SINGAPORE (Dec 31): The world is not going to be a kind place for small, trade-dependent countries such as Singapore. Geopolitical stresses, financial market turbulence, economic policy uncertainty in the big economies and trade frictions will make sure of that. The regional hinterland may offer some upside, but only so long as political and financial risks can be contained. As domestic demand in Singapore itself has been steady but lacklustre, the economy is vulnerable to shocks to external demand, which it depends on disproportionately. Fortunately, inflation is benign and the external surpluses remain large, giving the country considerable buffers to protect against a rough environment.

Modestly slower external demand with downside risks

The key drivers of the Singapore economy point to a slower pace of growth next year, at around 2.5%, compared with this year’s likely outcome somewhere in the region of 3.5%. This is seen in how the composite lead indicator — which predicts the course of the economy over the next year or so — has fallen for two quarters in a row. A look at the main international drivers of the economy supports this view:

  • G3 economies will slow but still raise global demand: The US economy is set to continue growing well above its long-term potential growth rate of just below 2%, but it will decelerate as the year progresses because the fiscal stimulus provided by President Donald Trump’s expansionary budget reforms will fade in the later part of the year. Similarly, the European and Japanese economies are also likely to lose momentum, but continue to grow in line with their long-term trend. So, the big three developed economies will add to global demand for Asian exports, but not as vigorously as in 2018. There is an important silver lining, though — US orders for electronic components are rising, which is positive for Asian exports, given the large footprint of the electronics industry in the region. Not only will our manufacturing sector benefit, as it is highly export-dependent, but our export-import sector will also enjoy greater demand, as we are a hub for sourcing electronic components for the region.
  • Global financial conditions will tighten further. Markets are at the moment hoping that the US Federal Reserve Bank will shift to a more dovish stance and avoid aggressive rate increases next year. This is, however, premature. The US economy is growing above its sustainable rate, and there are incipient signs that inflation will perk up. The Fed will raise rates at least twice in 2019 and continue to cut back on its quantitative easing. Similarly, the European Central Bank has made it clear that the slowing eurozone economy will not stop it from ending its quantitative easing policy in January. As global liquidity tightens, investors will continue to cut back on risky assets and become more rigorous in how they price assets. In a world full of political shocks and economic uncertainties, risk aversion is likely to prompt even more withdrawal of capital from emerging markets back into developed markets. So, global equity and bond markets will be volatile, while emerging market currencies will come under continuing pressure.
  • What happens in China will matter a lot. The economic data for November confirmed that the headwinds to growth are strengthening even in the face of an ongoing stimulus. Retail sales grew at the slowest rate since records started, while industrial production lost momentum, and investment did not accelerate as much as it should have, given the government’s ramped-up infrastructure and social housing construction.
    - Growth is not the issue: The authorities will turn more aggressive in further easing lending restrictions, cutting taxes and making it easier for local governments to raise investment spending. Consequently, economic growth will slow only a little from this year’s 6.5% to around 6.2% in 2019. Since the Chinese are responding to the US trade war against them by opening the economy up to more imports, there will be a better spillover of Chinese demand into demand for Asia’s goods and services than before.
    - The risk to Singapore and the region is from the side effects of policy stimulus: We think that there will be more speculative pressures on the Chinese renminbi. There will be knock-on effects if policy succeeds in boosting credit growth, raising household spending and improving investment. China’s current account balance, already in a small deficit after decades of surplus, will weaken further. Since China is no longer providing capital to the world but rather importing capital now, that changes the dynamics of the local currency for the worse. Credit-fuelled growth will also cause some financial imbalances to worsen, adding to concerns about the Chinese economy.

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