Manu Bhaskaran (CEO of Centennial Asia Advisors) and Linda Lim (Professor Emerita at the Stephen M. Ross School of Business, University of Michigan) argue that Singapore would benefit from a slower pace of reserve accumulation.
Many Singaporeans think that the government can engage in massive, even “generous”, deficit spending to rescue citizens, businesses and the economy from the COVID-19 pandemic and its devastating economic aftermath, because of its past “prudence” in accumulating large foreign reserves that can be tapped in this emergency. If we delve more deeply, however, it becomes clear that the issue is far more complex. 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.
Are large reserves needed to fund a budget deficit in an emergency?
A huge pile of reserves, while helpful, is not the only way for a government to mount a massive response to a crisis such as COVID-19. Indeed, recent experience from the United States, Japan, United Kingdom, Spain and Italy shows that a large budget deficit can be funded by borrowing on global capital markets—even for heavily-indebted advanced economies that routinely fund budget deficits by borrowing.
Wouldn’t such borrowing raise public debt burdens, and so impose a drag on economic growth, making it a superior strategy to build a large savings pool for a “rainy day”, as Singapore favors? But since the 2007-08 Global Financial Crisis and the ensuing Great Recession, and especially now, interest rates (and inflation) have been extremely low, zero or even negative, even for relatively high-risk countries. This situation of ultra-low interest rates is likely to persist, so the downside of relying on debt is not as high as it used to be.
Singapore is respected as a country with excellent credit ratings. This is based on strong fundamentals, such as a track record of consistent economic growth, conservative fiscal management, low inflation, a stable yet flexible exchange rate regime which discourages currency speculation, and sound regulatory systems that have produced a resilient financial system. Large external surpluses add to this creditworthiness, but Singapore does not need excessive reserves to borrow readily and on favorable terms. In any event, given that—unlike in other countries and contrary to international transparency norms—the size of Singapore’s reserves is a state secret, it is difficult for investors to gauge how much they should figure into credit risk assessments. Disclosure of the reserves would remove this uncertainty, making borrowing even easier and cheaper, in addition to other benefits discussed below.
Both reserve accumulation and borrowing involve inter-temporal, inter-generational transfers of financial resources, but their distributive consequences differ. Reserve accumulation is inherently regressive: it transfers resources from poorer earlier generations to today’s or tomorrow’s richer generations when reserves are eventually expended. Borrowing, on the other hand, must be repaid by future generations, who, given an expectation of positive economic growth, will be richer than today’s generation, so better able to afford repaying the debt. Only those with extraordinarily little faith in Singapore’s fundamentals and leadership would project a future of absolute economic decline, making debt repayment an issue more serious than that faced by most of the world’s troubled economies.
Where do reserves come from?
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, as represented in the standard macroeconomic equation:
(S-I) + (T-G) => (X-M) where S>I, T>G and X>M.
Savings (S) exceed Investments (I) when domestic consumption and investment are low. Consumption in Singapore has been low by historical and international standards for some three decades, accounting for around 35 percent of GDP, versus 55-70 percent in other middle- and high-income countries. That means that for every dollar of GDP, Singapore residents get to spend less than 40 cents. The roughly 45 percent wage (labor income) share of GDP is also very low, and the nearly 50 percent share of profits (returns to capital) extremely high, by historical and international standards. Savings have been high (between 35 percent and 50 percent of GDP every year since 1981) because of mandatory CPF contributions, a weak social safety net (necessitating high precautionary savings), demographics (low dependency ratio or number of dependents to working-age population), and high income inequality (since the rich save more of their income than the poor).
The government runs a budget surplus when tax revenues (T) exceed government spending (G), which in Singapore has amounted to above 5 percent and often above 10 percent of GDP nearly every year since 1990, by the Singapore government’s accounting. The different method used by the International Monetary Fund shows a fiscal balance roughly 5 to 7 percentage points higher in 2011-15. This means the government has taken in from the public, including private business, more than it has given out every year, for nearly two generations. 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.
Budget surpluses feed into current account surpluses, the excess of Exports (X) over Imports (M), which in Singapore have averaged well above 10 percent of GDP every year since 1991, and over 20 percent since 2005. Such persistently large external surpluses make us vulnerable to international accusations of “mercantilism” and “currency manipulation” (as were heard from the US last year). In a free market, excess demand for exports would cause the currency to appreciate, making exports more expensive and imports cheaper, until the surpluses are eliminated. 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.
Mathematically, a current account surplus equals a capital account deficit—capital outflows exceeding inflows. 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. This further adds to the large and rapid accumulation of reserves.
Government budget surpluses (public sector savings) mean that Singapore wage-earners, consumers and private businesses have had less to spend on consumption and investment (both of which spur economic growth and create employment) than they otherwise would have. Consumer welfare and living standards have been lower than necessary for three decades. 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.
Where do the surpluses go?
