SMU Political-Economic Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION - Taiwan An Interesting Stimulus Programme - A Case for Equities - The History of Financial Sector Reforms in Vietnam - A look into the past to understand the future The Fortnight In Brief (20th June to 2nd July) US: Obamacare and The Twist The Supreme Court made a landmark decision to uphold 'Obamacare', handing President Obama a political victory. With so much negative attention on the economy lately and the political gridlock in congress, this might be Obama's saving grace during the next election. In the meantime, the Federal Market Open Committee extended 'Operation Twist' up till the end of 2012 in response to recent weak economic data. This means more long-term assets would be bought by the Reserve Bank, thereby reducing long-term yields. Asia Pacific ex-Japan: Ups and Downs (again) With new orders and demand for exports dropping, Chinas PMI fell to 50.2 in June from 50.4 in May, the weakest expansion since year. On the other hand, despite Chinas slowing growth and the deepening of Euro crisis, the weakening of the Korean Won (approximately 6% against the US dollar) led to South Koreas exports registering gains, breaking the downward momentum that started since March. However, the trade ministry cut its estimate for export growth by almost halve to 3.5%, citing its concern of global economic slowdown. In the middle-east, sanctions on Iran by the EU come into full force, leading to a projection that supply of crude oil will be reduced by 1 million barrels a day. EU: Dodging yet another bullet The recent EU summit saw Eurozone leaders agreeing to restructure Spains 100bn bank recapitalisation plan, as well as creating short term relief measures for Italy amidst the debt crisis. While investors responded positively to the news by sending the Euro up 1.2%, the summit also exhibited the strained relationship between the northern member states pushing for budgetary reforms and the southern periphery looking for relief from high borrowing costs. The good news from the summit may calm markets for a time, but it remains to be seen if further steps will be taken to address the divisions within the EU at the root of the crisis. ISSUE 19 2 JULY 2012

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Taiwan An Interesting Stimulus Programme

By Lin Liye, Singapore Management University
This article looks at an interesting stimulus program undertook by the Taiwanese government during the global financial crisis to tackle the recession. During the Great Recession in 2009, the Taiwanese government had a creative stimulus plan to bring the economy out from recession - the Taiwanese government pursued a US$5.6 billion stimulus package, half of which was for the distribution of grocery vouchers to citizen born before March 31, 2009. Each citizen was able to redeem these vouchers, worth about US$108, and spend them on almost anything. The only drawback was that the vouchers would expire within a few months. This would ensure that no hoarding of vouchers was done and that the stimulus package would be spent and circulated in the economy. Because the money was in the form of vouchers, the people could not save it in the bank, and the only option was to spend it. Also, by making these vouchers faux money with an expiry date, the central bank would be able to withdraw them when the economy emerged from recession, which presumably would be the case when the expiry date was reached. This would ensure that the excess money in the economy would be withdrawn, reducing the risk of higher than expected inflation when the economy recovered. Indeed, the Taiwanese economy emerged strongly from the recession with a growth rate of more than 10% in 2010. Based on predictions by the Taiwanese government, through the multiplier effect1, approximately 1% of GDP would be due to the increase in domestic demand caused by the vouchers. This was indeed an interesting case of monetary policy, where the government pumped in vouchers that acted as money and ensured that the money would be circulating in the economy by allocating a fixed sum to every citizen. Administratively, these vouchers are easy to distribute and such policies can be easily duplicated in other countries. Since most countries today have a database of citizens and their addresses, these vouchers can easily be mailed to each citizen without fear of corruption. In Taiwans case, these vouchers were available at various collection points across the island. By putting money in citizens hands, there was a temporary boost in standards of living across the board. Receiving free money from the government, these vouchers would also surely boost the optimism and satisfaction levels of the recipients. Moreover, this move might be politically motivated as giving out vouchers to all citizens is a popular move and can help the incumbent party when elections arrive. This stimulus plan was not a novel policy invented by Taiwan. In fact, Japan was the first country to implement such a policy in 1998 as it sought new ways to crawl out from recession. However, a key difference was that the Japanese policy was less inclusive and had many restrictions, which led to only a quarter of the population receiving the vouchers. A study done in 2010 on the effectiveness of the policy in 1998 showed that the marginal propensity to consume2 (MPC) on semi-durables, i.e. consumer goods, increased by a small amount but there was no significant difference in spending on services and non-durables. This meant that the policy was successful in increasing consumption, and most people had used the vouchers for grocery shopping or necessities. However, some economists also argued that the boost to the economy was not as big as politicians had promised it to be because some households would just spend the vouchers and save the money that was supposed to be spent, reducing the impact of the policy. 2 Copyright 2012 SMU Economics Intelligence Club

