Singapore: Steering through challenging times Asia Pacific Economic Outlook, Q1 2016

Singapore recorded modest growth in Q3 2015. Manufacturing was a sore spot. The policy decision to stem the inflow of cheap foreign labor poses challenges for integral sectors of the economy, such as manufacturing, that rely heavily on low-skill foreign labor.

Singapore finds itself in a rough economic environment. Internally, the city-state continues efforts to transition to economic activity of higher value addition and value creation while also focusing on improving social welfare. As expected, the climb up the value chain as well as the policy decision to stem the inflow of cheap foreign labor poses challenges, such as sharp wage increases in an already tight labor market. Integral sectors of the economy, such as manufacturing, that have relied heavily on low-wage, low-skill foreign labor are now under duress. Additionally, the absence of gains in productivity is a cause for concern.

Despite the challenges that Singapore faces, constructive policies and healthy macroeconomic fundamentals continue to make it an attractive destination for investment and business. Externally as well, Singapore stands to gain from closer regional integration and trade agreements.

Furthermore, the correction in Singapore’s housing sector continues to be a drag on growth. Externally too, Singapore’s trade-driven economy faces a challenging environment. Low oil prices, a strong US dollar, and weak global demand are reflected in Singapore’s soft merchandise export growth figures. Weak growth in domestic merchandise exports, in turn, adds to the burden of the manufacturing sector, which has been the primary drag on growth in real GDP over the last two quarters. On the contrary though, the services sector has been a source of growth, and this will likely continue through the near term. As a whole, growth in real GDP in 2015 is likely to be modest. However, despite the challenges that Singapore faces, constructive policies and healthy macroeconomic fundamentals continue to make it an attractive destination for investment and business. Externally as well, Singapore stands to gain from closer regional integration and trade agreements.

Singapore_Figure 1. GDP growth (%, quarter-over-quarter SAAR) was positive in Q3 after contracting in Q2

Singapore records modest growth in Q3 after contracting in Q2

Singapore’s economy returned to growth in Q3 after shrinking in Q2. Real GDP growth on a quarter-over-quarter seasonally adjusted annualized basis was 1.9 percent, up from a contraction of 2.6 percent in Q2.1

Singapore_Figure 2. Rising labor costs without gains in productivity are a cause for concern

Yet again, manufacturing was a sore spot for the economy—the sector shrank 4.6 percent on a quarter-over-quarter seasonally adjusted annualized basis, continuing from a decline of 17.3 percent in the previous quarter. Weakness in the manufacturing sector shaved off 1.2 percentage points from year-over-year GDP growth in Q3.2 In fact the Purchasing Managers’ Index (PMI) reading, an indicator of the health of the manufacturing economy, has remained below the critical mark of 50 from July to October, indicating four consecutive months of contraction.3

Services producing industries grew 3.5 percent quarter over quarter in Q3, reversing a contraction of 0.2 percent in the previous quarter. Growth in services is likely to be driven by government-related services focused on skill development and education, household expenditure, and a healthy tourism sector. An increase in the number of tourist arrivals in Q3 compared to a year ago was reflected in the 11.9 percent growth in accommodation and food services in Q3.4 As a whole, the services sector is likely to compensate for the decline in the goods producing sectors of the economy. In fact, services producing sectors are likely to play an increasingly important role as Singapore climbs up the value chain. This is particularly pertinent as the focus for development shifts to clusters such as applied health services, logistics, and financial services.

Singapore_Figure 3. Weakness in NODX has continued into 2015, while services exports have seen growth

Internal challenges are likely to subdue growth

Singapore’s internal restructuring process was always expected to bring along its share of challenges, as all economic restructuring processes do. Not least among these challenges is the shift away from low-skilled, low-wage foreign labor, especially in sectors like manufacturing that have relied heavily on foreign workers since the foreign worker policy was liberalized between 2003 and 2008. In fact more than four-fifths of Singapore’s average annual growth of 5.8 percent over the last decade has been due to growth in the workforce.5 The current moderation of workforce growth, coupled with an already tight labor market, has resulted in sharp increases in the cost of labor—overall unit labor cost was up 4.5 percent from a year ago in Q3, continuing from increases of 5.4 percent and 5.1 percent in the previous two quarters. In the manufacturing sector, unit labor cost was up 8.1 percent in Q3 following a rise of 8.3 percent in the previous quarter.6

