A recession in the United States and Europe would badly hurt Asian Economies, especially Singapore’s, which still rely heavily on these two export markets for growth, according to economists.

a) Explain the effect of the US slow down on the Singapore’s economy. [12]

 

Intro

The emergence of sub-prime loan losses in 2007 kickstarted the US slowdown and exposed other risky loans and over-inflated asset prices. As a result the US experienced a slowdown or recession spanning over 18 months beginning in December 2007 and ended in June 2009,

Like many open economies worldwide, the global financial crisis triggered a marked slowdown in Singapore’s economy and particularly for Singapore, in the following areas: Economic growth, unemployment, inflation and balance of payment.

Impact on GDP through decrease in consumption and investment

The impact of the financial shock on Singapore’s economy and GDP can be analysed through several key channels. There was firstly an immediate impact on sentiment-sensitive segments of the domestic sector. As falling asset prices led to declining household wealth, consumer spending contracted which affected property sales and financial intermediation activities. Secondly, there was an effect on investment spending. Prior to the sub-prime crisis the cost of corporate financing was at a historic low. The credit crisis led to increasing scarcity and higher financing costs. This affected investment spending as projects were postponed or cancelled if their returns could not justify the cost of funds.

In addition, international banks and institutional borrowers faced the stress of a credit crunch. With the exception of Hong Kong, Singapore’s financial sector experienced the greatest decline in cross-border loans as a percentage of GDP, which were very high prior to the crisis and shrank when risk appetite receded. In the two years prior to the global financial crisis, the gross value of financial account transactions increased by a factor of more than three in Singapore, mostly due to increases in portfolio investment.

 

Impact on Trade – physical goods

As an economy structurally dependent on international trade, Singapore’s export sectors were affected by a slump in export demand. It was observed that the most iconic industries of Singapore’s value-adding restructuring effort – bio-medicals and tourism – relied heavily on external demand and had ironically made Singapore more vulnerable to the recession. Singapore was also one of the most exposed Asian economies during the crisis; as although volumes of intra-Asian trade in intermediate goods increased, US markets remained the final export destinations of high-end manufacturing products such as electronics. In 2008, GDP contracted due to manufacturing in Q2 and then the slippage extended to construction and a broad range of services.

Impact on Trade – services

Singapore’s position as a trade hub supporting trade-related services from transportation to trade finance meant that the slowdown had ramifications exceeding the export-oriented manufacturing sector. Its financial services industry contracted and trading activities fell substantially in foreign exchange, stock brokerage, and fund management. This accounts for why Singapore was one of the hardest hit economies during the global downturn. In fact, this financial crisis was the worst Singapore experienced since its independence in 1965. The downward pull of the global recession on Singapore’s economy continued into 2009 as negative GDP growth was forecasted at -9% to -6%.

Depreciation of Exchange rate.

Sing dollar MAY depreciate as demand for Sing dollar falls. Provided MAS is willing to allow it to depreciate.

BOP

As explained above, BOT will worsen as exports fall. Imports may also fall but the extent will not be large as Singapore kept the exchange rate at zero appreciation.

Draw fall in AD graph

As a result of a decrease in consumption and trade which are the main components of AD, Singapore’s economy will experience a fall in AD leading to a more than proportionate fall in NY through the reverse multiplier process as the reduction in AD leads to a fall in NY and the fall in NY causes a futher fall in AD.

Increase in Unemployment

As a result of the fall in aggregate demand, there will also be an increase in unemployment. As production falls, unemployment will increase as labour is a derived demand.

Fall in inflation

Inflation rate will fall as the economy moves away from full employment level of national income.

Conclusion

Singapore will be negatively affected by the US slowdown due to it’s small and open economy. In spite of this heightened potential vulnerability to capital reversals in the region, Singapore’s vulnerability to a slowdown in the financial market and capital outflows may be buffered by a consistent current account surplus, and a high sovereign rating of AAA.