Singapore’s Shanmugaratnam: Asia’s statesman sketches the face of global finance
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Singapore’s Shanmugaratnam: Asia’s statesman sketches the face of global finance

Singapore matters. The city-state continues to blaze a trail for the region by shifting its growth model in favour of productivity, securing its presence at the top level of international financial diplomacy. Tharman Shanmugaratnam, Singapore’s finance minister – and Euromoney’s Finance Minister of the Year 2013 – outlines his reform agenda and issues a sharp warning on reform inertia in the region, China’s growth model and destabilizing capital flows.

For decades, Singapore has seduced overseas talent thanks to its status as the Shangri-la of city-states, endowed with clean streets, diverse cuisine, water parks, a stunning skyline, botanical gardens and luxurious malls. Why are some nations doomed to a perpetual cycle of boom and bust, while others, notably Singapore, steadily graduate to high-income status? The success of the small city-state with big ambitions sheds light on this contested battleground of economic ideas while it continues to carry the torch for Asia’s transformation.

As investors lament the unsustainable credit boom and reform inertia that has blighted ChinaIndia and Indonesia, in particular, in recent years – raising the spectre this summer of a repeat of the 1997 Asia crisis – Singapore has consolidated its status as the region’s competitive dynamo, thanks to a flurry of supply-side reforms, backed by judicious fiscal and monetary policies.

Michael Zink, head of Asean and chief executive for Singapore at Citi, sums up the zeal of expatriate workers evangelizing over the Singaporean story. "It provides a great example of economic success that is endlessly nurtured," he says. "There is a never-ending benchmarking about who is the best today, or what is the next step in outperformance, or what is missing from our growth model. It is a very proactive policy orientation. The government has done so well because it has not stopped running."

And yet the city-state, ejected from the federation of Malaysia in 1965, is saddled with perceived obstacles: limited land and a small population, depriving the private sector of the economies of scale. What’s more, at independence, it lacked thriving neighbouring markets, foreign aid and an easily replicable growth model from other nations, while state administrators only a decade before were engaged in a bruising battle to root out drug trafficking and opium dens.

Fast-forward to 2013: five decades of explosive growth have propelled the city-state from low income to high income in two generations. Along with that of South Korea, that has been the fastest pace of economic development in modern history. The economy is the most competitive in the world, according to the World Bank, with the highest income per capita in southeast Asia, outpacing the US in recent years.

Unusually for economists, there is rare near-universal consensus about why Singapore has succeeded. The roots of Singapore’s transformation lie in the vision of Lee Kuan Yew, the first leader of the independent city-state, who assumed power at a time when per-capita income levels were equivalent to those of Angola or Kosovo today, according to the Cato Institute, a Washington free-market think-tank. His model: light taxation, a stable monetary system, free enterprise, a zero-tolerance policy towards corruption, complemented by a highly trained and well-paid workforce – with top officials typically earning million-dollar-plus salaries – and an open-door policy to migrant labour.

However, as Singapore Inc edges towards its 50th birthday, the economy is at an inflection point. Its model of attracting multinational firms through tax breaks, a strong business climate and relentless expansion of the overseas workforce is reaching a breaking point, given a shortage of space and rising tensions between domestic and foreign workers. The city-state needs a more sophisticated growth model, focused on expanding productivity of domestic businesses and building an innovative homegrown corporate sector. In some ways, the challenge is more vexing than crises in the past 15 years: the 1997/98 Asia crisis, the Sars outbreak in 2003 and the global recession in 2008. China’s growth model is now under siege, threatening one of Singapore’s top export markets; the city-state’s potential growth rate has almost halved to around 2.5%, according to economists, citing, in part, new curbs on foreign workers; and a strong Singaporean dollar, an ageing workforce and structurally high inflation will continue to erode competitiveness. What’s more, social cohesion is being threatened by rising income inequality – exacerbated by the growth of high-net-worth individuals in recent years that means Singapore now rivals Switzerland for private banking, while rival regional trade and investment centres are snapping at its heels in becoming innovative hubs.

Given Singapore’s reputation for blazing a trail for the rest of the region – from supply-side reforms, trade and investment strategies as well as financial-market growth – Asian policymakers are taking note of how the city-state navigates these challenges, with its energetic reformist finance minister, Tharman Shanmugaratnam – Euromoney’s Finance Minister of the Year 2013 – lionized as the region’s statesman on the international stage.

