Date: 12 Feb 1999

Economic Management in Singapore Scenarios, Strategies & Tactics

1   Introduction

1.1   In one and a half years, the Asian financial crisis has totally altered the economic landscape. The currencies of the East Asian countries depreciated, their financial and corporate sectors weakened, and their dynamic economies plunged into recession. The Asian miracle suddenly seemed to have been a mirage.

1.2   Recent months have seen signs that the region is stabilising, and perhaps even beginning to recover. Stock markets have rallied, buoyed by optimism over continued strong US growth and easier liquidity conditions. Exchange rates have stabilised. Interest rates have fallen to pre-crisis levels in several countries, including Thailand, Hong Kong and Korea. This has reduced the burden on heavily indebted corporations, and improved prospects for recovery.

1.3   While the omens are encouraging, it is still too early to conclude that Asian economies are firmly on the mend. Major uncertainties lie ahead, and markets remain nervous.

1.4   Compared to others, Singapore has not done badly, but neither has it come through unscathed. Analysts' forecasts for Singapore's growth in 1999 vary widely between -3% and +3%. The Government's own forecast is for growth to be between -1% and +1%. But this does not really mean that we are confident that growth will be close to 0%. It could well be better if there are no further mishaps, but it could also be worse if something does go wrong.

1.5   We are in a period of discontinuity. The future cannot be extrapolated from past trends. The Asian financial crisis was inconceivable two years ago, and yet it happened. Conventional economic forecasting is inadequate, because non-economic factors are critical to the outcome. Econometric models cannot quantify the herd psychology of investors, nor predict social and political upheavals. We need to stretch our minds and look beyond the conventional view, if we are not to be caught by surprise.

2   Scenarios - Coping with Uncertainty

2.1   How might Singapore manage in this highly uncertain environment? One technique for coping with the uncertainty is scenario-planning. Instead of trying to predict what will happen, we sketch different scenarios describing what may possibly happen. The aim is to identify the driving forces and critical uncertainties on which the outcome depends, and make sure that our policy responses are robust across different scenarios.

2.2   Tonight, I will sketch three scenarios of how the future may play out. I will then discuss the challenges that each scenario poses to us, and how we might set our economic policies to respond to them. I have called these scenarios Global Recession, Diverse Asia, and Recovering Asia. I emphasise that these are not predictions, nor am I attaching probabilities to the scenarios. Nevertheless, thinking through the scenarios will deepen our understanding of events, and help us to prepare for the future.

Global Recession

2.3   My first scenario is "Global Recession". This is the proverbial worst case - not likely, but a valuable thinking exercise. In this scenario, the US economy slides into a recession in 1999. In Asia, Japan's efforts to restructure and stimulate its economy fail. China's pump priming sharply increases bad debts in the banking system, which sets back pressing economic reforms. This triggers a severe loss of investor confidence across Asia. Rising unemployment in the US leads to protectionist measures. The international trading system seizes up.

2.4   For lack of decisive action by key global players, a renewed round of contagion engulfs financial markets around the world. The IMF can do little. It has lost the wherewithal and credibility to stem a further loss of confidence. Capital markets stagnate and bank credit tightens. Investment flows to Asia dry up. Asia enters a severe slump, which lasts until 2003. Amidst economic adversity, social and political problems mount.

Diverse Asia

2.5   My second scenario may be called "Diverse Asia". Here the external environment remains benign. The US and Europe continue to grow, but there is a vacuum in global leadership. The US is distracted by domestic political wrangling, while Europe is preoccupied with its own economic integration and Eastern Europe. In Asia, Japan remains paralysed, but China maintains steady growth, progressively removing the dead-weight from its banks and state-owned enterprises.

2.6   Restructuring imposes great stress on Asian countries. As unemployment rises and poverty spreads, demonstrators and rioters take to the streets demanding change. Social, ethnic and religious strains intensify, especially in less cohesive societies. Law and order breaks down. Beleaguered countries externalise their problems, picking quarrels with neighbours to distract their populations. Problems of illegal immigrants and piracy exacerbate cross-border tensions.

