This story was originally published in The Straits Times print edition on March 20, 2009.
WITHIN three years of becoming independent in 1965, Singapore was able to chalk up Budget surpluses year after year for close to two decades.
Government policies that encouraged foreign investors to set up shop here, a benign external environment and a prudent Government that stressed thrift boosted economic growth and helped build up this savings pool.
At the end of each government’s term in office, these and other savings were “locked up” as past reserves.
For a country with no natural resources, these reserves were deemed a critical form of insurance against the unexpected.
As these funds grew, the Government was concerned that Singapore’s key form of wealth could be wiped out rapidly by a profligate government.
It therefore introduced checks to safeguard the reserves.
But the Government also came to recognise that part of the extra income the reserves make can help meet spending needs in times of emergency or when revenue dips.
Thus, over the years, it has refined what is in the reserves, as well as the framework for managing them.
The aim: To strike a balance between growing them and drawing on part of them to fund current needs.
More recently, the Government’s draw on the reserves to save jobs and businesses in the current financial maelstrom is recognition that they are indeed meant for times of crisis.
The draw also puts into practice a procedure first thought up 25 years ago to ensure that the country’s accumulated wealth is carefully protected and used only when really needed.
Managing the money
THE Monetary Authority of Singapore (MAS) was the first agency to invest the accumulated reserves.
As the pool of funds grew rapidly, the need for a dedicated organisation to ensure it continued to grow over the long term became apparent.
The Government had also set up Temasek Holdings in 1974 to manage, on a commercial basis, a range of national companies, from Singapore Airlines to DBS Bank and Neptune Orient Lines.
What stood at little over $1 billion in 1965 was added to and invested.
By 1981, Singapore’s official reserves topped $15 billion.
The same year, the Government moved to create the Government of Singapore Investment Corporation to invest the reserves with an eye on better returns in the long term.
By 1984, the reserves were a sizeable $23 billion.
The Government also became concerned about protecting what it had built up from being frittered away needlessly should a profligate government come into office.
In the 1984 General Election, the People’s Action Party won 64.8 per cent of the votes, down from 77.7 per cent in the 1980 election.
Then-Prime Minister Lee Kuan Yew mooted the idea of a “block” on the reserves, so that they could be drawn down only with the President’s assent.
After much consideration, the Constitution was amended and the elected Presidency came into effect in 1991.
The principal sum of past reserves was locked up to safeguard it for crises that might afflict future generations.
Since then, past reserves (estimated to be worth between $300 billion and $450 billion today) can be tapped only with the consent of the President, who would hold the “second key” to these reserves.
Should the need to draw them down arise, the first key – or guardian – is the Prime Minister and his Cabinet.
The Government will then have to go to the President, who will consult his advisers before deciding whether or not to approve the withdrawal.
Uses in a crisis
THIS block on past reserves, however, did not mean money made from this pool of funds could not be used.
The reserves generate an annual investment income in the billions of dollars, all of which was available for spending until 2001, when a spending cap of 50 per cent was imposed.
The investment income was considered part of the “current reserves” that the government of the day was free to spend during its term, as it was accumulated under its watch.
However, the Government did not use this income.
Strong economic growth meant the Government had no need to draw on it to augment what it had for current spending, even in a crisis.
When the impact of the Asian financial crisis hit home in 1998, the Government was able to rely on the previous year’s budget surplus of $6 billion – which were lying in its current funds – to pay for off-budget measures costing $2billion in mid-1998.
Nevertheless, it took the opportunity to reiterate the importance of the reserves to Singapore in a crisis.
Then-Finance Minister Richard Hu noted that were it not for the strong reserves, the Singapore dollar and stock markets “would have been much more severely affected by the fallout from the financial crisis”.
Unlike the Thai baht, which was hit hard by speculators and had to devalue, the Singapore dollar did not come under serious attack.
This was credited to its healthy surpluses, zero debt, and sizeable reserves which would have allowed the country to defend the currency’s value.
Finding a balance
IN THE 1990s, then-President Ong Teng Cheong raised several queries about the reserves to which the Government replied.
The outcome was a White Paper on principles for determining and safeguarding the accumulated reserves of the Government, which both Mr Ong and the Government had agreed upon. The document was released in 1999.
Among other things, it defines past reserves, sets out a convention by which the President protects them, and requires the Government and key agencies that manage reserves to provide the President with regular financial reports.
But even before the 1998 crisis, the Government had begun studying how to further safeguard the reserves by locking up some investment income that would then go to building up past reserves.
This was partly occasioned by concern that as the population ages, there would be more pressure for part of this income to be spent on social needs, such as health expenses and social support.