The economic plan centres on increasing productivity by imposing restrictions on cheap foreign labour to coerce companies to embark on reforms to maintain margins – and to correct the policy misstep of opening the floodgates to foreign labour over a short period – while introducing fiscal and educational measures to reward industry innovation. In addition, the government is beefing up the social safety net to address discontent over strained infrastructure and rising living costs, driven by a surge of migrant workers, equivalent to a near 10% increase in the workforce in recent years.

This restructuring effort, officially in its fourth year, aims for annual labour productivity growth of 2% to 3% between 2010 and 2020. In a wide-ranging interview conducted in a meeting room near his office, the minister, in classic Singaporean fashion, arrives bang on time. He is visibly enthused as he agitates for further reforms and pinpoints the much-lauded economy’s weaknesses. "We are no longer a developing economy. But we are not yet a truly advanced economy, because on the basis of productivity and skill levels we still have some way to go," he says.

The key economic objective now is to ensure that domestic businesses boost their competitiveness and productivity, says Shanmugaratnam, finance minister since December 2007. Citing a system of ex-ante grants and ex-post taxes, he says: "We want to force firms to innovate and change their methods by influencing their behaviour. It is about injecting pain and gain in the system. Businesses need to pay the government a levy to employ foreign labour and we inject revenues back into the system to reward those industries that are investing in productivity."

Official measured productivity has missed targets over the past two years, while few economies have managed to sustain productivity gains over a decade. However, economists are supportive of the government’s focused policy targets, which serve as a sharp contrast to the failure of many Asian economies over the past year, from India, Indonesia, China to Vietnam, to embark on structural supply-side measures, in part, accounting for the market sell-off this summer.

Michael Spencer, chief economist, Asia-Pacific, at Deutsche Bank
Michael Spencer, chief economist, Asia-Pacific, at Deutsche Bank

Michael Spencer, chief economist, Asia-Pacific, at Deutsche Bank, says: "Singapore has been loth to depreciate the exchange rate to boost competitiveness. The government’s approach has been to use currency appreciation to create an incentive to ensure businesses themselves create competitiveness." He adds: "Targeting 2% annual labour productivity growth did not look too ambitious at the time, but disappointing US and European growth has scuppered targets thus far. Nevertheless, the strategy is correct." Chua Hak Bin, head of emerging Asia economics at Bank of America Merrill Lynch, says: "Singapore has accepted the need for a lower growth rate and has embarked on competitiveness reforms in the good times."

Singapore’s economic model has achieved the rare feat of being lionized by free-market libertarians and redistributive statists alike. In contrast to its free-market stereotype, Singapore has an activist state, which has been aggressive in establishing winning and losing industries and scouring the globe for investment.

Through the Research, Innovation and Enterprise Council, chaired by the prime minister, Singapore boasts a large collaborative network of government agencies, ministries, schools and research institutes that seek to attract the world’s largest corporations. The result: the 10-year cumulative US investment in Singapore stood at $138 billion at the end of 2012, twice the level received by China and outpacing Australia and Japan.

Thanks to a shift from low-end to high-end manufacturing – the sector as a whole accounts for over 20% of the city-state’s economy, compared with less than 5% in Hong Kong – Singapore boasts strong capabilities in petrochemicals, semiconductors and electronics.

However, for a ruling party that has enjoyed uninterrupted power since independence, political realities are now shaping the economic agenda, after a contentious 2012 paper revealed that the population would need to expand from 5.3 million currently to 6.9 million to ensure growth by 2030 would be sustained, placing further pressure on house prices, infrastructure and social cohesion.

A Wall Street Journal investigation in November 2012 that revealed apparent mistreatment of bus drivers from mainland China underscores the challenge of establishing industrial harmony, given rapid changes in the city-state’s demographics. But Shanmugaratnam remains unbowed. "The WSJ story does not describe the labour landscape, in general, and if it did, you would not have a very strong demand from mainland Chinese for Singaporean jobs, when they have alternative choices. It’s not a lawless place where employers have free rein to do what they like. I would say the strength of the system depends on how well it works for the ordinary worker, and social cohesion is a critical pillar in this," he says, citing plans to prioritize healthcare, affordable housing and employment benefits.

Piyush Gupta, CEO of DBS
Piyush Gupta, CEO of DBS

Piyush Gupta, CEO of DBS, Singapore’s largest lender, says: "Our rapid progress brings some stresses with it, chiefly those from increasing income inequality. Consequently, the government’s restructuring efforts to address this issue are critical. Getting the balance between growth and social welfare will always be tricky, but they are doing a good job of this so far." Balancing wage competitiveness, which is typically boosted by the flow of foreign workers, with a reduction in net immigration in the coming years can only be achieved by raising productivity. Promisingly, the spirit of the restructuring plan is already being met, with real median income growing 3.1% annually over the past four years and by 30% between 2010 and 2020.