For Singapore to keep growing, the alternative to workforce growth is gains in productivity, and the need for this is particularly significant given the uptick in the cost of labor and, more importantly, Singapore’s demographic challenge—an ageing population and slowing population growth. However, productivity growth numbers are a cause for concern—output per employed person has declined on a year-over-year basis for four of the last seven quarters. In fact productivity growth has been slowing since Q2 of 2010.7 The absence of productivity growth is Singapore’s immediate and most pressing concern as it attempts to move up the value chain to higher value addition and value creation.

Another internal challenge that Singapore’s economy faces is the unravelling of the housing sector. House prices have declined on a year-over-year basis for seven consecutive quarters with the largest decline of 4.24 percent in Q3 of 2015. The rental index for all residential property has also been in decline for seven consecutive quarters, and the vacancy rate for private residential property hovers close to 8.0 percent. It is highly likely that the oversupply in the housing sector will persist through the near term and therefore be a drag on overall growth.8

Trade headwinds are another concern

Singapore’s internal concerns, taken along with its external challenges, make for an overcast picture. Total merchandise exports in US dollar terms and on a year-over-year basis have contracted for each of the last 13 months. The low price of oil, the relative strength of the US dollar, the slowdown in China, and weakness in overall global demand are the primary factors that have weighed upon global trade in general and Singapore’s exports in particular. Non-oil domestic exports (NODX) from Singapore, a more specific indicator of the country’s domestic goods export sector, have been patchy at best. On a year-over-year basis, NODX declined by 3.0 percent in Q3, reversing growth of 2.1 percent in Q2.9 In October, NODX decreased 0.5 percent from a year ago, with exports to China declining 8.7 percent and exports to the United States declining 2.2 percent.10

Singapore’s trade in services helps to brighten the picture. On a year-over-year basis the export of services grew 2.8 percent in Q3, following a 4.4 percent increase in Q2.11 However, any further weakening of global demand is likely to keep exports of services under check.

Given the headwinds that Singapore faces on the trade front, the Monetary Authority of Singapore (MAS), the country’s central bank, announced a slight reduction in the rate of appreciation of the Singapore dollar’s nominal effective exchange rate (S$NEER) policy band (in October). This measure is conservative at best, but leaves the MAS room for further easing of monetary policy, which is a possibility in the near term. Moreover, liftoff of interest rates in the United States is likely to cause further depreciation of the Singapore dollar against the US dollar, therefore providing some support to exports. However, higher interest rates in the United States will also cause depreciation in the currencies of emerging markets, some of which are Singapore’s competitors in trade.

A few bright spots amid the concerns

Though the economic situation for Singapore is indeed difficult, it is definitely not all doom and gloom. The positives include an increase in government spending—the budget for 2015 outlines an increase in spending on education and infrastructure investment through to 2020. SkillsFuture, the government’s nation-wide skills development program, is a positive step toward creating and sustaining gains in productivity. Furthermore, the identification and development of future growth clusters such as advanced manufacturing, applied health services, logistics, smart urban solutions, financial services, and aerospace, will make Singapore’s transition up the value chain a smoother process. Closer integration with the Association of Southeast Asian Nations (ASEAN) through the Asian Economic Community is also likely to boost growth (by 9.5 percent by 2030).12 Integration with ASEAN will also allow firms to shift lower-value manufacturing from Singapore to countries with lower labor costs, thereby allowing for efficiency and increased focus on higher value addition and value creation. Singapore also stands to gain from the Trans-Pacific Partnership as the dropping of tariff and non-tariff barriers is likely to boost trade.

In addition to these bright spots, Singapore’s macroeconomic fundamentals remain solid. As a result, the city-state still finds itself at the top of the Ease of Doing Business ranking.13 For now though, Singapore’s challenges will keep growth “close to 2.0 percent” in 2015 and modest over the near term.14