The Minister of Finance delivered the F2010 Budget Speech late Monday afternoon. Below, we highlight three key points regarding the budget as well as our comments:
1) Unsurprisingly, it was a mild fiscal deficit
The government expects a mild fiscal deficit of 1.1% of GDP for F2010 (ending March 2011). This is similar to F2009 estimated fiscal deficit of 1.1% of GDP, but recall that policymakers had initially expected a fiscal deficit of 3.5% of GDP for F2009. However, macro growth and hence operating revenue had come in better than expected (+15% of GDP versus the original expectation of 13.4%) and total expenditure (including special transfers) has also been correspondingly lower at 18.8% of GDP (versus 20.0%), hence lowering the deficit. For the F2010 Budget specifically, both total revenue (operating revenue plus net investment income/returns) and total expenditure (including special transfers) are expected to be marginally lower than in F2009, at 17.5% of GDP (versus +17.7% in F2009) and +18.6% of GDP (versus +18.8% in F2009), respectively.
Our comments: The mild fiscal deficit should not come as surprise to the market. A contractionary fiscal stance, in the form of a fiscal surplus, is not likely, given the still nascent recovery. Yet, the fact that the recovery is already underway reduces the need for aggressive stimulus measures, in our view. Moreover, Singapore policymakers do tend to be relatively more fiscally prudent compared to other ASEAN economies. Indeed, since late last year, policymakers have already started to gradually roll back on some of the stimulus measures announced in the F2009 Resilience Package. The wage subsidy in the Jobs Credit Scheme will be gradually reduced from 12% to 6% and then 3% in 1H10. The Special Risk Sharing Initiative, while extended for another year, is on revised terms. Selected property-related measures, which expired in January 2010, were also not extended.
The fiscal deficit of 1.1% of GDP is not significantly different from the 1.5% of GDP deficit embedded in our model. In this regard, we do not see any material impact on our 2010 GDP forecast of 5%. Indeed, with the high export-orientation, we think external demand still remains the single-most important driver of the Singapore economy.
2) The Budget is more macro than micro and more long term than short term
During the trough of the recession, the F2009 Budget had focused more on providing a short-term cushion via the S$20.5 billion Resilience package. With the macro trough now behind us, the F2010 Budget moves beyond the short term to focus on longer-term growth sustainability. Specifically, the Budget places emphasis on the three areas of productivity, competitiveness and growth inclusiveness. To increase productivity from 1% in the last decade to 2-3% over the next ten years, policymakers will spend S$5.5 billion over the next five years on measures such as Continuing Education & Training (CET), enhancement of the Workfare Income Supplement (WIS), Productivity and Innovation Credit and National Productivity Fund. On improving competitiveness, policymakers are relying on a mixture of R&D expenditure, financing, partnerships and tax incentives. Meanwhile, as measures to foster greater growth inclusivity, policymakers announced a shift from a flat property tax system to a progressive tax system on all owner-occupied residential properties, tax reliefs and fund top-ups.
Our comments: As part of the macro rebalancing process, the Economic Strategies Committee (ESC) was set up in May 2009 and tasked to map out the longer-term macro strategy. The recommendations have been made earlier in January and the Budget announced yesterday laid out the measures to be adopted. We think the three key thrusts outlined in the Budget addressed the issues facing the economy from within and from without. The policy direction itself is not new, but the F2010 Budget points to renewed and greater emphasis in these areas through a greater variety of measures.
In our view, the thrust on productivity and growth inclusiveness address the macro issues emanating from within. The 8.4% average GDP growth seen in 2004-07 had been predicated on the global liquidity supercycle and to a certain extent on factor input from strong foreign labour growth (the population saw average 3.8% growth). Arguably, the latter may have brought with it effects such as higher demand for property and invisible costs such as in terms of transport, perhaps suggesting a limit to such factor input-driven growth. Locally, with the total fertility rate standing at 1.27 (similar to Japan's), the demographic tide will start turning unfavourable, in our view. Additionally, until late in the last upcycle, the growth recovery had also been uneven in distributing income among the different income groups. In this regard, focusing on productivity is definitely key to future growth sustainability and income growth. Yet, this is a long-term policy goal and the results will only be seen in the longer run.
On the other hand, the focus on competitiveness addresses the issue from without, i.e., growth extraction could be more difficult to come by if the developed world, such as Europe, were to continue to see subdued growth. As we had pointed out previously (see ASEAN MacroScope: Macro Rebalancing Singapore-Style, July 30, 2009), we think the growth strategy will remain one of export-orientation. Indeed, the F2010 Budget showed no signs that policymakers intend to switch to a domestic demand growth strategy and rightfully so, in our view. Additionally, the F2010 Budget suggests a continuation of the macro model we had highlighted in the note. The macro model is to define the issue/identify a need, provide a platform in Singapore and bring together the public, quasi-public and private sectors to test-bed and co-develop a product/service/solution catering to such a need, which is then hopefully scalable and exportable to global markets. The focus on R&D expenditure and cross-linkages between public and private sector R&D suggests that policymakers want to give legs to this model right from the start of the production chain. Some of the issues we have highlighted with regards to this model have also been addressed. For example, we had wondered to what extent local companies would be able to participate in the production chain once the idea becomes commercially viable after R&D since part of the difficulty lies in identifying the part of the production chain Singapore corporates can participate in and profit from. In this regard, a new programme (Partnership for Capability Transformation) to help companies develop competencies has been set up. Having said that, however, while we think the policy measures are favourable, questions still remain on whether Singapore has a comparative advantage over other economies in drawing foreign companies to come and test-bed ideas here as well as the profitability of some of the industries focused on.