Prime minister Lee Hsien Loong in August announced plans to double capacity at southeast Asia’s busiest airport, to build a new waterfront development and free up land for development. Although the frenetic pace of government-backed industrial growth has reaped dividends – boosting, in recent years, the biomedical sciences and clean-energy sectors, for example – the strategy does have its downsides. Manu Bhaskaran, an analyst at Centennial Asia Advisors, a political and economic consultancy, says: "The government does follow free-market principles in many areas, but Singapore is still an economy with a large state element, where the state controls a large proportion of national saving as well as land supply [around 85%] and influences the marginal supply of labour through its foreign-worker policies." He says the government’s penchant for national industrial planning should make way for market-oriented activity, and laments the lack of homegrown multinational companies, fearing that a competitiveness gap in innovation has opened up between the city-state and rival economies, leaving Singapore’s economic cycle perennially hostage to outside forces in global trade.

Michael Wan, Singapore economist at Credit Suisse, adds: "The question is whether Singapore will continue to enjoy its status [as southeast Asia’s principal economic hub]. Every single Asean city is gunning for the title, as is Shanghai and other Chinese cities." Fearing rising competition with regional hubs – Hong Kong’s growing connectivity with mainland economic centres; and the Greater Mekong Sub-Region, which brings Thailand together with Myanmar, the Chinese provinces of Yunnan and Guangxi, Vietnam, Laos and Cambodia – Bhaskaran calls for further export diversification to regional partners and a higher share for wages and the profits of Singapore-owned SMEs in national GDP. Rather ambitiously, he reckons one way to reduce consumer and rental price pressures in the city-state would be through a relocation of economic activities to Iskandar Malaysia, a budding development hub across the water in Johor.

Promisingly, Singapore – which in effect has been run like a well-managed corporation for the past 50 years – knows a thing or two about microeconomics. Take one small example: as the economics professor and blogger Tyler Cowan has noted, the government imposes a consumption tax for public-order offences. Shocked by the epiphany that this highly unorthodox policy is backed by a sound rationale – the fine-generating activity should be taxed, in principle, if individuals derive consumption from it – Cowan concludes: "[this tax is] how you know Singaporeans are really serious about microeconomics," a boon for Singapore’s likely success in adjusting its economic model.

Although the city-state outperformed in the Asian market sell-off over the summer and the government has raised its 2013 growth target to between 2.5% and 3.5% from between 1% and 3%, thanks to higher-than-expected growth in the services sector, it also faces near-term domestic headwinds. Moody’s recently downgraded its outlook on Singapore’s banking system, citing cross-border leverage risks, fears of a property bubble and rising indebtedness. Credit growth in recent years has greatly outpaced nominal GDP growth, with household borrowing, as a proportion of GDP, at an elevated 77%, compared with 64% in 2007. Nevertheless, Shanmugaratnam, who also serves as chairman of the central bank, the Monetary Authority of Singapore (MAS), is sanguine. "We thought it was useful that it [Moody’s] issued that warning, albeit from a high base since we are the highest-rated banking system in the world," he says. "It is useful to warn that no one will be immune from the effects of the normalization of interest rates in the next few years. Nevertheless, we have moved to restrict loan growth and have imposed a total debt-servicing ratio [for home loans]. The banks are going to be OK because they have substantial capital and liquidity buffers. The advantage in Singapore is that the lower- and middle-income groups are insulated because they go through the government in the form of housing board loans, which have strict prudential limits. We don’t have a US-style sub-prime problem, and the value of real estate assets has risen faster [than loan growth] in recent years."

Singapore has been grappling with similar challenges to those of its neighbours: large-scale credit expansion is in part attributable to domestic exuberance over rising real estate prices and limited tools to control domestic credit conditions, as its exchange-rate band effectively imports loose G7 policy. The difference, in typical Singaporean fashion, is that the authorities were more active in curbing credit excesses by introducing tighter prudential regulations relatively early in the post-Lehman credit cycle and through seven rounds of property-cooling measures, including steeper stamp duties and lower loan-to-value ratios for mortgages. These measures, combined with regulatory vigilance, have averted fears that a drop in real estate valuations would pose a systemic financial risk, say analysts.