2.7   Individual Asian countries take different approaches to recovery and national survival. Some reject global markets, but others stay plugged into the global grid. In the former, the political contest drives leaders to express anti-West sentiments. They reject free trade and globalisation, and push for an Asian trading bloc. They succeed in sheltering their economies for a time, but this only drags out their restructuring and debt resolution process.

2.8   Other countries stay the course of reforms and achieve a more sustained recovery. But they are retarded by the uncertain regional climate, which dampens capital inflows and new investments. Also investors are now more discriminating, having learnt from the last crisis. They assess country risks carefully, judging each country on its political stability, economic policies, and likely long term returns.

Recovering Asia

2.9   By contrast, my third scenario, "Recovering Asia" is a positive one, describing a resumption of steady Asian growth. No external shocks hamper recovery. The US continues in the charmed state of a Goldilocks economy - low inflation and interest rates, high productivity and growth. The Euro is a success. Reinvigorated European companies actively seek new opportunities around the world. The two Asian giants, Japan and China, provide a boost to the region. Japan makes significant headway in restructuring. China makes credible progress in reforming its banking system and state-owned enterprises, and maintains high growth.

2.10   Most countries in crisis Asia navigate through delicate political transitions without mishap. Pragmatic new leaders emerge, enjoying popular support, and pursuing market-oriented pro-growth policies. As restructuring programmes begin to succeed, investor interest and confidence return. Japanese investments, and exports to a growing Japan, give the whole region a boost. This virtuous cycle stabilises social and political conditions.

2.11   The fundamentals which under-pinned the last Asian boom - high savings rates, well-educated, hard working people, entrepreneurship, development oriented governments - lay the basis for another sustained period of growth. But competition is now fiercer. Most countries have improved their business environment and economic policies. Not all are fully transparent or free-market oriented, but overall they are much stronger than before.

3   Critical Uncertainties

3.1   These three scenarios - Global Recession, Diverse Asia and Recovering Asia - span the range of plausible outcomes for this crisis. The actual denouement will depend on several critical uncertainties. I will highlight four.

The US

3.2   The US is the linchpin of the world economy, the world's buyer of last resort. Neither Europe nor Japan is in a position to play this role. How the US economy performs will determine whether the world avoids a major recession. Continued US growth will sustain global demand and facilitate an export-led recovery of the crisis economies. Recent economic numbers suggest that the US economy remains remarkably robust, and has the momentum to continue powering ahead for this year. The question is what might derail US growth.

3.3   One possible trigger is the bursting of the US asset bubble. When the Dow Jones index was 6,400 in December 1996, Alan Greenspan said that the US stock market was exhibiting "irrational exuberance". Today the Dow is above 9,300. Individual Americans have invested heavily in the stock market. 76% of Americans' retirement funds are invested in stocks. Since stocks have risen spectacularly, Americans are feeling richer and spending more. This high consumer spending underpins strong US growth. But it is also America's Achilles heel, as the household savings rate has become negative and the current account deficit has widened sharply.

3.4   If something shakes the US stock market, for example an unexpected twist in the Brazilian crisis or protectionist measure by the US Congress, the wealth effect will work in reverse. The US economy will go into recession. A hard US landing will affect the whole world.

Japan

3.5   The second critical uncertainty is Japan. This is one significant difference between Diverse Asia and Recovering Asia. Japanese investments and imports contributed to the region's growth in the late 80s and early 90s. For the whole of Asia to recover, Japan must once again be in a position to play this role. The Japanese economy must start growing again.

3.6   Japan is already helping crisis-struck countries in Asia. It has launched the US$30 bn Miyazawa plan, and provided direct bilateral aid, including trade financing. However, of far greater significance would be the economic energy which a restored Japanese economy would radiate throughout the region.