Based on the experiences of Taiwan and Japan, the policy of giving out vouchers to citizens is effective in expanding consumer spending by about 1%. Nonetheless, such a policy only serves as a temporary boost to the GDP of a country without solving any underlying problems of the economy. In the case when the recession is caused by a lack of competitiveness, policies that focus on education and retraining workers will be more effective in the long run as they will resolve the structural problems that the economy faces. Not surprisingly, the above policies are also what the Singapore Government engages in during the recession in 2009, focusing on retaining the competitiveness of the local workforce instead of giving hand-outs to the population. Furthermore, giving out vouchers to citizens can be construed as a populist move of garnering more support and votes in an upcoming election, instead of a purely economically motivated cause. As history has shown, Japan remains mired in deflation and poor growth since 1998 despite the voucher stimulus, because there were other serious problems with the Japanese economy such as a heavy reliance on exports, a strengthening yen and an ageing population, among other problems. In Taiwan, even though the economy rebounded strongly the following year, there could be other reasons why the economy recovered. For example, the recovery in demand for exports of western economies was probably a bigger factor in the recovery of Taiwans recovery than the issuance of vouchers, since Taiwan is essentially an export-oriented3 economy with the US as its biggest market. It remains to be seen whether this novel policy of issuing out vouchers will be implemented by the Singapore Government as a tool to fight recessions in the future. It may be a useful tool for the government to retain votes and support, but such policies are not effective when recessions are caused by structural problems in the economy, such as a loss of competitiveness. Marginal propensity to consume The MPC is a measure of how much of an additional dollar is spent on consumption when income increases by one dollar.
1

The multiplier effect is an effect in economics in which an increase in spending produces an increase in national income and consumption greater than the initial amount spent.
2

An export oriented economy is one that targets most of its production to sell in foreign markets, using this as a main driver of growth.
3

Sources: CNN, BBC, and Journal of Public Economics

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A Case for Equities

By Gabriel Tan, Boston University

Let me begin this article with a disclaimer: The purpose of this article is not to tell you how to invest your personal portfolio even if I do overtly tell you how to invest. Instead, this article uses investment advice as a means to draw your attention to a simple but important notionnever follow market sentiment blindly. In the wake of 2011 and the first quarter of 2012, we have seen some incredibly turbulent and emotional times for investors. In 2011, we saw macro headlines driving market sentiments. With an abundance of uncertainty, the S&P 500 jumped almost 200 points between its highs and lows of the year. We witnessed events such as the Japanese Tsunami, major political events, and credit rating downgrades of major economies. As the Euro zone began to be the centre of investors focus, we saw continuous volatility as the headlines drove investors short term sentiments and this resulted in a tumultuous year for equities. This theme of investor sentiment permeated the equities markets as stock prices were highly correlated with general risk aversion. We saw a market in which fundamental bottom up valuation of firms no longer seemed to work. In fact, we found that undervalued stocks were punished severely in this risk-off environment. However, 2012 swung around and the world began to seem less scary. The S&P 500 had its strongest first quarter gain since 1998 and we saw around 150 points added to the index. This was driven mostly by the easing of the Euro crisis through a second Long Term Refinancing Operation (LTRO)1. This time round, the European Central Bank lent approximately 530 billion to banks. Just as the world seemed to be creeping out of a darkened global economy, April and May hit markets like a freight train. Mixed US economic data, Chinas growth slowing and the extent to which Spain was in trouble all came to light. The S&P 500 dropped over 140 points and market volatility was back to 2011 standards. During all of this however, the US economy still grew 3% in the 4th quarter of 2011 and 1.9% in the 1st quarter of 2012, and corporate America still posted strong earnings. Despite the good news, we saw declines in the equity markets. Investors began to flee from equities toward fixed income2 for safety throughout this period. Equities were simply deemed too scary. My question is, are they really too scary or are headlines deflating prices and deviating too much from fundamentals? When we invest and think about pricing and valuation, we have to think about the long run. If we, as investors, engage in trades at every news headline and pull out of equities every time the S&P dips and reinvest in treasuries3, your portfolio will likely suffer. When we think about investing we should be thinking about the next 5, 10 years at least. If we are to focus on the long run, valuation enters the picture again. Just because equity markets were all over the place in 2011 and valuation failed us then, does not mean that valuations will not come to fruition in 5 years. If we look at the relative price to book value of the S&P in Figure 1 below, we see that the index is at its lowest relative pricing since the 90s. This means that even if equities return 10% per year for the next 5 to 10 years, they would still be within a reasonable range and not overvalued.

