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V. Anantha-Nageswaran

The February 28 exercise in New Delhi was preceded by one in Singapore, and is to be followed by another in Hong Kong. V. Anantha-Nageswaran looks at what has been done in one city-state and what the other is likely to do.

IT IS budget time in Asia. On the same day that the Finance Minister, Mr Jaswant Singh, unveiled his Budget blueprint for 2003-2004, Singapore presented its budget too. Next week, Hong Kong is due to present its fiscal policy statement. For both these city-states (Hong Kong is now called the Hong Kong Special Administrative Region, or HKSAR, and is part of China under its "One State, two systems" principle), the budget document has assumed far greater degree of importance than it used to be, in the past.

Singapore and Hong Kong are mature economies

High growth was more the norm than the exception in the years gone by, for both Singapore and Hong Kong. Not so in recent years. In 2001, Singapore real GDP contracted by about 2 per cent and went up by 2.2 per cent in 2002. The net result is that the real GDP level is the same as it was at the end of year 2000. This year, the government forecasts the real GDP growth to be between 2 and 5 per cent. That is a wide estimate and for those of us who have got used to seeing the risks to government forecasts, the most likely growth number is between 2 and 3 per cent. For a mature economy like Singapore such a growth rate is not necessarily calamity. However, it gives rise to cries of anguish as the citizenry is, as yet, unaccustomed to such low growth rates and see themselves as perennial underdogs that need to grow at 8-9 per cent for ever to continuously catch up (with what or with whom?). Perhaps, with a few more years of modest growth would come acceptance of the reality.

Singapore, in this author's view, is suffering from a problem of prosperity. With growth and prosperity, better living standards, higher wages and cost of living follow. It is neither possible nor is it appropriate for Singapore to aspire to the wage levels of India and China without accepting their present state of economic development. Hence, erosion of cost competitiveness is inevitable for all nations as they achieve higher levels of economic prosperity.

Mature economies cannot compete on costs

Nations can chip away at a few areas of costs, offer a few concessions to new businesses to reduce their operating cost but it is mostly a losing proposition to compete on costs with developing economies such as China on manufacturing and India on services. The value that Singapore offers cannot be cost-centred but other forms of efficiency and excellence.

What Singapore is going through is a structural economic slowdown as opposed to a cyclical slowdown. It is likely to last longer than the latter. It signifies the end of one long economic cycle and the beginning of another. The first step to dealing with it is acceptance. Acceptance of reality as it stands even as one sets about improving it makes a material difference to the state of mental health of individuals. States are no exception.

It is time to relax on fiscal discipline

Having accepted it, then the country has to rely on its strengths to survive the difficult years. For instance, fiscal surplus reserves built up during good times should be put to use, to help the citizens cope with the loss of jobs and income. It is important not to make fiscal rectitude a habit at all times. After all, individuals are advised to build up safety nests for tough times. The same goes for nations. Fiscal surplus is not an end in itself and certainly not for all times. In the case of Singapore, it has built up substantial reserves and has taken some steps to put them to use. It has lowered (its already low) tax rates for individuals and corporations and issued Singapore shares for its citizens that could be redeemed for cash.

However, it has sought to offset this with higher user charges for public transport, hospitals and an increase in the General Sales Tax. This author finds it a little hard to digest the arguments in favour of such fiscal compensation from the government standpoint. Even if one were to accept the argument that the government was not recovering costs, it might have been prudent to let the implicit subsidy continue for it would be another form of counter-cyclical fiscal expansion in difficult times?

Nonetheless, one has to record that the government has allowed fiscal deficits to arise and even rise. Hence, the intent is there and the issue is whether the government could or should do more.

Besides putting past savings to use, mature economies should then set about identifying areas where it can grow and provide value, instead of trying to compete on costs. In this regard, the Singapore government appointed an Economic Reform Commission to explore, identify and develop such niche areas of growth. It has identified wealth management, hospitality services (business conventions and conferences), health care and education as such niche areas where it could grow.

In the field of education, institutions of higher learning in Singapore have sought to increase course offerings in recent years by striking alliances with Western universities. Strengthening the education sector has other advantages too. It attracts foreign students to use the city-state as a learning centre. It also raises the chances of them staying behind to seek employment. Singapore thus has the opportunity to retain the best and the brightest of them. In this regard, it is seeking to clearly take a leaf out of the books of England, America and Australia in recent times. Indeed, the technology boom in Silicon Valley is largely attributable to top talent of the Indian Institutes of Technology that found a home there. There is another advantage.

