October 17, 2015
Monetary Easing in Singapore as Growth Sputters
The Monetary Authority of Singapore (MAS) announced on October 14 that it will ease its monetary policy for the second time this year by slowing the pace of SGD nominal effective exchange rate (SGD NEER) appreciation (often called slope) in an effort to support the economic growth.
Unlike most countries, the city-state uses exchange rate as its main policy tool because of its small size and high degree of openness to trade and capital flows. Non-oil exports constitute ~45-50% of its GDP and the import content of domestic consumption is as high as 40%. These circumstances necessitate a regime of managed float in which exchange rate is allowed to fluctuate within a policy band – at a prescribed level and direction announced semi-annually to the market – to achieve the twin objectives of growth and price stability. But the choice of the exchange rate as the main instrument of monetary policy means that MAS cedes control over the domestic interest rate which is largely determined by foreign interest rates and investors’ expectations of the future movement of the SGD (i.e. depreciation in SGD puts an upward pressure on local interest rates as investors seek higher yields as compensation for holding a weakening currency).
Economy to grow at a modest rate ~2-2.5% for next two years….
The central bank expects the economy to grow at a modest rate of ~2-2.5% (with risks tilted towards the downside) for next two years because gains from the improvement in the US economy would be moderated by weaker growth prospects in other regions such as the Eurozone, Japan and China.
According to the advance estimates, the economy avoided a technical recession as it grew 1.4% in Q3-2015 following a 2% growth in Q2. The manufacturing sector registered a negative growth for third straight quarter (-6.0% in Q3 vs -4.9% and -2.6% in Q2 & Q1 respectively), reflecting persistent weakness in the electronics, precision engineering, and transport engineering clusters. Growth in financial services was weaker amid the slowdown in lending to the region. In contrast, domestic-oriented sectors such as construction and services witnessed steady growth during the quarter (1.6% & 3% respectively), partly supported by increased public residential construction. Segments such as wholesale trade and transportation too were boosted by an upturn in oil-related activities. The central bank forecasts that, in the quarters ahead, subdued global growth will exert a drag on the external-oriented sectors such as manufacturing and IT whereas domestic-oriented sectors will expand at a moderate pace, underpinned by sustained demand for healthcare and education services, as well as public infrastructure spending.
Inflation to stay subdued in 2015 but will pick up gradually over 2016….
The monetary policy statement noted that the core inflation will stay low in 2015, but will gradually pick up in 2016 and move towards its historical average of ~2% once disinflationary effects of lower oil prices, budgetary measures and SG50 price promotions begin to fade.
The core inflation, which excludes the costs of private road transport and accommodation, remained subdued at 0.3% y-o-y in July-August 2015, following the 0.2% registered in Q2. This was primarily due to the transmission of low crude prices to domestic retail prices of oil-related items and dampening of services inflation (on account of enhanced medical subsidies, budgetary measures as well as the modest pass-through of costs to consumer prices). Costs of private transport and accommodation declined too, as reflected by fall in housing rentals and lower Certificate of Entitlement (COE) premiums for cars. Thus, on an aggregate level, CPI-All Items inflation fell to -0.6% y-o-y in July-August 2015 from -0.4% in Q2.
Going forward, the central bank expects the external sources of inflation to stay benign given ample supply of commodities and weak global demand conditions. On the domestic front, while a passive domestic growth environment will constraint the pass-through of wage cost pressures to consumer prices, increased supply of COEs and newly-completed housing units could further dampen overall inflation. Consequently, it is only by end of this year that the dis-inflationary effects of lower global oil prices, budget measures and SG50 price promotions will begin to wane and inflationary pressure will gradually pick up. For the year as a whole, core inflation is projected to average ~0.5% in 2015 and around ~0.5–1.5% in 2016. CPI-All Items inflation is estimated to be approximately -0.5% in 2015, and in the range of -0.5–0.5% in 2016.
MAS maintains the modest and gradual appreciation policy but recalibrates the rate of SGD NEER appreciation….