After spending much of his professional life at the MAS, where he was the chief executive of the famously well-managed institution, with a pool of foreign-currency reserves ($260 billion) almost equivalent to the size of national GDP ($275 billion), Shanmugaratnam entered politics in 2001, culminating in his appointment as deputy prime minister a decade later. The minister has earned acclaim in the region for his wide-ranging and ahead-of-the-curve warnings for Asia to beef up supply-side reforms to address tightening labour markets and calls for cross-border regulatory coordination over systemic banking risks and financial imbalances.

Shanmugaratnam’s views carry weight. He has assumed a statesman-like role in the region in recent years as a member of the Group of 30 and chair of the International Monetary and Financial Committee (IMFC) of the IMF – its first Asian head – that reports to the IMF board of governors on international monetary and fiscal affairs. With degrees in economics from LSE, Harvard and Cambridge, Shanmugaratnam adds credibility to the battle to craft rules boosting global financial and trade liberalization. His name was whispered during the IMF leadership debate in 2011, underscoring the faith invested in him among the policymaking community.

Shanmugaratnam’s immediate concerns are three-fold: China’s growth model; destabilizing capital flows to and from Asia; and the slow pace of supply-side reform in the region in recent years. Before the disorderly emerging market rout this summer, most Asian economies faced the economic policy conundrum known as the impossible trinity – the challenge of managing exchange rates, controlling inflation and allowing the free movement of capital all at the same time. Strong portfolio flows heaped on inflationary pressures, and interest rate increases, in response, risked sucking in yet more overseas credit, while capital controls are a contentious form of financial protectionism. Shanmugaratnam believes policymakers should heed the lessons learnt over the past three years. "A completely free-floating exchange rate regime is not a good idea for most emerging markets, and not even for advanced economies, because, even though they might pretend otherwise, every [central bank] is prone to intervention that changes exchange rate outcomes. So a completely free-floating exchange rate regime does not, in reality, exist, and it’s not a good idea for emerging markets or smaller economies, in particular."

He says Singapore’s experience over the past two decades proves the efficacy of managed-float regimes by facilitating adjustments to exogenous shocks, providing counter-cyclical firepower and mitigating the spillover impact of trade and financial shocks in the real economy. However, this won’t by itself barricade Asian economies from the tide of external liquidity. "Small, open economies were in a quandary because they had a flood of liquidity. The raising of interest rates could lead to more money flowing in because currency has become an asset class – it is not just the price for goods and services – which conventional exchange-rate analysis does not factor in. I think, while we cannot have a perfect trinity, you can have an imperfect trinity. You can have a managed-float exchange rate and have some autonomy in domestic monetary policy, if backed by prudential measures."

Shanmugaratnam says that unless the US Federal Reserve looks beyond its core domestic employment-inflation mandate and considers the impact of its monetary stance on emerging markets, Asia could be locked in a perpetual cycle of credit booms and busts. Without this shift, the perpetual cycle of incurring credit-driven current-account deficits and a corresponding dependence on fickle foreign capital will continue, even with greater domestic vigilance and beefier prudential tools, while a volatile monetary policy in response would exact a heavy toll on the real economy.

"For emerging economies, the sharp monetary policy trade-off can lead to lower growth and lower unemployment. The basic conclusion – emerging economies can solve this [capital-cycle challenge] alone – is wrong. There is nothing in economic theory that says you can solve this on your own." He adds: "The world is becoming more interconnected, and aggregate demand from emerging markets increasingly matters for the US. If the emerging world goes through a significant retrenchment [in part triggered by Fed-induced unsustainable credit stimulus], it will rebound on US exports and global growth."

He reckons that tighter fiscal and monetary policy, rather than an almost exclusive reliance on still-orthodox prudential requirements, would have softened market fears that large economies in the region, such as India, China and Indonesia, have kept rates too low, without sufficient attention to the financial cycle. But he adds: "[The emerging market rout] won’t be catastrophic. Asian and Asean economies, especially, are on a sound footing. Some credit cycles have gone too far. But banking systems are not at risk."

Still, he laments how Asian policymakers since the Lehman collapse have largely focused on counter-cyclical stimulus, neglecting supply-side structural reform. "For a few years, I have been saying beware of hubris. It has happened repeatedly through history and it is during the good times when money flows that you tend to relax. Asian economies still have quite a few areas to improve," he says, citing impediments to long-term infrastructure investment, a lack of labour market reforms and investment in technical skills.

