OUTLOOK FOR 1999

Notwithstanding the bleak picture in 1998, some positive signs have emerged over the last three months that the crisis is stabilising. The quick succession of US federal rate cuts and the co-ordinated interest rate reduction initiated by European central banks toward the close of last year helped to allay concerns of a global credit crunch and set the stage for a rapid, albeit fragile, recovery of financial markets in early 1999.

Financial indicators have also stabilised in the region. Interest rates have dropped sharply, improving liquidity and reducing debt-servicing expenses. Confidence has been further boosted, particularly in Korea and Thailand, by credible progress on policy reforms, sizeable trade surpluses and strengthening foreign reserves.

In Singapore, some economic indicators are starting to improve. The Composite Leading Index (CLI), which leads economic activity by about nine months, increased marginally in the third quarter of 1998 and picked up momentum in the fourth quarter, after three consecutive quarters of decline. Increased new orders, lower manufacturing unit labour costs and improvements in business expectations helped fuel the turnaround in the CLI.

There are also nascent signs of a recovery in the global electronics industry. Demand for disk drives and semiconductors is on the upturn, following the corrections in inventory overhang and healthy new orders from the US. The global semiconductor industry is forecast to grow by 15% in 1999, after contracting by 6% last year (Source: Dataquest.). Global shipments of disk drives are expected to rise by 18%, with revenues growing by 7% (Source: TrendFocus).

Despite these positive signs, 1999 may well turn out to be another difficult and challenging year for Singapore. We are in a period of sharp discontinuities. Many uncertainties in the external environment can still unravel, including significant economic, social and political risks. Their outcome will substantially affect our prospects this year.

Global Financial Market Volatility

Financial markets, especially in the emerging countries, are still fragile and prone to bouts of nervousness, as is evident from the recent episode of the Brazilian Real flotation. More importantly, the process of de-leveraging and portfolio re-balancing in response to heightened volatility and risk aversion in emerging markets is not yet complete. This will restrict the region's much needed access to international capital.

Health of the US Economy

With Japan stagnating and EU adjusting to its new monetary union, the US remains the linchpin of the global economy. Some analysts have remarked that "what happens in the US is make-or-break for the world economy this year". (Financial Times, "Cracks in Wall Street", 7 January 1999, Samuel Brittan.) The current US expansion has entered its 92nd month, the longest peacetime expansion since the 1850s. Rapid above-potential growth, however, has led to some macroeconomic imbalances in the US economy. The savings rate has turned negative. Current account deficits are at a record high. The US economy is widely expected to moderate to slower growth this year. This is viewed as a welcome breather for the overheated economy.

There are, however, several downside risks to this projection for a soft landing in the US economy. For one, a sharp correction in the US stock market may push the US economy into a sharp contraction rather than a benign easing. An estimated 40% of the average US household's net worth is in the stock market. The negative wealth effect from a substantial correction on Wall Street is potentially large. The OECD has estimated that a 20% fall in US equities could lead to a 1% reduction in US GDP as a result of lower consumer spending. (December 1998 OECD Working Paper, "Stock Market Fluctuations and Consumption Behaviour: Some Recent Evidence".) This does not account for the impact on investments or the secondary knock-on effects, particularly on global financial markets, which are likely to be substantial.

Aside from the equity risk, there could also be significant repercussions on the US banking sector and economy if Brazil falls into full-blown recession and drags down the rest of Latin America. The US extended 51% of its total overseas lending and directed 21% of its exports to Latin American countries. In terms of corporate exposure, 20% of US' earnings from direct investments abroad were derived from Latin America. The linkages are significant and pose a potential threat to the health of the US economy.

Economic Recovery in Japan

Japan accounts for 64% of Asia's output and absorbs about 12% of Asia's exports. It is a key source of capital investments and loan financing for Asia. After last year's package of counter-cyclical policy measures, the Japan Economic Planning Agency (EPA) has estimated that with sufficient stimulus, real GDP growth of 0.5% in FY1999-2000 should be achievable. The Diet has passed a stimulatory budget worth 82 trillion yen for the coming fiscal year. If the Japanese economy recovers as expected by the EPA, it can be the locomotive to pull Asia out of its slump. However, the chances are that economic stagnation will continue for some time. Competitive pressures may undercut export earnings. Rising bond yields have raised long-term borrowing costs, while over-capacity in the manufacturing sector is dragging down profits. Consumer and business sentiments are bearish, weighed down by bankruptcies and high levels of unemployment. These factors make prospects for a near term recovery very uncertain.

Socio-Political Developments in the Region

The success and pace of economic reforms, restructuring and recovery in the region hinges on restoring and maintaining social and political stability in the affected countries. Popular support and social order are pre-requisites to carry out tough reforms, implement rational policies and restore confidence. This is a challenge which all the crisis-hit Asian economies are grappling with.

The biggest uncertainty is Indonesia, where social and political tensions threaten to undermine financial and economic reforms. The coming June elections will be a milestone in determining how the fragile political and social conditions develop. If the elections proceed smoothly, the newly elected government can ride on its popular mandate to rebuild the economy. However, there are considerable stress points ahead. In particular, the possibility of civil unrest derailing the reform and recovery process is worrisome. An unsettled Indonesia will colour the entire ASEAN region, including Singapore.

Amidst this backdrop of uncertainties, the Ministry of Trade and Industry has maintained a 1999 GDP forecast of between -1% and +1% for Singapore. If the global and regional environment remains benign and none of the major risks I have outlined above materialise, and in particular the situation in the region stabilises and begins to turn around, then it is conceivable that our GDP growth may exceed +1% in 1999. On the other hand, if some of the critical uncertainties in the external environment do unravel, then Singapore will face a more dismal economic backdrop and GDP may contract by more than 1%. On balance, we feel that -1% to +1% is an appropriate forecast in an uncertain situation.