3.7   In the past year, Japan has made determined efforts to pump-prime its economy and recapitalise its banking system. Even sceptics now acknowledge that the Japanese government has done the right thing. Yet there are still no clear signs of recovery. Consumer confidence is still abysmal, undermined by rising unemployment and falling real wages. The credit crunch remains acute, hampering fresh investments by Japanese companies. The hope is that by next year the measures being taken will show results and growth will resume. The concern is that this may not come about, or worse but less likely, the Japanese economy goes into a deeper slump.

China

3.8   China is the third uncertainty. In sheer economic weight, China cannot match Japan. But China's opening up and spectacular growth were a major factor for the Asian boom. Even now, the region's pessimism is tempered by the sense that China's economy is continuing to grow, and the Chinese government is making headway tackling the problems of banks and state-owned enterprises.

3.9   These structural problems are daunting. Non-performing loans in China dwarf those in many Asean countries. Reform of the SOEs will displace millions of workers, many of whom will be unemployable. The Chinese have coined a four-character phrase to express their fear - hungry peasants will revolt.

3.10   Overall, the signs in China are positive. China has a strong top economic team, led by Premier Zhu Rongji. They are trying to strike a delicate balance between pressing on with reforms and managing the social and political side effects. But in the nature of things, success cannot be a certainty.

3.11   For example, China has allowed GITIC to fail, and forced it to undergo bankruptcy proceedings. This will set an important precedent for managing other failures. However, it is also having an immediate astringent effect on foreign lenders and investors, who have business with other Chinese companies. They are reassessing the new ground rules, and revising the risk premiums for doing business in China. The repercussions have to be carefully monitored and managed.

The Crisis Economies

3.12   The fourth uncertainty is how the crisis economies in Asia cope with their problems. This is the key difference between Diverse Asia and Recovering Asia, more important even than the Japanese factor. To recover, the crisis economies cannot just hope for the tide to rise again and good times to return. They must press on with economic reforms and restructuring, whatever their views on the role of global markets and capital flows in the crisis. All the crisis-affected countries have many more painful steps to take, including Thailand and Korea, the two countries which have gone the farthest so far.

3.13   But the more important question is how the crisis economies manage their social and political problems. Even in Thailand and Korea, with elected governments committed to economic reforms, political support for reforms cannot be taken for granted. In other countries undergoing political transition, politics is in command. If there is prolonged manoeuvring and uncertainty, leaders will not be focussed on economic recovery. Unemployment, poverty and human suffering will worsen. We must hope for peaceful, orderly transitions that produce legitimate governments, with the popular support to implement tough reforms and rational policies, restore confidence and start setting things right.

3.14   Indonesia is a key factor. What happens in Indonesia will affect the whole of South East Asia. In the 1960s, an unsettled Indonesia engendered regional instability. In the 1980s and 1990s, the whole area benefited from a peaceful and prosperous Indonesia. The kaleidoscope has now turned, and Indonesia is in a new phase. Much now depends on Indonesia finding its way to a new era of stability and progress.

4   Challenges for Singapore

4.1   We have to watch these critical uncertainties, to anticipate which scenario is likely to happen and respond accordingly. Some of our strategies will depend on the scenario. Others are robust, valid whichever way events turn out.

Global Recession

4.2   Should a Global Recession take place, we will be in for a long drought. As a small open economy, Singapore cannot insulate itself if the rest of the world is in recession. We too must expect higher unemployment and negative growth. Our social cohesion and sense of community will be put to the test. But our strong economic fundamentals, and the savings we have put away during good times, will help to see us through this worst-case scenario.

Diverse Asia

4.3   In a scenario of a Diverse Asia, we will have to diversify beyond the region, to strengthen our economic links with the developed countries and growing markets elsewhere in the world. We have to broaden the target for our markets and investments. More than half our manufacturing output is exported to countries outside the region. But in services we are more dependent on the region. We must make ourselves useful not just as a regional hub, but as a pan-Asian and even a global node.