Then-President Ong favoured amending the Constitution to lock up 50per cent of investment income, with the other half available for present use.
The Government eventually decided on this split, and put the new rule in place in 2001.
Dr Hu said the split arose as it was necessary to “strike a proper balance between restraining a profligate government on the one hand, and allowing a responsible government enough flexibility to operate, on the other”.
Further, income earned from reserves built up by the present Government will still be added to its current reserves, which it is able to spend.
THESE funds have come in handy.
In a bid to keep the economy competitive as it entered the 21st century, taxes, fees and charges were cut, thereby reducing operating revenue.
Combined with the bursting of the dot.com bubble in 2001 and the severe acute respiratory syndrome crisis in 2003, this meant that Government revenue was not sufficient to keep up with spending.
Fortunately, funds from investing the reserves could be – and were – deployed to balance the Budget in the years since then.
These monies helped avert Budget deficits – or reduce their size.
Said the Finance Ministry in 2005: “Singapore’s reserves, built up over time, have therefore provided a fiscal buffer that allows the Government to enhance Singapore’s competitiveness by lowering taxes, and to respond flexibly via discretionary measures in a cyclical downturn.”
Nanyang Technological University economist Tan Khee Giap says the reserves played a critical role in these times.
Because they were there, and able to generate a flow of income, the Government did not have to resort to borrowing to fund current spending, as other countries did.
The question it faced, going forward, was how to find that equilibrium between having enough in – and growing – its kitty while leveraging on that sum to spend a little more in prolonged periods of slow economic growth and declining revenue.
So the Government began studying how to improve the system so that the reserves could be tapped for a flow of income that was more reflective of changes to its value.
The Government looked at, among other models, the endowment funds of top American universities like Yale and Harvard, which had robust and sophisticated spending rules, preserved the value of what they had, and generated a stable, sustainable income flow.
Last October, it amended the Constitution to put in place a new framework to draw on the reserves.
What was called the net investment income (NII) framework was replaced with the net investment returns (NIR) framework.
The key changes were: including capital gains – and not just interest and dividend income – in the definition of returns, and using a calculation based on long-term expected real returns, as opposed to present returns.
More funds available
THE change resulted in increased funds for use: For the upcoming financial year, the NIR is $7.7billion – almost 20 per cent of projected total expenditure.
This is more than three times what the reserves would have yielded in the current fiscal year if the NII framework had applied.
But the revised framework is not without further safeguards.
For instance, the Government has to seek the President’s concurrence on what it projects to be the expected rate of return over the next 20 years, before the start of each financial year.
If the President disagrees with this rate, then the average historical real rate of return over the previous 20 years will be used instead.
Drawing on the reserves
THE NIR amendment came around the same time the President had to exercise his custodial powers for the first time, last October.
That was when he had to consider and approve a potential draw on the past reserves, when the Government issued a $150 billion guarantee on all bank deposits here.
The Government has said the probability of an actual payout is low, but the move had to be backed by the reserves to be credible.
Not long after, in January, the Government got in-principle approval from President SR Nathan to draw $4.9billion from past reserves to fund one-off Budget measures to boost the economy.
These are: Jobs Credit to subsidise wage costs in a bid to save jobs, and a Special Risk Sharing Initiative to give companies more access to credit.
It says these moves are temporary and come in “exceptional” circumstances, as the country braces itself for the most severe global recession in decades.
It is also making the draw despite having enough savings in its current reserves since it began its term of office in 2006.
Explained Finance Minister Tharman Shanmugaratnam in January: “Tapping on past reserves now gives us the resources that we need to deal decisively with the current economic crisis and also ensures that we have all the resources we need to respond to the considerable uncertainties that lie ahead.”
Among the funds at the Government’s disposal is the healthy $6.45billion surplus it chalked up in financial year 2007, and which now forms part of current reserves.
These could come in handy should off-budget measures be needed to further stimulate the economy, which is officially forecast to shrink by up to 5 per cent this year.
And if they are not needed, these funds will become past reserves.
THE Government has not ruled out a further draw on past reserves, should the need arise as this crisis plays out.
But Singapore is fortunate in having this pool of funds many other countries lack, no longer have, or have seen dwindle in a short span of time.
Even once-successful countries like Iceland have gone deep into debt in the space of months because their debts outweighed their savings.
The Government has been mindful of the need for continued prudence.
Senior Minister Goh Chok Tong this year stressed that any drawdown has to be one-off, for a temporary relief and not for social spending. But the pressures to spend more will not go away soon.
If anything, the story of Singapore’s reserves is still unfolding.