This write-up gives a summary of the article published on academia.sg. The articles highlights the benefit from of slower rate of reserve accumulation, as detailed by the CEO of Centennial Asia Advisors, Manu Bhaskaran, and Professor Emerita at the Stephen M. Ross School of Business, University of Michigan, Linda Lim.
Government surpluses and foreign reserves in Singapore
According to the authors, the bulk of Singaporeans think that the state can simply conduct “generous” deficit spending to aid households, businesses and the economy during the COVID-19 pandemic because the government has consistently maintained large foreign reserves over the years.
They argue that tapping into the reserves during an emergency is a more complicated issue once delved into more deeply.
“Indeed a strong case can be made that a slower pace of accumulating fiscal surpluses would actually deliver far better outcomes for the Singapore economy,’ the authors remarked.
Are large reserves necessary to fund a budget deficit in an emergency?
A large pile of reserves, although helpful, is not the only method a government has to provide a large response to a crisis such as the current pandemic, they stated. Based on recent country experiences like Italy, Spain, the United Kingdom, Japan and the United States, large borrowing can be done on the global capital markets to fund a large budget deficit. This is the case even for advanced economies with high debt that habitually borrow to fund deficits.
Therefore, the question arises: Is Singapore’s approach of building up large savings pool for a “rainy day” better than borrowing funds? Borrowing can impose a drag on the economy and increase the burden of public debt, they argued.
Even for relatively high-risk nations, the current interest rates and inflation have been very low, zero or negative since the Global Financial Crisis and the Great Recession. Amidst the very-low interest rates which will likely continue, the risks of borrowing are not as high as before.
Singapore is respected due to its excellent credit ratings. The foundation behind this is strong fundamentals, including (1) low inflation, (2) stable yet flexible exchange rate regime which discourage currency speculation, (3) conservative fiscal management, (4) sound regulatory systems which have produced a resilient financial system and (5) a track record of consistent economic growth.
The country’s creditworthiness is bolstered by large external surpluses event though excessive reserves are not required for it to borrow readily on favourable conditions, the authors stated. The size of Singapore’s reserves is also a state secret, so investors cannot really incorporate the figures into their credit risk assessments. This is different to other countries and to international transparency norms. Borrowing can be easier and cheaper, with additional benefits discussed below, if this uncertainty is removed by disclosing the reserves.
There are aspects of inter-temporal and inter-generational transfers of financial resources involved in reserve accumulation and borrowing. However, there are different distributive consequences, they stressed.
“Reserve accumulation is inherently regressive”, the authors stated. Resources are shifted from the earlier, poorer generations to today’s or tomorrow’s richer generations when the reserves are expended.
On the contrary, through borrowing, the future generations must repay the funds. The future generations will be richer than today’s generations if there is an expectation of positive economic growth. Thus, they can better afford to repay the debt, they explained.
Expecting a future outlook for an absolute economic contraction can only come from “those with extraordinarily little faith in Singapore’s fundamentals and leadership”. This will make debt repayment a more serious issue than even the world’s troubled economies.
Origin of reserves
The authors stated regarding reserves: “Reserves are derived from an excess of domestic savings over investment and/or a government budget surplus, yielding a current account (trade in goods and services plus income from foreign investment and remittances etc.) surplus of exports over imports.”
This is represented by the standard macroeconomic equation:
(S-I) + (T-G) => (X-M) where S>I, T>G and X>M.
When domestic consumption and investment are low, Savings (S) exceed Investments (I).
For over three decades, even by international and historical standards, consumption in Singapore has been low. It accounts for about 35 per cent of GDP, compared to 55-75 per cent consumption in other middle-and-high-income economies, the authors noted.
This means that, Singapore residents can spend less than 40 cents per dollar of GDP. By international and historical standards, the almost 50 per cent share of profits (capital returns) is very high whereas the approximately 45 per cent wage (labour income) share of GDP is also extremely low.
There a several reasons for why savings have been high; between 35-50 per cent of GDP per year since 1981, the authors noted. They are (1) mandatory CPF contributions, (2) a weak social safety net (needing high precautionary savings), (3) demographics (low dependency ratio or number of dependents to working-age population), and (4) high income inequality (because the rich save more of their income than the poor).
A budget surplus is when tax revenues (T) exceed government spending (G). Based on the Singapore government’s accounting, budget surplus totalled to move than 5 per cent and frequently above 10 per cent of GDP almost each year since 1990.