4.4   For example, in financial services SIMEX is linked up with the Chicago Mercantile Exchange, and forming an alliance with Globex. Many cable and satellite broadcasters are locating their Asian operations here, making us a communications and media hub. MNCs are beginning to base key global headquarters functions in Singapore. Caltex was the first example. Shell has just announced that as part of a world wide restructuring, they will be creating a Shell Oil Products East, covering the Middle East and Asia Pacific, and the President, East Zone will be based in Singapore. These companies are coming despite the regional crisis. They have confidence in Singapore.

4.5   To support this strategy, we have to convince investors that although our region may be distressed, Singapore is radically different. We must do this by the policies we pursue, by the way Singaporeans respond to the crisis, and by the stability and security we offer.

4.6   After the initial panic that saw a general withdrawal from the region, analysts and journalists are now beginning to distinguish us from the pack. As a recent Merrill Lynch Securities report

noted: "In short, thanks to the regional crisis, the competitiveness gap that Singapore enjoyed over its neighbours appears to widen dramatically. This was on account of diminished attractiveness of key competitors and the imminent metamorphosis of the Singapore financial sector".

Recovering Asia

4.7   The third scenario, Recovering Asia, is the most favourable for us. Opportunities in the region will open up once again. But restructured and refitted neighbours also present challenges. They will be operating from lower cost bases. They will be more efficient, more focussed on development, less burdened by the weaknesses and excesses which led to the crisis. In short, they will be very competitive and attractive to investors.

4.8   As the recovering economies progress, they will begin to do many of the things which Singapore has been doing. As one minister from a neighbouring country asked me, long before the crisis: "What will Singapore do, when we become really developed?" That will indeed be a challenge for us. Nevertheless neighbours who are thriving, and spurring us to rethink strategies and climb higher, are far better for us than neighbours in trouble, casting a pall over the whole region.

4.9   To prosper in Recovering Asia, we must constantly stay ahead of our competitors. Our competition is not just regional, but global. We will have to offer better products and services, which have a higher skills content, and embody greater knowledge and added-value. We must develop areas of special expertise, and not merely duplicate what others can do. Hence the push for excellence, innovation, life long learning, and a knowledge-based economy.

5   Getting the Basics right

5.1   While each scenario poses different challenges and requires different policy responses, certain basic strategies for success are robust across all scenarios.

Strengthen Social Cohesion

5.2   First, we must continue strengthening social cohesion and national resilience. This is one key reason we have been able to respond to the crisis the way we did. Singapore is not the only economy needing to cut costs, tighten its belt, restore competitiveness, and respond as one to external challenges. But we are one of very few that can actually do it.

5.3   We have reduced wages and CPF contributions, with the full support of employers and workers. This is not because our policies are smarter, or Singaporeans are more docile. It is because people understand what is happening around them, and what they must do to help themselves. The Government has explained the crisis honestly and candidly to the people, and the message has sunk home.

5.4   This is not the task of a few weeks or months. The political leaders and people have worked closely together for many years. They have established mutual trust and understanding, and forged a firm social compact. The Government has balanced the interests of different groups in society, and made sure that every group enjoys the benefits of growth. The people are confident that the Government has their interests at heart.

5.5   We must continue to get Singaporeans to root themselves to Singapore, bond with one another, and work together in order to continue thriving in an uncertain region. This is crucial to our long term viability as a nation. The Singapore 21 Committee is addressing this issue.

5.6   This will not be our last crisis. The experience of tackling it will strengthen these ties, and help us deal with many future challenges together.

Short-term: Focus on Cost-competitiveness

5.7   Second, we must strengthen our cost-competitiveness. This is the main strategy for the short term, because other measures take much longer to show results. We have already implemented a $10.5 bn cost reduction package last November. If the situation deteriorates much further, we have the resources to do more. But we cannot fine-tune the outcome, for example to guarantee that we achieve positive growth this year.

5.8   Therefore the Government will not be taking major new initiatives in the Budget. Having administered the medicine, we must now wait for it to work. Meanwhile we will watch carefully how external events unfold, to see what new problems we must deal with.