Slower than expected growth, dwindling inflation and negative growth in industrial output for three consecutive quarters prompted MAS to announce that it will it will ease the monetary policy for the second time this year by slowing the rate of SGD NEER appreciation (interpreted as ~0.5% pa against ~1% maintained in April meeting). Slowdown in China, Europe and other emerging markets and competitive monetary easing undertaken by many of Singapore’s major trading partners and competitors that had eroded SGD’s competitiveness in past couple of months also seem to have weighed heavily.
Since 2012, MAS had maintained a policy that allowed SGD NEER to appreciate gradually against a basket of currencies (at ~2% pa). Such a level was assessed to be appropriate for balancing the twin objectives of growth and price stability. However, a crash in global commodity prices and resulting deflationary pressures across the globe prompted the central bank to reduce the rate of SGD NEER appreciation in January this year (meaning that instead of allowing SGD NEER to appreciate at around 2%, the rate was fixed around ~1% annually). The modest and gradual appreciation path of SGD NEER at ~1% pa was assessed to be appropriate in view of the moderate growth and inflation prospects and the same was maintained in the April meeting as well.
The latest move of MAS to slow the pace of appreciation of SGD NEER @ 0.5% pa was in contrast to market expectations which had forecasted an outright devaluation of SGD, given low growth and inflation. However, the central bank seem to have decided against more aggressive easing to guard against the risk of importing excessive inflation. This is because even though SGD has been appreciating against almost all major currencies, it continues to retreat against the USD. Going ahead, the measured adjustment is expected to support the economic growth into 2016, while ensuring price stability over the medium term.
Market implications….
Given sizable expectations of policy easing, MAS’s decision to go for a mild reduction in the slope of SGD NEER was not as unpopular as initial reactions suggested. Despite the talks that banks would cut their long USD-SGD positions, markets actually reacted positively to the subtle move. The local currency appreciated more than 1% against the greenback (i.e. USD) within minutes of the announcement to reach close to 1.39, the lowest USD-SGD exchange rate since early August. Analysts believe that a surprise upside in the preliminary estimate of Q3 GDP contributed to the SGD demand.
However, given that the monetary policy statement also pointed towards growth challenges and global headwinds, the SGD recovery could well be short-lived. In that case, continued downside risks and the sense that the recovery in SGD is only temporary could feed into the interest rates markets by putting an upward pressure of lending rates. To conclude, still-uncertain global outlook and expected strengthening of the USD due to normalization of Federal Reserve interest rates has kept alive hopes for further policy easing by the MAS.
October 13, 2015
What India Can Learn from Richard Koo's Balance Sheet Recession
Nomura’s Richard Koo has been banging on about the similarities between Japan’s balance sheet recession and the current financial malaise for a long while.
His main point has always been that the financial system won’t recover unless corporates and households complete their deleveraging journey.
Let’s start with Japan’s corporate sector. Up until the Japan’s bubble collapsed in 1990, the country’s corporate sector was growing at rapid pace with liabilities growing faster than assets. Or as he puts it “businesses were borrowing large sums of money to purchase financial assets and real assets.”
After the bubble burst, that growth in financial liabilities slowed sharply, even turning negative in 1997 — indicating that corporates had actually started to pay down debt. This deleveraging continued until 2004, even though interest rates were at zero, indicating “just how desperate corporates were to repair their balance sheets”.
The paying down of debt only stopped in 2005. But instead of taking on new liabilties they moved to restore the pool of financial assets that had been depleted during the difficult years.
A similar story can be observed in Japan’s household sector, despite the fact that financial asset growth far outpaced the growth of financial liabilities.
Financial asset growth in Japanese households greatly exceeded the growth in financial liabilities through the first half of the 1990s, reflecting a history of high savings rates. But growth in financial assets (savings) fell steadily after the bubble burst and had dipped nearly to zero by 2003. This was attributable more to sluggish incomes than to aging demographics, in my view. It was during this period that employment and wage adjustments began and “restructuring” became a buzzword, pushing many households into a tight financial corner. Financial assets did not resume growing until 2004, when improvements in the job market enabled households to start saving again.