According to the different accounting approach by the International Monetary Fund, Singapore’s fiscal balance is about 5-7 percentage points more in 2011-15. This suggests that for nearly two generations, the state has absorbed from the public and private business more than what is has given out each year.
“A public sector surplus always equals a private sector deficit, but the size and longevity of Singapore’s annual budget surpluses would be historically unprecedented worldwide in the post-feudal capitalist era,” the authors clarified.
Budget surpluses also fuel current account surpluses, which is the excess of Exports (X) over Imports (M). Singapore’s average current surpluses have been above 10 per cent of GDP for each year since 1991, and above 20 per cent since 2005.
The country is vulnerable to international accusations of “mercantilism” and “currency manipulation” (such as the accusation by the US in 2019), due to its consistently big external surpluses. In a free market, the currency will appreciate if there is high demand for exports. This leads to exports becoming more costly and imports cheaper, until surpluses are eroded.
The authors pointed out: “Instead, Singapore has avoided excessive currency appreciation by deploying much of its current account surplus abroad, in the form of portfolio investments by its sovereign wealth funds.”
From a mathematical standpoint, capital outflows exceed capital inflows when a current account surplus equals a capital account deficit.
“But in Singapore’s once-again unique case, Singapore’s basic balance—the sum of its current account surplus and long term capital flows—has a chronic extra structural surplus due to capital inflows funding foreign direct investment (FDI), as well as structural portfolio inflows, largely safety and portfolio diversification funds,” they highlighted. Therefore, this fuels a large and rapid increase in reserves.
Singapore wage-earners, consumers and private businesses have had to consume and invest less due to government budget surpluses (public sector savings), than they could otherwise. Both consumption and investment stimulate economic growth and create employment. Thus, for three decades, living standards and consumer welfare have been lower than necessary, the authors stated.
“This is the (opportunity) cost of reserves—what else the money could have been spent on at home if not sent abroad—and the reason why persistent reserve accumulation is considered undesirable by economists, since they can reduce growth,” they added.
Where do the surpluses go?
Excess public and private sector savings form the foreign reserves. The authors asked: “Why suppress domestic consumption and investment, and government spending, to invest outside the country?”
Singapore’ two sovereign wealth funds, Temasek and GIC, conduct most of this investment which is held in portfolio assets abroad. These assets include foreign exchange funds, bonds and stocks. There is also some direct investment in private equity, commodities, real estate among others.
According to both Temasek and GIC, their only goal is to maximize financial returns and not to make strategic investments that would strengthen Singapore’s real (productive) economy. Of the two, GIC has more conservative risk requirements.
For the past 30 years, most of their investments have yielded higher portfolio returns than Singapore financial assets, even during lower GDP growth rate and currencies that are weaker against the Singapore dollar, they noted. Most of these investments are in other rich developed countries, for security and stability reasons.
The next question posed by the authors: “Don’t Singaporeans benefit from the investment income generated from these reserves?” Singaporeans do benefit as the reserves offer a “net investment returns contribution” or NIRC to the budget, they stated. The contribution accounted close to 20 per cent of total government expenditure in fiscal year 2017.
However, the authors stressed that: “NIRC figure given in each budget is not the actual investment income earned each year; rather it is very conservatively defined as up to 50 percent of the long-term expected real returns (including capital gains) of the relevant assets.”
The 50 per cent figure is just an arbitrary rule of thumb with no particular justification. On the other hand, the term “relevant assets” also suggests that not all assets are included.
The asset value used in computing the NIRC is likely quite less than the actual asset value in any one year. This is because, the value of the “relevant assets” is computed based on a long-term historical average of a growing pool of savings.
In addition to this, there is substantial discretion as to the expected nominal return and inflation rate across time and the assumptions by the government are probably and sensibly conservative. This is due to the NIRC being calculated as an expected real return.
“It would not surprise us if the actual flow of investment income each year was more than double the NIRC figure used to compute the budget,” the authors bore in mind.
Utilising reserves to promote the recovery and restructuring of Singapore’s economy in the post-COVID-19 era
Economists in Singapore have argued for more government expenditure to fund a larger social safety net, even prior to the ongoing pandemic. This can be done by a rich country which spends much less on social goods compared to other countries at the same income level, they reasoned.
According to the former Chief Economist of GIC, Yeoh Lam Keong, the estimate of only 0.5-1 per cent of GDP is needed to remove absolute poverty by pushing up the income level of Singapore’s poor and elderly to a basic income level. The decades of low consumption and high savings by the elderly have contributed to the accumulation of reserves.