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Figure 1: S&P 500 Relative Price-to-Book Value Source: Barrons

For fear of stepping beyond the scope of an economics article and to begin delving into the world of portfolio theory, I will keep my final section brief but it is necessary to drive this point home. There are generally 2 schools of thought when it comes to investing, passive and active. Active managers will tell you they can generate alpha, which is basically excess returns considering how much risk you are taking on, and historically, a lot of managers have been able to generate alpha and their funds have outperformed benchmark indexes. There are 2 problems with this however, one, managers are expensive and their fees eat away at returns, and two, most managers have trouble providing consistent alpha over a long period of time. Now with that being said, there is the alternative to that, passive investing. If you want returns with no unsystematic risk (individual security risk), an ETF is the way to go. An Exchange Traded Fund (ETF) is a fund that an individual can purchase that mimics the portfolio of an index. In this case, if you subscribe to my belief that the S&P 500 is incredibly under-priced as a whole, you would go out and buy S&P ETFs. With that being said, US equities are not the only securities available in the market and risk should of course be diversified appropriately over different asset classes. To sum this up, the message is not to go and put all your money in S&P 500 ETFs. Rather, it is to remember that just because the market is afraid of equities and things seem volatile, do not forget about the long term goal of markets. They are meant to reflect the underlying value of assets. In this case, the equity market was only an example. Blindly following market sentiment and psychology has led us to some devastating outcomes in the past. If everyone remembered the fundamentals of economics and pricing of assets, the markets would be a far less scary place than it is today.

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Operations undertaken by the European Central Bank to lend money to banks at low interest rates maturing after 3 months, 6 months, 12 months and 36 months.
1

A type of investing or budgeting style for which real return rates or periodic income is received at regular intervals at reasonably predictable levels.
2

The US government's negotiable debt securities. A Treasury bill has a maturity of up to one year, and is basically a money market instrument used to meet short-term cash requirements and regulate money supply. A Treasury note has a maturity of more than one year and less than 10, while a Treasury bond has a maturity of 10 years or more. The yield on the US government's 30-year Treasury bond - also called the long bond - is a key benchmark for other long-term bonds. All Treasuries are tradable in the secondary market.
3

Source: Barrons, Bloomberg, Bureau of Economic Analysis

The History of Financial Sector Reforms in Vietnam A look into the past to understand the future
By Hang Dieu Quang, Singapore Management University
Due to the chronic problems of macroeconomics1 volatility, Vietnam central bank - the State Bank of Vietnam (SBV) has been pressured to not only employ stringent credit controls and monetary policies to rein in the hike in inflation rate, they must now plan for a major restructuring of the entire financial sector. Many are hopeful that such reforms will bring about an end to the volatility and at the same time, prepare the financial sector to support an economy that is growing fast into its next phase of development. But evidences from past reforms are not so encouraging. The problems are far more complicated than they seem. Perhaps taking a look into the events that happened in the past decades may shed light on what needs to be done and where are the root causes of the problems at present.

Inflation (annual GDP deflator) Source: WDI (2010)

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Consensus Governance As pointed out by Dr McCarty, a professor from National Economics University in Vietnam, neither the Government nor the omnipresent Vietnamese Communist Party (VCP) exercised a tight control over all types of activities in the economy. They are present in all organized activity but only to intervene when they feels threatened. Interest groups interplay is allowed within this governance framework without permitting discrete points of authority to stand out. According to a study conducted by Sida2 on programme aid to Vietnam, the method of rule by the VCP is described as a system of checks and balances operating around the principle of consensus. As such, as described by Appold and Phong from Economic Development and Cultural Exchange in Vietnam, central planning committees and ministries are locuses of negotiation and bargaining between the state and its economic agents. With the Government preference for social and political stability, and its tradition of consensus governance, reforms in the financial sector are most likely be slow and takes a very long period of time to be executed. Independence of SBV The State Bank of Vietnam, the central bank, is a branch of the Government. Although it has gained more independence from the Government since the initial round of reforms that took place in the late 1980s, evidence of indirect controls were, and are still present. These controls hinder the efforts and capability of the central bank to carry out its essential roles as an important economic agent such as management of inflation, monetary policies, management and supervision of the private financial sector. The Governor of the SBV is a member of the Government. The supervision department in the SBV is a department under the control of the State Inspectorate. The independence of a central bank from a countrys Government is essential in ensuring the effectiveness of certain monetary policies such as those that aim at tackling inflation hikes. Although the legal independence of SBV was established with the passing of the Law on State Bank in 1998, its effort on regulating and supervising its own branches and other institutions under its responsibility is usually interfered by the Government. Policy Lending and Ever-greening of loans In 2001, the Government announced that policy-induced lending would be phased out except under limited and explicitly identified circumstances with Government guarantees. With limited transparency in its lending policies on state-owned-enterprise (SOEs), it is hard to estimate whether such policies has effectively been phased out as claimed. Over the past few decades, non-performing loans (NPLs) has been a key issue for stateowned-commercial-banks (SOCBs) that issued loans to the SOEs under policy-induced lending. The value of the NPLs in the SOCBs system is hard to estimate given the low transparency level. Another issue that makes estimation of the health of the SOCBs hard is the practice of ever-greening of loans - in which loans are rolled over and those that are defaulted are not registered nor declared. In 2009, the NPLs estimate by Vietnamese Accounting standard was 3% of the total sector loan while the estimate based on International Accounting standard was 13% according to banking sector analyst report by Vietcombank Securities. That said, it should be noted that the governing body has tried to adjust the accounting standard to match that of the International regulations. On top of the resistance from productive sectors in the Government, with SBV being a part of the Government, it is inevitable that unwarranted relationships between the SOEs and SBV 7 Copyright 2012 SMU Economics Intelligence Club

