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2012 Outlook on Singapore’s Economy: Eurozone Spectre to Overshadow Intra-regional Trade

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by Jared Heng

Increasing incomes and intra-regional trade in Asia will still be overshadowed by the negative impact from the eurozone crisis, according to UOB senior economist Alvin Liew.

“While domestic demand in Asian economies is increasing from rising incomes, it is not rising at a pace fast enough to replace the loss in demand from the developed economies, such as those in Europe,” Liew said in a mid-December interview with Biz Daily.

He explained intra-regional trade often does not end when the goods are sent from one Asian country to another, and that the percentage of final exports going to developed economies remains fairly significant.

This reflects the fact that the increase in intra-regional trade links in Asia is still largely dependent on final demand from the developed economies.

Economic Growth

Meanwhile, the Monetary Authority of Singapore (MAS) expects the nation’s economic growth for 2011 to be about 5 per cent, before slowing to 1 to 3 per cent in 2012 on expected weaker demand from developed economies.

Earlier this month, Barclays Capital predicted that Singapore’s economy will grow 5.2 per cent for 2011 and moderate to 3 per cent next year, in line with MAS’s forecast.

Liew predicts Singapore’s 2012 GDP growth at 2.5 per cent based on the assumption that there will not be any external shocks that will lead to a global recession.

“Growth will still be positive but it won’t be a strong recovery like in the case of an absence of the ongoing difficulty seen in the European situation,” he said.

Kit Wei Zheng, a Citigroup economist, wrote in a report in early December that Singapore’s economy is forecast to slow sharply to “a possibly below-trend growth rate” of 3 to 5 per cent in 2012.

“Growth will likely remain sub-par in the next one to two quarters but could bottom in 1Q2012 on electronics restocking,” he said.

Meanwhile, as China’s domestic demand grows, Singapore is expected to benefit from increased trade with the world’s second-largest economy.

However, UOB’s Liew cautioned that this will only partially cushion against the reduced demand from European economies, given that on an aggregate regional level, Europe is a key trading partner for many Asian countries.

Earlier this month, trade promotion agency International Enterprise Singapore noted that the city-state’s non-oil domestic exports (NODX) to China expanded 0.3 per cent year-on-year in November.

However, NODX to the EU and US was down by 20 per cent and 11 per cent respectively amid the economic woes faced by both trading partners.

Citigroup expects the euro area to contract 1.2 per cent in 2012, with four consecutive quarters of contraction starting from this year’s fourth quarter.

“We see drags from spillovers from a European recession on trade and FDI (foreign direct investment), particularly when the EU is Singapore’s largest NODX market and European firms are the top foreign direct investors in Singapore,” Citigroup’s Kit said.

However, he added an “important mitigating factor” was that close to 40 per cent of Singapore’s NODX to Europe is in pharmaceuticals, compared with 13.2 per cent for the US.

“Pharmaceutical exports are volatile and can see large boom / bust cycles, but more due to industry specific / product mix factors, rather than reasons tied to the broader macroeconomic cycle,” Kit said.

Sector Performance

While reduced demand from the developed economies is still likely to be broad-based next year, weakness in Singapore’s electronics sector could be more pronounced than some other sectors and is expected to continue over the next few months, Liew said.

However, he added it was still “too early” to assess how deep the impact of the Thai floods on Singapore’s electronics sector would be.

“Barring any kind of unexpected events, there should be a recovery process for the Thai floods, probably with a more pronounced impact in next year’s first half, and also in the second half assuming nothing goes terribly wrong in the European situation,” he said. “Some electronics segments that are more commoditised might also face pressure to be relocated to cheaper production areas.”

Liew said some other sectors such as biomedical manufacturing might outperform electronics in 2012 due to several reasons.

For example, while pharmaceuticals growth might moderate in 2012 from this year, its relatively inelastic demand, the increasing global population and ageing societies of many countries should bode well for the segment.

Coming off from a very low base, medical devices might also experience significant growth rates next year, supported by Singapore’s existing expertise in precision engineering, Liew said.

Also, if oil prices remain at current levels near US$100 per barrel, this could support growth of the marine and offshore engineering segment next year.


MAS expects inflation to average between 2.5 and 3.5 per cent in 2012, remaining elevated over the next few months before easing in next year’s second half. This is a significant moderation from its 2011 inflation forecast of about 5 per cent.

It also expects core inflation, which excludes private road transport and accommodation costs, to remain stable and come in below 2 per cent from the second half of 2012.

Liew forecasts Singapore’s inflation rate at 5.1 per cent for 2011, before moderating to 3.2 per cent next year as expected weaker demand weighs on commodity and import prices.

“I think it (the inflation rate) is still fairly elevated if you look at the historical average for the last 10 years…3.2 per cent is still above the 10-year average CPI inflation numbers for Singapore,” he noted.

Referring to Singapore’s bidding system for the right to buy vehicles, Liew said Certificate of Entitlement (COE) prices will continue to support headline inflation somewhat next year as the government lowers the vehicle growth rate over the next three years.