Long Term: Develop New Capabilities

5.9   For the longer term, we must develop new capabilities. We are now benefiting from measures put in place long before the crisis - a flexible wage system, an efficient economic infrastructure, and investment in IT. With a crisis going on all around us, we have the luxury not to be preoccupied with fire fighting. We must continue to look ahead, and take measures now which will show results in 5 or 10 years' time.

5.10   Cost competitiveness alone is not enough. Singapore already has one of the highest per capita incomes in the world, in purchasing power parity terms. We cannot stay at such rarefied heights simply by offering low cost services. We must offer something exceptional. Hence, our emphasis on education and manpower training, and on encouraging creativity and life-long learning.

Sound Macroeconomic Policies

5.11   A key reason we have been much less affected than other countries in this crisis is our sound macroeconomic policies, both fiscal and monetary. We have maintained high savings rates, budget surpluses, and a stable Singapore dollar. We started from a strong position.

5.12   We should not take these old-fashioned virtues for granted, and abandon them unthinkingly for short-term gains. Once lost, they are very difficult to restore, as the experience of many Asian and Latin-American countries shows.

(A) Fiscal

5.13   On fiscal policy, reserves built up during the past years of strong economic growth gave us the wherewithal to reduce government charges and boost spending. Increasing government spending in a recession is orthodox economic theory. But we cannot do Keynesian pump-priming, boosting aggregate demand by paying unemployed people to dig holes in the ground and fill them up again. Our economy is too open. 54 cents of every dollar spent in Singapore leaks abroad through imports, so the multiplier effect of government spending is small.

5.14   Instead, we are reducing government charges to lower business costs, and increasing spending on infrastructure. The projects have to support our long-term needs, and make economic sense. Thus we are speeding up reclamation works, and building more schools, and LRT and MRT lines, but we have postponed Changi Terminal 3 because of lower projected demand.

5.15   Our long term aim must still be to return to balanced budgets, and where possible modest budget surpluses, once the crisis has passed. A prudent fiscal policy is the foundation for macroeconomic stability. Low interest rates, low inflation, and a steady currency all depend on this. We must never shift from a mindset of saving for our children, to one of spending what our parents earned, or worse, mortgaging our children's future through chronic budget deficits and external borrowing.

5.16   Therefore when we cut revenues and up spending for the short term, we must carefully distinguish between temporary measures to be rescinded when the crisis has passed, and permanent measures which we will maintain over the long term. We must not undermine our long term fiscal position. Thus for example we did not reduce the GST rate in the cost reduction package, because we would have run a high risk of being misunderstood as making a permanent GST cut.

(B) Monetary

5.17   Our monetary policy is centred on the management of the Singapore dollar exchange rate, rather than on domestic interest rates. In a small open economy, exchange and interest rates are not independent of each other. We have chosen the exchange rate as our policy variable, because it has a more immediate and direct impact on prices and a stronger effect on aggregate demand. Once we have set our exchange rate policy, we must leave interest rates to work themselves out.

5.18   Our policy on the S$ is the subject of much market speculation. MAS' tactical activities in the forex markets must necessarily remain opaque in order to be effective. However, the operational framework, objectives and philosophy of the S$ policy are not mysterious.

5.19   MAS manages the S$ not against any single currency, but against a trade-weighted basket of currencies of Singapore's main trading partners. Its policy objective is price stability. MAS sets a target band for the exchange rate, which it assesses to be consistent with Singapore's economic fundamentals. An overvalued exchange rate is a prime target for speculators, while an undervalued currency leads to overheating.

5.20   MAS intervenes to moderate exchange rate fluctuations, and to guide the exchange rate to the target band. During this crisis, MAS has managed the S$ with greater flexibility and widened the target band, because of the volatility and uncertainty in financial markets. MAS is, however, ready to intervene to repel speculation, should it judge that the exchange rate has been pushed excessively in directions that are not justified by fundamentals. This has rarely been necessary.