While these measures are sound and deserve to be pursued, they would yield dividends over time. In the short-term, Singapore remains an externally dependent economy and particularly on electronic exports to the US. Hence, there is a need for the government to continue to support the public in the short-term while it facilitates the aforementioned long-term growth areas. Let us see how the budget for the fiscal year 2003-04 tackled these two challenges.

Fiscal 2003 budget is only modestly expansionary

The Singapore government has lowered the salary ceiling for companies to contribute to the Central Provident Fund in two stages from SGD6000 to SGD5000. The time-frame for employers to restore their contribution to 20 per cent of salaries (subject to the aforementioned ceiling) has been extended by two years. These measures are meant to lower cost of operations for businesses. It has also exempted from tax foreign income earned by Singapore companies located abroad. It has enhanced the exemption limits allowed for companies under the double tax deduction scheme when they recruit top talent for Singapore, by extending it to spouses and two children. The government committed to divesting from non-strategic companies held by its statutory boards and named three companies that it would be divesting from.

Mostly, one gets the impression that the budget is good on intent and heavy on details without too many surprises that could cause either anguish or excitement. The government has reiterated its commitment to balancing the budget over the term of the government. It does not seem necessarily warranted. The arguments were laid out earlier. The government acknowledges the risk of the unemployment rate rising to around 5.5 per cent from the present 4.4 per cent. If so, it would be historically unprecedented. The determination to avoid deficits unless exceptional circumstances warrant sits oddly with this assessment. In a way, it reminds one of central bankers fighting yesterday's inflation battle when the problem, here and now, is one of deflation.

Hong Kong has to restore fiscal discipline

The situation with Hong Kong is different. It really has to show a commitment to lick its deficit problem. In economics, no two situations are similar. It is worth repeating here. Economic policies and prescriptions must be flexible over time and across nations. Budget revenues for Hong Kong have dried up in the last few years due to the total collapse of revenue from land sales as property prices have plummeted. The beginning of such a steep decline in Hong Kong's property prices coincided with the return of the territory to China. Of course, the Asian economic crisis of 1997-98 played an important role in deflating the speculative bubble in real estate across much of East Asia.

In recent years, the end to technology boom, the inability of the US economy to grow at the same rate as it did in the nineties and the willingness of global businesses to deal directly with China have all cast a pall of gloom on Hong Kong's property prices. Many predict an end to the deflation this year based on a normalisation of the global economic cycle. It would be dangerous to bet on the outcome. After all, uncertainties for the global economy have never been greater.

Otherwise, the financial system could be strained

The HKSAR government can rely on its exchange reserves to finance the deficit. However, at the present rate of fiscal deficit (HKD70 billion), reserves would be exhausted in four years. Hence, every one is anxious to see what plans the government has to arrest the fiscal deficit. At 15%, Hong Kong has one of the lowest income tax rates for businesses and individuals. There is scope to increase it gradually. Moreover, its civil service is big and is well paid, too well paid according to some.

Alternatively, the government can finance the deficit by borrowing instead of running down reserves. Some argue that if the Hong Kong government abandons the currency peg to the US dollar, it does not have to worry about exhausting its reserves and could issue debt as well.

Opponents of this proposal counter that if the government resorted to this solution only to continue to be able to run fiscal deficit, it might be seen as callous and result in significant currency depreciation once it begins to float. Panicky residents might move their assets out of the country, straining the financial system. In their view, the government has to first restore confidence in its ability to govern and show that it has the resolve and imagination to rein the deficit in. Then, allowing the Hong Kong dollar to float would be a reasonable second step. Where there is lack of confidence, fiscal prudence would not exacerbate the cyclical economic downturn. It could turn out to be positive if it boosts business and consumer confidence. However, Hong Kong residents that this author spoke to over the weekend express scepticism over the prospect of such an orderly process of deficit reduction and floating of their currency.

If the government proves such sceptics right, then Hong Kong interest rates would become volatile and the anticipated funds withdrawal would begin to happen sooner. Any instability in the Hong Kong financial system would be an unwelcome distraction for China as it has a big problem with its own financial system. Its banks are reeling under a mountain of bad loans, reliable estimates of which are not available. Further, the region facing another year of tough global economic environment, high oil prices and coping with terrorist risk, can surely do without a mini or mega re-run of the financial crisis of 1997-98. Hence, a lot is riding on the Hong Kong administration's budget statement due on the fifth of March. Not just Hong Kong residents would be watching it anxiously.

(The author is Director of Global Economics and Asset Allocation in Credit Suisse, Asia-Pacific. His views are personal. Feedback may be sent to anantha@nageswaran.com)

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