will develop, and the potential conflict of interest will hinder efforts in reducing NPLs. Any attempt to restructure and strengthen the financial sector would have to be supported by or preceded by a rigorous shake-up of the SOEs. Over the past decades, the Government performance on equitizing3 the SOEs is abysmal with a disappointing performance of only 6 successful cases between 2011 and first few months of 2012. Such results suggest that the efforts in reforming the financial sector seemed futile. Trust With the collapse of the system of credit cooperatives in 1990 and subsequent hikes in inflation in the past few decades, the market has become sceptical about the formal financial market and its reforms. This in turn has restricted the pace of reforms as it will take a long time to re-cultivate trust in the system. Subsequently, development of markets that are arguably essential in supporting the financial sector, such as the Government bonds and the real estate, will be prolonged. Conclusion The pressure is mounting on the Government and the SBV to devise a concrete and detailed roadmap for the financial sector such that the pace of development is fast enough to support the rapid growing economy accompanied by the increasing foreign presence. Recent gradual reactivation of more comprehensive and fundamental reforms represents an end to the beginning rather than a beginning of the end of reforms. Rather than focusing on choosing the right system for the financial sector, the Government of Vietnam should focus on developing a strong institutional regulatory and supervisory framework. Such approach is recommended by many analysts whose work focuses on transition economies like Vietnam where equity and securities markets are not sufficiently developed to support a more market-based approach to financial sector reforms.
1 The

field of economics that studies the behavior of the economy as a whole examining the economy-wide events such as the changes in national income, inflation, and unemployment etc.
Swedish International Development Cooperation Agency Government organization under the Swedish Foreign Ministry that administers portion of Swedens budget for development aid
2 3

The process of partial privatization of Government-controlled enterprises.

Sources: National Economics University (Vietnam), Sida, Economic Development and Cultural Exchange, Vietcombank, , From Monobank to Commercial Banking Financial Sector reforms in Vietnam (Book), The Changing Face of Vietnamese Management (Book).

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The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents Shane Ai Changxun (Vice President, Publication) changxun.ai.2010@smu.edu.sg Singapore Management University Singapore Herman Cheong (Vice President, Operations) Wq.cheong.2011@economics.smu.edu.sg Singapore Management University Singapore Fariha Imran (Marketing Director) Farihaimran.2010@economics.smu.edu.sg Singapore Management University Singapore Randy Lai (Editor) Tw.lai.2010@smu.edu.sg Singapore Management University Singapore Lin Liye liye.lin.2011@economics.smu.edu.sg Singapore Management University Singapore Hang Dieu Quang dqhang.2010@economics.smu.edu.sg Singapore Management University Singapore Ben Lim (Vice President, Publication) ben.lim.2010@smu.edu.sg Singapore Management University Singapore Tan Jia Ming (Publications Director) jiaming.tan.2010@smu.edu.sg Singapore Management University Singapore Vera Soh (Liaison Officer) Vera.soh.2011@economics.smu.edu.sg Singapore Management University Singapore Seumas Yeo (Editor) Seumas.yeo.2010@smu.edu.sg Singapore Management University Singapore Gabriel Tan gtan@bu.edu.sg Boston University The United States of America

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