspent returns) and it continues to be beholden to chasing ever decreasing global investment returns by not following the example of Norway having the flexibility to use up to 100% of long-term real returns.