5.21   We do not rely on exchange rate depreciation to boost our export competitiveness. We prefer to do this directly, by reducing business costs, improving labour productivity and enhancing capabilities. The cost-cutting package last year is in line with this philosophy.

5.22   Before the crisis, the economy was growing rapidly and operating at full capacity. MAS allowed a trend appreciation of the S$ exchange rate. This contained inflationary pressures and prevented the economy from overheating. But since the crisis began in July 1997, aggregate demand has weakened. The economy has slowed into recession in the past few quarters. Moreover, given global deflationary pressures, imported inflation is not a threat. MAS has therefore adopted an easier policy stance.

5.23   Against the US$, the S$ has depreciated by about 20%. But in terms of the nominal trade weighted basket, the S$ has remained roughly stable since July 1997. Initially, when the currencies of the crisis economies fell much more sharply than ours, the S$ rose modestly against the basket. Subsequently the S$ eased back. It is now close to where it was when the crisis began. MAS believes that the present level of the S$ exchange rate, in trade weighted terms, is broadly appropriate for current economic conditions and prospects.

5.24   Confidence in the S$ has allowed interest rates to decline. Our domestic interest rates are low - lower than US$ interest rates, as they were for a long period before this crisis. This shows that the S$ is not being held up by tight monetary conditions, but is at a level the market is comfortable with.

Microeconomic Environment

5.25   A sound macroeconomic framework must be complemented by correct microeconomic policies. The government cannot make businesses prosper; it only creates enabling conditions for businesses to prosper. Good economic performance results from efficiently functioning free markets, which allow companies, individuals and investors to strive for themselves, and through the invisible hand create prosperity for all.

5.26   Our system is not pure laissez faire. The Government does intervene in the market, particularly in education, housing, and basic health care. But as far as possible it does so in ways that work with rather than against the market. Thus even for subsidised services like health care, we require co-payments.

5.27   For example, we are reducing government levies and charges, but in ways which do not distort price signals. So we are raising PUB water tariffs, but giving rebates to households to cushion the adjustment. This is much better than deferring the water tariff increases, and thus reducing the incentive for households to conserve water.

5.28   As another example, EDB works very hard to get MNCs to invest in Singapore. Our pioneer status scheme gives qualifying MNCs a tax holiday for up to 10 years. The company will benefit from this only if it is making profits, and so is liable to pay tax. If it is not making profits, the tax holiday costs the government nothing.

5.29   Now that competition for investments is fiercer, we sometimes hear suggestions that we go beyond tax holidays, to give outright cash grants to MNCs. But this is qualitatively different. The Government will be out of pocket whether or not the company makes money. Worse, we will attract more non-viable companies which only come for the sake of the handout, but create no added value.

5.30   Some European countries do give cash grants to MNCs, x dollars for every job created. But these countries have expensive unemployment benefit schemes. It makes sense for them to pay companies to build plants and reduce the unemployment rolls. Happily, we are not in that position.

5.31   It is not too difficult to work out the correct microeconomic policies. But it is much harder to get political support for them and carry them out. For example, any trained economist will confirm that tendering COEs is an economically sensible way to ration vehicle ownership, in the absence of a full ERP system charging for road usage. But when the economist himself is seeking to buy a car, and has to bid for an expensive COE, it is remarkable how dissatisfied he can become with the COE system. This is only human. So the Government has to work hard to persuade Singaporeans that sound microeconomic policies are in their own interests.

6   Conclusion

6.1   I have talked about the scenarios that may confront us, and the strategies that will help us to deal with them. This is not just an intellectual problem to be solved like a chess puzzle. It concerns the lives, hopes and futures of 3 million Singaporeans. To succeed, we must not only find the right policies. We must convince Singaporeans, mobilise them, and get them to work together to reach our goals. This blending of rational analysis and social cohesion will ensure that Singapore endures and prevails, whatever scenario comes to pass.