3) Market reaction to budget announcements in the immediate aftermath is typically muted
Given the long-term nature of the F2010 Budget, market reaction has been fairly muted. The FSSTI virtually traded sideways since the start of the Budget speech, only to decline marginally towards the end, finishing the day almost flat (+0.01%).
Our comments: In our view, this is likely due to the public sector economy (public expenditure and spending) tending to be a relatively small part of the overall economy and that fiscal policy tends to be a tool for longer-term macro management more so than a tool for short-term cyclical management (given the well-known import leakages and low multiplier effect), equity markets do not typically have big reactions to budget announcements. In the past ten Budgets since 2000, markets have fallen on five occasions and risen on five occasions and have outperformed the S&P four out of ten times in the day after the budget announcement. On average, markets have declined by a marginal 0.2% in the same period, underperforming the S&P500 by a marginal 0.1%. Stretching the horizon further out to 30 days, the conclusions become slightly mixed. The share of positive performance counts still remains almost equally divided. However, on average, markets declined 3.2% and underperformed the S&P by 1.4% in the 30 days after the budget announcement.
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Default or Inflate or...
February 25, 2010
By Gerard Minack | Sydney & Jason Todd, CFA | New York
So many countries with so much debt; crisis seems very likely at some stage: As we've noted elsewhere, the options seem to be severe belt-tightening (threatening renewed developed world recession), bail-out or default, overt or covert. Last Friday we looked at what belt-tightening requires (see Downunder Daily: What Sort of Escape? February 19, 2010). Bail-out is possible for an individual country, but not really feasible this time, given the breadth of the problem. Who could bail out the G-20? So, here we look at the third option.
We've taken three messages from Reinhart & Rogoff's This Time Is Different: Eight Centuries of Financial Folly, April 16, 2008. First, debt levels now are very high by historical standards. Second, sovereign default is, on a long view, quite common. The past few years have seen a lull, but there have been lulls before. Third, this time will probably not be different.
Sovereign borrowers can default overtly or covertly: Covert is currency debasement: literal debasement in the case of commodity-based money; by inflation with fiat money. (There used to be a third option: ‘creditor reconstructions'. Absolute monarchs had a history of executing creditors, which was one reason why it was not unusual for sovereign debt to trade at an interest rate premium to private debt.) History shows that inflation tends to rise in times of sovereign stress. This is one reason why Joachim Fels says that sovereign risk boils down to inflation risk (see "Five Themes for 2010", The Global Monetary Analyst, January 6, 2010; for more details see also S. Andreopoulos, "The Return of Debtflation", The Global Monetary Analyst, February 10, 2010).
As we've noted before, inflation doesn't solve a debt problem, unanticipated inflation does: Think of it this way: If a borrower's debt is tied to inflation (along the lines of TIPS), then it's not possible to inflate away the debt. From a macro view, a sovereign can inflate away the debt if the average interest rate on the debt falls below the growth in nominal GDP. (It doesn't matter whether it's volume growth or inflation driving GDP.) This is how the public sector deleveraging after World War II was accomplished. The average interest rate on public debt in the US was below the nominal GDP growth rate.
The key question now is: Can governments get the nominal growth rate above the average interest rate? We're not persuaded that targeting higher inflation will do the trick. In part that's for obvious reasons: it would require a wholesale abrogation of many of the institutional arrangements put in place over the past few decades - such as independent central banks and inflation targets - and the hard-won gains achieved through the disinflation period starting from the early 1980s.
In part we're sceptical because markets are seemingly awake to the risk: Most countries with high debt are already paying interest rates above expected nominal GDP growth. And markets demand a higher premium as debt increases.
In the US there is a clear link between nominal GDP growth and the bond yield (and, with a lag, the average actual rate paid on the stock of public debt). As an additional complication, Dick Berner notes that in the US nearly half of budget outlays are now effectively indexed to inflation (see We Can't Inflate Our Way Out, February 19, 2010).
How to push interest rates below nominal growth? Interest rates were below nominal growth rates in the years after World War II, which was also when the public sector accomplished most of its deleveraging. This was largely due to financial regulation. The Federal Reserve, which was not at that stage independent, acted to cap long-end rates at 2.5%. This arrangement ended with the Treasury accord of 1951.
Regulation may be the answer: Here's our key point: If the way to covertly default is to pay an interest rate below the nominal growth rate, we think it's possible that policymakers will aim to lower the interest rate rather than lift the inflation rate. In a sense, central banks buying government debt are already a small step down that path. A medium-term approach, however, could be to compel private financial institutions to purchase government debt. Such holdings were often mandated (as prudential measures) prior to the deregulation of financial systems in the 1980s.
In the US, for example, commercial bank holdings of Treasury paper have fallen significantly, both as a percentage of bank assets and as a percentage of the stock of Treasuries on issue. Commercial banks now have a balance sheet of around US$8 trillion. Requiring them to hold 20% of their assets in Treasuries would imply demand for over US$1.5 trillion of Treasury paper. All else equal, this would obviously squeeze the provision of credit elsewhere in the system, unless regulators allowed banks to increase their leverage (which would be justified on the basis that so much of their asset base is in ‘safe assets'). We are not recommending this. But it seems to us that high sovereign debt may be resolved not by a deliberate shift to higher inflation, but by re-regulation that compels buyers to accept uneconomic yields.
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