Growth in financial assets slumped again as the global financial crisis depressed incomes, but picked up sharply last year following the March earthquake and tsunami. The disaster—and the subsequent problems at the nuclear plants—fueled widespread concerns about the future, prompting people to cut consumption and increase savings.
Growth in household financial liabilities fell sharply after the bubble burst, and from 1998 onward households not only stopped borrowing money but in most years were paying down existing debt.
So how does this story compare to India?
In a balance sheet recession, consumer spending is put on the backburner in favor of saving and paying down debt.India can learn a lot not just from the Japanese model, but from other Asian model. The fact is, 25-30 years down the line, when your demographics is right up there, there will be many options for investment in India. India is already entering its demographic peak. That being said, there is a huge need for serious reforms on the supply side to get the growth momentum going.
When asked if emerging markets could face Japan like stagflation, Richard Koo in an interview with The Economic Times, India, earlier in 2012 said that emerging economies are in very different world. Unless you have a massive bubble, housing bubble and bubble burst, balance sheet recession would not be your concern. The balance sheet recession happens only after a major nationwide asset price bubble financed with debt burst and even if in India people are worried about something like that or in Brazil people are worrying something like that, I do not think balance sheet recession is going to be a concern.
His main point has always been that the financial system won’t recover unless corporates and households complete their deleveraging journey.
Let’s start with Japan’s corporate sector. Up until the Japan’s bubble collapsed in 1990, the country’s corporate sector was growing at rapid pace with liabilities growing faster than assets. Or as he puts it “businesses were borrowing large sums of money to purchase financial assets and real assets.”
After the bubble burst, that growth in financial liabilities slowed sharply, even turning negative in 1997 — indicating that corporates had actually started to pay down debt. This deleveraging continued until 2004, even though interest rates were at zero, indicating “just how desperate corporates were to repair their balance sheets”.
The paying down of debt only stopped in 2005. But instead of taking on new liabilties they moved to restore the pool of financial assets that had been depleted during the difficult years.
A similar story can be observed in Japan’s household sector, despite the fact that financial asset growth far outpaced the growth of financial liabilities.
Financial asset growth in Japanese households greatly exceeded the growth in financial liabilities through the first half of the 1990s, reflecting a history of high savings rates. But growth in financial assets (savings) fell steadily after the bubble burst and had dipped nearly to zero by 2003. This was attributable more to sluggish incomes than to aging demographics, in my view. It was during this period that employment and wage adjustments began and “restructuring” became a buzzword, pushing many households into a tight financial corner. Financial assets did not resume growing until 2004, when improvements in the job market enabled households to start saving again.
Growth in financial assets slumped again as the global financial crisis depressed incomes, but picked up sharply last year following the March earthquake and tsunami. The disaster—and the subsequent problems at the nuclear plants—fueled widespread concerns about the future, prompting people to cut consumption and increase savings.
Growth in household financial liabilities fell sharply after the bubble burst, and from 1998 onward households not only stopped borrowing money but in most years were paying down existing debt.
So how does this story compare to India?
In a balance sheet recession, consumer spending is put on the backburner in favor of saving and paying down debt.India can learn a lot not just from the Japanese model, but from other Asian model. The fact is, 25-30 years down the line, when your demographics is right up there, there will be many options for investment in India. India is already entering its demographic peak. That being said, there is a huge need for serious reforms on the supply side to get the growth momentum going.
When asked if emerging markets could face Japan like stagflation, Richard Koo in an interview with The Economic Times, India, earlier in 2012 said that emerging economies are in very different world. Unless you have a massive bubble, housing bubble and bubble burst, balance sheet recession would not be your concern. The balance sheet recession happens only after a major nationwide asset price bubble financed with debt burst and even if in India people are worried about something like that or in Brazil people are worrying something like that, I do not think balance sheet recession is going to be a concern.
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