Wednesday 15 August 2012

Boosting growth momentum a priority

By Aaron Low, The Straits Times, 14 Aug 2012

AGE catches up with everyone; muscles once taut soften with time and bones become brittle.

Singapore at 47 is young compared to other nations. But if the performance of the economy this year is anything to go by, Singapore is facing middle-age strain.

The economy is expected to grow by between 1.5 per cent and 2.5 per cent this year, not unexpected given the slowdown in the global economy as a whole.

What disturbs some economists is that while growth has slowed, prices have continued to rise steadily, at a pace much faster than historic inflation rates.

The consumer price index (CPI) rose by 5.1 per cent in the first half of the year. That's down from 5.5 per cent in the second half of last year but is more than twice the historic inflation rate of around 2 per cent.

This lethal combination of slow growth and high inflation prompted DBS economist Irvin Seah to describe the current economic situation as one of "stagflation" in a report that raised eyebrows.

Up to the 1970s, stagflation was not considered possible because economic theorists said that inflation could not exist alongside high unemployment and low growth. If people were unemployed, they would not have the means to push prices up faster, the school of economists belonging to John Maynard Keynes reasoned.

But they were proven wrong.

In the 1970s, the United States experienced inflation rates of above 10 per cent while unemployment soared to 8 per cent, a phenomenon British politician Iain Macleod termed "stagflation".

Economists blamed the oil shock, in which the oil exporters cut back on supply, which made oil prices shoot through the roof. This simultaneously raised prices while sending the economy into a recession.

Singapore, Mr Seah argues, is facing a similar stagflation threat this year, with growth slowing even as inflation remains elevated.

What's more, it does not seem to be such a rare event any longer.

Over the past 30 years, growth dipped below inflation only a few times. The first was in the 1980s, when Singapore went into a severe recession; the second was during the Asian financial crisis; and the third was during the 2001 bust recession.

But since the 2008 financial crisis, Singapore has seen growth fall below inflation four out of the past five years - in 2008, 2009, last year and this year.

"In contrast to past years, Singapore will be home to the weakest growth and one of the highest inflation rates in South-east Asia," Mr Seah says.

"Singapore is struggling with stagflation."

But is this stagflation-like scenario a symptom of a mature economy running beyond its potential, or is it a result of circumstance?

To be fair, Mr Seah's piece probably overstated the idea of stagflation in Singapore.

Yes, 5 per cent inflation is high by Singapore's extraordinarily stable CPI record over the years.

But it is by no means considered "runaway inflation" and is far from reaching close to double-digit rates.

At the same time, the current high rate of inflation is slightly more peculiar than normal.

The central bank has said that more than 60 per cent of headline inflation is due to the cost of cars and housing rents, items that do not significantly affect a large proportion of the population.

Of these, the rise in car prices is largely due to the administration of certificates of entitlement (COE), which is directly controlled by the Government.

The Government has made it a policy priority to reduce the number of cars on the road by cutting back on the number of COEs. This has in turn led to a sharp rise in car prices.

In other words, a large part of inflation is not due to an external shock, but due to a deliberate policy to minimise road congestion.

Conversely, elevated inflation can also be explained by the tight labour market and the tight foreign worker policy, which are keeping wages and costs high.

Another inflationary worry is rising food prices, given the droughts in the US, which has led to corn and wheat prices increasing to record levels.

However, as HSBC economist Frederic Neumann argues, food inflation is unlikely to result in another broad-based rise in inflation the way it did in 2008.

This is because oil prices have started to moderate. The price of rice, an alternative to wheat which is the staple for most of Asia, has remained stable.

Thus, it could be argued that inflation is not the key issue in the current economic climate.

What is of greater and more pressing concern is the sharp drop in growth momentum in the Singapore economy.

The economy shrank by 0.7 per cent in the second quarter, compared with the first three months of the year. This was a sharp reversal from the 9.5 per cent quarter-on-quarter expansion seen in the first quarter.

At the same time, forward looking indicators such as the purchasing manager's index, which measures the sentiment of manufacturing firms, as well as the Trade and Industry Ministry's own composite leading index are all pointing south.

Externally, it has also been one piece of bad news after another, with the latest Chinese trade growing just 1 per cent in July, far below market expectations.

All this means that the tide is finally turning and tipping the balance towards growth concerns rather than inflationary worries.

This is also consistent with the fact that core inflation, which excludes accommodation and private car transport, is likely to fall to 2 per cent towards the year end, said the Monetary Authority of Singapore (MAS).

This is slightly above the historical core inflation rate, which MAS uses as a gauge of underlying cost pressures, of 1.7 per cent.

Some analysts are already calling for the MAS to ease monetary policy when it next meets in October to set the country's exchange rate policy.

Bank of America Merrill Lynch economist Chua Hak Bin said that he expects the MAS to slow the pace at which the Singdollar appreciates to help exporters cope with the weaker demand.

Citigroup economist Kit Wei Zheng notes that while the MAS has been insisting that its April policy decision, which was to tighten policy, remains relevant, he believes the growth trajectory has changed for the worse.

Easing monetary policy will help exporters cope with the downturn in demand and hopefully make their exports more competitive with a weaker Singdollar.

There is also a case to be made for the Government to use fiscal policy to help stimulate the economy in order to stave off further contractions in an already weakening economy.

There may be no need to implement off-Budget measures, like the Government did in 2001, since the economy is not in recession.

But next year's Budget, due in February, might be a good time for the Government to give a boost to support businesses in these uncertain times. They can position themselves and train their staff in preparation for the next upswing in global growth.

Singapore's mature economy may not be able to return to its former days of achieving rapid expansion of 7 per cent or 8 per cent annual growth.

But give it the right boost and a dose of monetary medicine and the economy still has legs to carry Singapore through the difficult period ahead.

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