“Of course, we are coming from a high base as well, so I think the impact (from COE prices) will not be as acute as what we have seen in 2011,” he added.

Liew’s assessment ties in with the government’s October announcement, which said the lower vehicle growth rate is not expected to have a large impact on the COE supply over the next few years due to a predicted uptrend in vehicle de-registration numbers.

Citigroup’s Kit forecasts that inflation may only moderate to 3 per cent next year, far above the historical average of 2 per cent, despite the gloomy economic situation of developed economies.

“Supply-side constraints from immigration tightening have likely worsened the growth-inflation trade-off in 2012,” he said, referring to the government’s latest policies on foreign labour.

In August, the government announced tighter eligibility requirements for employment passes that will take effect from 1 January 2012. And it has raised the administrative fees for work passes since the start of December this year.

“Given risks to growth, MAS is likely biased towards further easing to neutral (in its next policy meeting expected in April 2012), but with inflation still likely to be high in 1H2012,” Kit said.

Meanwhile, Barclays Capital expects inflation to average 3.1 per cent in 2012, compared with 5.2 per cent this year. It also does not foresee a significant increase in accommodation and private transport costs next year.

Barclays’ forecast followed the government’s announcement earlier this month of the latest cooling measures for private residential property. And in the transport space, COE prices have generally been falling in the last three bidding exercises since late November.

Like Kit, Leong Wai Ho, senior regional economist of Barclays Capital, also expects inflation to stay “elevated for a few more months”.

However, “our view is that headline inflation will cool next year, especially as we enter a period of slower activity”, he said, when contacted by Biz Daily.

“Although elements like services costs may remain elevated for a while longer, this should also cool later next year as the recent cuts to electricity tariffs are felt in the CPI,” Leong added.

Monetary Policy

Meanwhile, Liew said it would be a “pretty tough call” for the MAS to ease monetary policy from its current gradual appreciation stance during its next meeting expected in April 2012.

However, he added that the central bank would have “more manoeuvrability” to do so then, given the lower outlook for GDP and inflation.

“If for some unexpected reason, there is a credit event coming out of the European situation, we cannot discount the fact that MAS could ease its policy to neutral and it could even bring this forward before (its next) policy meeting itself,” Liew said.

An example of such a credit event, which he describes as “not in our base case scenario”, is where a European country defaults and leaves the eurozone, or the European banking sector faces a shock similar to that in the 2008 financial crisis.

Liew said that while these high-impact credit events were still of fairly low probability at the start of 2011, such probability has increased as 2012 approaches. This is reflected by the increased yields demanded by the market from some eurozone countries.

There has been a recent acceleration in the pace of finding a decisive resolution to the eurozone problem. Compared with 12 months ago however, Liew said the risk of a credit event happening before such a resolution has increased and will go up further the longer eurozone leaders take to resolve the crisis.

“I think the main (MAS) policy response to a significant slowing (of the economy) is fiscal, not monetary. Like we saw in 2008, fiscal policy is faster acting and more targeted,” Barclays’ Leong said.

He added that uncertainty remains over whether commodity prices and imported inflation will subside, especially if the European Central Bank embarks on larger-scale quantitative easing to support growth.

As such, monetary easing by the MAS is likely to come gradually and it is “not yet a given” that the central bank will go “to neutral” at the expected policy meeting in April next year, Leong said.

Labour Market

While job creation is expected to be “much slower” next year due to the uncertain external outlook, the brunt of any negative employment adjustments could be absorbed by foreign workers in light of the government policies, UOB’s Liew said.

Consequently, these policies are expected to add on directly to wage costs and support CPI growth pressures in 2012 despite the subdued inflation outlook.

With the increase in foreign labour costs, there could be a “like-for-like” substitution effect in favour of domestic employment if employers have to choose between local and foreign workers of the same profession, Liew said.

However, he also noted that some manpower-intensive sectors are still quite reliant on foreign labour, such as construction, food and beverage, hotels and services-related sectors.

“Definitely, the impact of increased costs from the foreign worker policies will be particularly felt by these sectors,” Liew said.

“Of course, many of these sectors will need to innovate (through more capital intensive processes) to depend less on labour as an input, but short-term wise, I think it will be very difficult to switch out completely,” he added.

Citigroup’s Kit said that in more extreme cases, firms highly dependent on foreign labour may be forced to relocate out of Singapore altogether as the increase in foreign worker levies squeeze margins.

With the limited ability of certain businesses to substitute foreign labour for local workers, wage and inflationary pressures might remain “quite elevated” in some industries next year, even through the downturn, he said. This is likely to be supported further by Singapore’s tight labour market.

The continued rise in unit labour costs ‒ exacerbated by the foreign labour policies ‒ might continue to exert pressure on margins of labour-intensive sectors, Kit said, adding it may only be “a matter of time” before firms pass on wage costs to consumers.