The authors highlighted ways to achieve this modest transfer, which include (1) reducing or eliminating budget surpluses through higher expenditure and lower taxes and (2) larger investment income contributions from reserves, which will continue growing in the long term.
“Over time, such an inclusive growth strategy will reduce demand on government resources as lower-income cohorts are enabled to become more self-sufficient, lessening the need for use of reserves, and slowing their accumulation,” they explained.
Ms Lim, among others opined that, even prior to COVID-19, Singapore cannot afford to persist with its state-directed, multinational-led, export-oriented and input-intensive economic growth model. This model is being jeopardised by the increasing changes in the environment, world economy, geopolitics, technology and corporate strategy. The de-globalisation and economic disruption will become more pronounced as the pandemic develops.
Singapore’s economic development strategy for thirty years have depended heavily on (1) supply-side policies of infrastructure provision, (2) corporate subsidies or “investment incentives” (3) wages controls or subsidies as well as (4) education and skills upgrading to entice foreign investment.
“Yet in the recent period topline GDP growth has inexorably slowed, the share of indigenous GDP in total GDP has been falling, and there has not been evolution of a self-sustaining indigenous productive capacity, let alone a cadre of domestic multinationals that can lead private sector growth,” the authors pointed out.
Therefore, Singapore’s economic challenge is to find new sources of demand, and this is increasing in urgency due to the COVID-19 pandemic and possible future pandemics that ruin highly globalised industries.
Demand is limited by surpluses and reserves. In other advanced countries, this is known as “austerity”. Thus, simply cutting or increasing large reserves as well as cutting or eliminating budget surpluses, would expel this contractionary momentum from the economy, the authors stated.
From a corporate perspective, big cash reserves signal that a firm is unable to find better investments, and they should ‘return money to shareholders” in the form of higher dividends. In the economic context, it is government spending.
Increased government spending, lower taxes and forced savings on an larger social safety net, would increase domestic demand by increasing consumption as well as investment.
“It would reduce or remove the serious long-term social protection gaps Singapore already has compared with OECD (other rich) countries in healthcare, retirement adequacy and unemployment compensation, among other needs, and would also provide for the long term reinvestment required in public housing,” the authors explained.
As for private entrepreneurship, it could be encouraged by several factors. These are (1) lower cost of taxes, rents, other fees and charges paid to government agencies, (2) enlarging domestic market and (3) reducing risk provided by a social safety net.
Due to the heightened nationalist policies spurred by the pandemic, Singapore companies are in better footing in terms of competitive advantage if they operate in medium-income neighbouring nations, as opposed to distant rich foreign countries.
The country’s increasingly gloomy state-dominated stock market can benefit from the lower diversion of domestic savings abroad (smaller accumulation if not actual decline of foreign reserves) as well as more local private enterprise formation. This in turn will help the financial sector alongside Singaporeans’ retirement savings.
The authors stressed that changes in how foreign exchange reserves are managed are crucial to all of this. They then present three points regarding it below.
“First, to develop a coherent strategy, we need to know how our long-term spending needs (which determine social well-being, competitiveness and productivity) compare to our long-term fiscal resources,” they noted.
Due to the fact that reserve amount is secret, this is not possible at the moment. This in contrast with global transparency norms and the best practices of other advanced economies.
For instance, the Congressional Budget Office forecasts the long-term fiscal resources in the US, a body that is independent but reports to the Congress. In Norway, governance and performance, such long-term forecasts, which include the growth and size of reserves, are public information.
In the case of Singapore, the authors note that reserves greatly exceed global standards and is beyond the amount needed to fund even long-term unanticipated emergencies in the current situation. This is captured by the large GDP share comprised of the budget and current account surpluses for the past three decades, in addition to the reasonable rates of return obtained over that period.
“Second, investment returns from existing reserves could be increased, and made more secure through competition and risk diversification, if they were managed by more than a single secretive institution (GIC). This would further reduce the need for such high savings rates,” they suggested.
“Third, Singaporeans, whose decades of suppressed consumption are the source of government surpluses and reserves, should be more involved in discussions determining how their social savings are invested. This could increase productivity and improve distribution.”
Concluding thoughts
The world after COVID-19 will see slower global growth, including Singapore’s even as it was slowing down before the pandemic struck.
Nevertheless, the domestic economy can be strengthened, be made less volatile and less externally-reliant, more inclusive and equitable through a higher GDP share in wages and profits, alongside a stronger social safety net, the authors note.
“Let us allow this crisis to bring us together in harnessing all our collective financial, social and human resources, to manage what will be a very different—and possibly better—future,” they concluded.
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