RETURNS ON RESERVES AND GOVERNMENT SPENDING

RETURNS ON RESERVES AND GOVERNMENT SPENDING: 3.

Mr Gautam Banerjee:

Mr Gautam Banerjee:

Mr Gautam Banerjee asked the Minister for Finance what are the additional amounts available for Government spending included in the revised estimates for the year ended 31st March 2009 and the budget for the year ending 31st March 2010 as a result of the constitutional amendment in October 2008 that now allows the Government to spend on the basis of total returns on relevant assets.

Mr Gautam Banerjee asked the Minister for Finance with regard to investment returns on our reserves (a) what are the key assumptions in computing the expected long-term real

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rate of return on relevant assets for the purpose of determining the total returns on these assets; and (b) how does the "expected long-term real rate of return" compare with the actual historical long-term real rate of return.

Mr Gautam Banerjee asked the Minister for Finance with regard to investment returns on our reserves, how he has satisfied himself with the reasonableness and fairness of the assumptions inherent in the computation of the expected long-term real rate of return on the relevant assets.

The Minister for Finance (Mr Tharman Shanmugaratnam): Mr Speaker, Sir, with your permission, I would like to take Question Nos. 3, 4 and 5 together.

Mr Speaker: Yes.

Mr Tharman Shanmugaratnam: Sir, Mr Gautam Banerjee asked about the additional amounts available for Government spending for year ended 31st March 2009 and year ending 31st March 2010 under the new Constitutional framework for spending from investment returns.

The new framework for spending will take effect from 1st April 2009. It, hence, does not affect the amount of investment income taken into the Budget for spending for the fiscal year ending 31st March 2009, which continues to be based on the earlier framework of actual interest and dividend income alone. For this fiscal year which is ending soon, the Government took in a Net Investment Income Contribution of $3.7 billion.

For the coming fiscal year ending 31st March 2010, the Net Investment Returns Contribution (NIRC) was estimated in the Budget to amount to $7.7 billion. The figure was reflected in the Budget Statement in January 2009. Compared to the Net Investment Income Contribution

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taken in last year under the old framework, the NIRC of $7.7 billion is an increase of about $4 billion, or about 1.6% of GDP.

Members would know that this Net Investment Returns Contribution starting with the coming fiscal year is based on the new framework of spending out of long-term expected real returns, not limited to interest and dividends. The framework applies to expected returns on the reserves managed by GIC and MAS. There is no change in rules for spending out of Temasek's returns, which continue to be based on actual dividends.

The process for determining the long-term expected real rates of return of the reserves invested by GIC and MAS has been rigorous. The rates, which refer to the expected real returns over the next 20 years, were proposed by the Boards of GIC and MAS respectively, based on detailed study and assessments by investment professionals in the two agencies. The GIC and MAS teams first projected the expected returns on each individual asset class, such as bonds or real estate. This was followed by aggregating the expected rates of return on the individual asset classes into the overall rates of return on the GIC and MAS portfolios, which take into account their respective asset allocation strategies.

The GIC and MAS took into account both historical trends and a forward-looking analysis of the investment outlook, before reaching their best judgments. The methodology did not in any instance involve a mechanical extrapolation of past trends. In making their assessments, they also took into account projections of future returns on each asset class by their peers amongst institutional investors.

The Ministry of Finance undertook a thorough review of the methodologies used by the GIC and MAS, and was

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satisfied that their approach was sound and the estimated long-term rates of return were reasonable. As Minister for Finance, I therefore proposed these rates to the President for the purpose of Budget 2009. The President obtained the advice of the Council of Presidential Advisers, as required under the Constitution, before concurring with the Government's proposals.

Mr Banerjee asked how the expected long-term real rate of return compared with the actual historical long-term real rate of return. The expected rates of return – to repeat what I mentioned earlier, which are estimates of the average returns expected over the next 20 years – reflected the GIC and MAS Boards' assessment that the future investment environment is likely to be less benign than that over the last 20 years. The expected rates of return for the individual asset classes over the next 20 years are, in fact, generally lower than the historical rates. However, the expected rates on GIC's overall portfolio also reflect the fact that it is now considerably more diversified across a range of risk assets than it was 20 years ago.

Mr Gautam Banerjee (Nominated Member): Sir, I thank the Minister for the explanations. Given the complexity of the process, the inherent risk of the assumptions that have been used in this expected long-term rate of return and, obviously, the interest by everyone in making sure that the process is robust and transparent, would the Minister consider, at some stage, giving a little bit more information and communicating on some of these details so that there is confidence and acceptance of the new procedures?

Mr Tharman Shanmugaratnam: Sir, first, of course, I can assure Mr Banerjee

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and Members that the process is a robust one. We spend a lot of time on this. First and foremost, within the GIC and the MAS – professional staff and the boards. The Ministry of Finance gets into a fair level of detail in assessing the methodology – we are not professional experts but we have got to make sure that the methodologies are sound and are comparable with the best practices in the investment world. The President, advised by the Council of Presidential Advisers, does an independent check on the methodologies so as to assure himself that the final proposals are sound.

This is not a science. It involves judgment, and this is judgment principally on the part of seasoned investment professionals. The best way of ensuring that the system is robust is to ensure these internal processes of governance, first, of putting professional expertise into play; second, internal governance within the GIC and MAS; third, the Ministry of Finance doing its own due diligence on the methodologies used; fourth, the Council of Presidential Advisers taking an independent look and advising the President; and, finally, the President deciding on whether to approve the Government's proposals. That is really the basis of our system. But I am sure the GIC will, in its annual reports in future, give a flavour of its thinking on the investment environment going forward. It has done so in its last annual report and I am sure, going forward, it will also provide a feel for its thinking on how the investment environment is likely to shape up.