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Emerging Markets

Singapore: Unintended consequences

Singapore is using its national reserves to shore up its faltering economy. But new questions are being raised about its sovereign wealth strategy

Singapore is slinging cash into its faltering economy. Armed with huge foreign reserves, the city state is fighting back against collapsing trade and capital outflows. In January, the government unveiled a stimulus package worth S$20.5 billion ($3.7 billion) – a move that pushed the budget deficit to a record 3.5% of GDP.

As an innovative trade and financial hub, Singapore has built up substantial balance of payment surpluses thanks to plentiful foreign investment over the past three decades. But for the first time ever, the government has raided its national reserves – held by the Monetary Authority of Singapore (MAS, the central bank) and the Government Investment Corporation (GIC) – for S$4.9 billion.

The move is a response to a global crisis that has hit from every angle. Singapore’s economy contracted by 17% in the last quarter of last year, and by a further 11.5% in the first three months of 2009. Manufacturing, retail and financial service industries are experiencing double-digit decline.

New precedent

The amount tapped from sovereign reserves may be relatively small, but it sets an important precedent – amid awkward questions about Singapore’s reserve management strategy.

The GIC was created in 1981 as a diversified, long-term investor in offshore markets to complement its smaller sister fund Temasek, which has historically focused on equity investments domestically. But in the bull market of recent years, both funds have taken aggressive yield-hungry bets across the globe. The pitfalls of this approach came to light in February when Temasek announced a 31% fall in the value of its portfolio from S$185 billion to S$127 billion between April and November last year. This was partly driven by high-profile and loss-making investments in the western banks, Merrill Lynch and Barclays.

To add insult to injury, GIC has also seen its $18 billion investments in UBS and Citigroup – made at the top of the market – drop like lead. Some reports suggest total assets under management at GIC have fallen by 25% against its peak last year, estimated at around $250 billion at the time.

The losses have caused public outrage and have sparked a debate about Singapore’s approach to its foreign reserves. “There has been a lot of talk, even at coffee shops at the grassroots level and among our residents, about the losses by our SWFs [sovereign wealth funds] and whether this government has undone what our past government had so painstakingly built up,” said Inderjit Singh of the ruling People’s Action Party this February.

Long-term view

Yet the country’s finance minister Tharman Shanmugaratnam believes this stance is misguided. “The whole idea is not to be too influenced by a single investment cycle or a cyclical boom but to take a long view – roughly three investment cycles,” he tells Emerging Markets in an interview.

Over the past 20 years, GIC has returned 7.8% annually compared with 7% for the world stock market, the MSCI World Index, while Temasek has had an average 18% annual return on its investments since its inception in 1974. But whether such returns can be sustained given the rupture in global capital markets remains an open question; the MSCI tumbled a record 42% in 2008.

“The fundamentals suggest lower rates of return across most asset classes over the next 20 years, but at the same time, asset allocation [in Singaporean state funds] is more diversified, and this is an offsetting factor,” argues Shanmugaratnam.

There have been growing calls for new, more restrictive controls on asset allocation by GIC and Temasek, in light of their controversial losses. But the minister, also a GIC board member, is noncommittal on the prospect of the government imposing such measures. Instead of insisting, as many critics have, that investments should be ploughed into credit at the expense of equities or into less risky tracker indices, he argues that GIC’s government-mandated performance criteria themselves impose strong risk controls.

Shanmugaratnam says the government’s guidelines for GIC on maximum permitted losses over the medium to long term also help mitigate risk. The suggestion is that if losses on GIC’s western equities are absorbed by strong risk-adjusted returns on other investments across its broad portfolio, the fund may escape tighter restrictions on its asset allocation strategy.

State funds globally are increasingly turning to domestic markets under political pressure to provide much needed liquidity. But Shanmugaratnam argues neither GIC nor Temasek should be formally mandated to invest domestically to shore up credit conditions.

The global economic crisis has highlighted both the financial and political benefits of having easily accessible and large cash reserves. But the minister denies the MAS will be beefed up at the expense of these state funds in future capital allocations. Nor will GIC be forced to increase its proportion of cash reserves significantly, he says. “We are comfortable with the current availability of cash reserves [at the MAS, GIC and Temasek] should we require to draw upon it,” he says.

Despite the unprecedented fiscal intervention this year, most consensus forecasts predict a 4% contraction in GDP – the worst performance on record. As a result, Shanmugaratnam “cannot rule out” drawing on reserves again in 2010 in the event of a protracted downturn.

Changing landscape

The developments in Singapore are taking place against a rapidly changing global financial landscape that has become increasingly hospitable to sovereign wealth funds in the past six months. Western governments were recently fearful of the political motives of foreign sovereign funds. But now, says Shanmugaratnam, the need for capital providers has “probably” moderated western hostility to SWFs.

As large, unleveraged long-term investors, such funds “may play a bigger role in stabilizing the global financial landscape” now western banks and hedge funds are severely constrained, says Peter Kerger, Asia-Pacific head of DB Advisors in Hong Kong, Deutsche Bank’s asset management division.


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