Foreign reserves come from excess public and private sector savings. But why suppress domestic consumption and investment, and government spending, to invest outside the country? Most of this investment, undertaken by Singapore’s two sovereign wealth funds, Temasek and GIC, is held in portfolio assets abroad—stocks, bonds, foreign exchange funds—but some is direct investment in real estate, commodities, private equity and so forth. Both funds insist that their only goal is to maximize financial returns (GIC has more conservative risk requirements), not to make strategic investments that would bolster Singapore’s real (productive) economy. For security and stability, most of their investments are in other rich developed countries, which in the past thirty years have yielded higher portfolio returns than Singapore financial assets, despite lower GDP growth rates and currencies which have depreciated against the Singapore dollar.
Don’t Singaporeans benefit from the investment income generated from these reserves? Yes, the reserves provide a “net investment returns contribution” or NIRC to the budget, accounting in fiscal year 2017 for close to 20 percent of total government expenditure. But the 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. There is no particular rationale for the 50 percent figure, which is simply an arbitrary rule of thumb, while the term “relevant assets” suggests that not all assets are included. Since the value of the “relevant assets” is calculated based on a long-term historical average of a growing pool of savings, the asset value used in calculating the NIRC is probably quite a bit lower than the actual asset value in any one year. Further, since NIRC is computed as an expected real return, there is considerable discretion as to what the expected nominal return and inflation rate are over time, and the government probably, and sensibly, employs conservative assumptions. 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.
How can reserves be used to recover and restructure Singapore’s economy in the post-COVID-19 era?
Even before the current pandemic, Singapore economists have argued for more government expenditure to fund an expanded social safety net. This is eminently affordable for a rich country that spends a lot less on social goods than others at the same income level. For example, Yeoh Lam Keong, former GIC chief economist, estimates that it will take just 0.5 to 1 percent of GDP to eliminate absolute poverty by bringing Singapore’s poor and elderly up to a basic income level. Notably, the latter group especially contributed to the build-up of reserves through their decades of high savings and low consumption. This modest transfer can be achieved by reducing or eliminating budget surpluses (cutting taxes and raising expenditure), and by larger contributions of investment income from reserves, which in the long term will continue to grow. 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.
Linda Lim, among others, has also argued—even before COVID-19—that Singapore cannot continue with its state-directed, multinational-led, export-oriented and input-intensive economic growth model, given changes that have been gathering steam in the world economy, geopolitics, technology, corporate strategy and the environment. COVID-19 will only accelerate and intensify the de-globalization and economic disruption that these trends portend.
For thirty years, Singapore’s economic development strategy has relied heavily on supply-side policies of infrastructure provision, corporate subsidies (“investment incentives”), wage controls or subsidies, education and skills upgrading to attract 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 economic challenge for Singapore then has been to find new sources of demand, made much more urgent with COVID-19 and likely future pandemics which devastate highly globalized sectors. Surpluses and reserves constrain demand—they are policies that in other advanced economies would be characterized as “austerity”. So simply reducing if not eliminating budget surpluses, and shrinking or not increasing voluminous reserves, would remove this contractionary force from the macroeconomy. (In the corporate world, large cash reserves indicate that a company cannot find better investments, so should “return money to shareholders” in the form of increased dividends—here, government spending.)
Lower taxes and forced savings, and higher government spending—for example, on an expanded social safety net—would stimulate domestic demand through higher consumption and 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.
Private entrepreneurship would be encouraged by the lower cost of taxes, rents and other fees and charges paid to government entities, by the expanding domestic market, and by the reduced risk provided by a social safety net. Singapore firms are more likely to have competitive advantages operating in medium-income neighboring countries, than in distant rich foreign markets, particularly given heightened nationalist policies fostered by the COVID-19 experience. Less diversion of domestic savings abroad (smaller build-up if not actual shrinkage of foreign reserves), and more new local private enterprise formation, will even give a lift to Singapore’s increasingly moribund state-dominated stock market, to the benefit of the financial sector and Singaporeans’ retirement savings.
Changes in the management of foreign exchange reserves are critical to all of this.
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. This is currently not possible, because a major part of our resources—the reserves—are secret, in contravention of global transparency norms and the best practices of other advanced countries. In the US, for example, long-term fiscal resources are forecast by the Congressional Budget Office, an independent body reporting to Congress. In Norway, a small rich country with potentially hostile large neighbors, whose sovereign wealth funds are the world leaders in size, performance and governance, such long-term forecasts, including the size and growth of reserves, are public information.
In Singapore’s case, we only know that reserves vastly exceed global norms and what would be needed to fund even long-term unanticipated emergencies in our particular circumstances. This can be seen from the huge share of GDP accounted for by budget and current account surpluses over the past three decades, and the reasonable rates of return they have earned 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.
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.
The bottom line
Post COVID-19, global growth will be permanently lower, and so too will Singapore’s growth, already lackluster before the pandemic. But a higher indigenous share of GDP in both wages and profits, and a stronger social safety net, would at least partly compensate for this, while also strengthening the basis for a more stable, less volatile, less externally-dependent, more equitable and inclusive domestic economy. 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.
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