Given the huge pool of global financial capital looking for returns in a world of deficient demand, the trend among US and EU pension funds to allocate a greater proportion of their capital from a currently low base to Asia, and the prospect of continued financial repression in the west, triggering a bid for high-yielding products in Asia, the high-growth region could be held hostage to the bubbles and financial imbalances for years to come. Shanmugaratnam says the summer market sell-off in Asia is a cyclical blip in a structural bull market, and the region’s policymakers should urgently redouble efforts to expand the supply of investable financial assets for foreign investors and productive projects in the real economy, such as infrastructure. He reckons renminbi-denominated long-duration bonds, listed infrastructure trusts, maturity-transformation services and the cash management industry’s projected growth will help sate overseas appetite for exposure to Asia. "The long-term secular trend will be a reduction of home bias by institutional funds, mutual funds, insurance funds and pension funds in the west, which are still under-invested in emerging markets and want to increase allocations in favour of Asia. If you don’t want recurrent bubbles, then you need deeper capital markets."

China’s economy is the surging river that flows through the region and Shanmugaratnam sounds more bearish than most on its near-term challenge of reducing credit growth without imperilling financial stability, and the medium- to long-term bid to shift to a consumption-driven economy, by reducing its investment-to-GDP ratio, liberalizing financial markets and boosting household income. "There is no assurance of success or a smooth transition. The challenge is to catch up on time lost over the past decade. It does not have much time left, as the society is ageing," he warns. "Several reforms need to be done simultaneously not just sequentially: for example, financial market reform, fiscal reform, between central and local governments – that goes to the heart of the shadow-banking issue – then there is reform of the SOEs [state-owned enterprises], which, again, is about allocation of capital. There is also social reform, which is not without contention. So we should not be surprised if there are hiccups. They will probably act a little too cautiously, but that’s understandable."

The minister is too diplomatic to say it, but he seems sympathetic to fears that the global financial crisis might delay a shift in China’s liberalization of its closed monetary model, which threatens to defer much-needed domestic adjustment and the resolution of global capital imbalances until it’s too late, although he says Chinese leaders are committed to reform in principle.

In any case, Shanmugaratnam pronounces the likely end of the China-driven global commodity super-cycle, which will trigger a "significant" shift in the Asian supply chain "away from commodities and materials that fed investment-led growth to products and intermediary inputs to feed consumption," a boon for Singapore’s strengths in financial and environmental risk management, urban planning and high-value manufacturing.

Singapore is well suited to the art of financial diplomacy. It lacks emotional bias, having sharply rebounded after the global financial crisis and, as one of the world’s most open economies, has substantial self-interest in globalization’s continued march, but touts the virtues of a prudent pace of capital-market reform, having been swept by the storming Asia crisis.

In the near term, governments in the region are grappling with the impact of volatile capital flows and their effect on policymaking. Spencer at Deutsche Bank says: "The message that policymakers can draw is that, put simply, international capital flows can be incredibly disruptive. How can emerging market sovereigns absorb capital flows from a large global financial system? Even if these flows have been absorbed within the local government bond market, this depresses local interest rates. And when the tide begins to turn and there are relatively modest dollar outflows, you have seen some exchange rates down as much as 17% year to-mid September against the dollar."

Shanmugaratnam says targeted capital controls, tough bank regulation and counter-cyclical domestic policy to cool credit booms – the Fed and the IMF’s conventional policy recommendations to emerging economies faced with overwhelming flows – should be complemented with greater international policy coordination. Rather than recommending politically unfeasible measures, such as current-account targets to reduce global imbalances, or a new international reserve currency to challenge the dominance of the US dollar, Shanmugaratnam calls for the IMF to flesh out a code of practice on how and when to implement targeted controls depending on the type of portfolio inflows to boost market expectations and avoid beggar-they-neighbour capital-flow policies. He also calls for the IMF to boost its surveillance role and for greater monetary policy coordination. "Rather than search for a grand new paradigm, we should talk about greater predictability in macro-prudential measures, so markets can build this into their expectations." Amid efforts to craft an early-warning system at the IMF, the minister clearly fears that ever-volatile capital flows, triggering domestic imbalances and divergent national responses, might cause Asian policymakers to roll back on liberalization.

As finance minister, deputy prime minister, chairman of the MAS, board member of the Government of Singapore Investment Corporation, head of the IMFC and parliamentarian, Shanmugaratnam strikes a Stakhanovite tone when asked how he finds time to unwind. "Sometimes work can be quite relaxing," he says without irony. Amid the balkanization of the global banking system, it’s heartening that Singapore’s dynamo is battling valiantly for prudent globalization in the world’s most dynamic region.

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