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The Business Times

Budget in a year of pain and change

BT BUDGET ROUNDTABLE

Participants

* Manu Bhaskaran: Founding director and CEO, Centennial Asia Advisors

* Mohamed Ismail Gafoor: CEO and co-founder of P&N Holdings (parent company of PropNex)

* Kit Wei Zheng: Director, Asia Pacific Economic and Market Analysis, Citigroup Global Markets Asia Limited

* Ramkishen S Rajan: Visiting Professor, Lee Kuan Yew School of Public Policy, National University of Singapore

* Tay Hong Beng: Head of Tax, KPMG Singapore

Moderator

* Vikram Khanna: Associate Editor of The Business Times

BUDGET 2012 comes at a time when the economy is overcast with uncertainty. However, the five participants of The Business Times' Pre-Budget Roundtable think this year's Budget will be one focused on the long-term, one that will not spare businesses the pain necessary for Singapore to transition into a new phase of productivity-driven, sustainable growth. Here is an edited transcript of their discussion.

Vikram Khanna: How do you see the external environment panning out this year, and what effect will it have on Singapore?

Kit Wei Zheng: Our house view is for a global slowdown, but not a recession. For Europe, we're expecting a recession that will last six quarters, starting from last quarter (Q4) but there is still great uncertainty about its depth and duration.For Singapore too of course, because Europe is the single largest market for non-oil domestic exports. But, 40 to 50 per cent of Singapore's NODX to Europe comprises of pharmaceuticals, which are far less related to the macroeconomic cycle and volatile due to industry-factors. We expect Singapore to grow 3 per cent this year - at the high end of the government's forecast. There is a huge amount of uncertainty. I think it's easy to be very pessimistic, it's also fashionable.

But looking at the experience of 2009, it was when people were most pessimistic that forecasts started to be upgraded.

Tay Hong Beng: There is definitely a slowdown. And for us, in business, we see less activity, compared to previous years.

Wei Zheng: Singapore has already started to see some of the effects of the slowdown in China. Not so much on manufacturing which has been slow anyway, but in tourist arrivals.

When we did a seasonal adjustment on November's tourist arrivals, we found a 17 per cent month on month drop in Chinese tourist arrivals . . . But the job market is holding up quite well for now and that will provide an important cushion for domestic demand.

Manu Bhaskaran: My suspicion is zero plus minus growth this year. We're going into a longer period of de-financialisation where the financial sectors that we made such a big bet on will definitely contract as deleveraging, tighter bank regulations have a knock-on effect.

There has been an adjustment of the cost base in Singapore to a more difficult environment. Maybe that takes a longer time to play out, but if that kicks in earlier than most expect, then this year might see slower growth.

We also face internal issues, problems and imbalances, some of our own making because of policy decisions taken. That includes changes to the foreign worker policy, changes to COE, all kinds of recalibration that will impose a cost on our economy.

There's also the political drag. Nov 6 is the US election, I think Obama will lose, in which case you'd have a new president who would not have his new administration in place until May or June. If you're a businessman, you know that there are many uncertainties, you also know for sure that there will be fiscal contraction in 2013. Are you going to make big bets on hiring, capital spending in the second half of this year? I don't think so.

Globally, there are so many flash points that could become critical (including) Iran and North Korea. We are a beta play on the global economy. The global economy swings, we swing much more.

Ramkishen Rajan: It's easy to be pessimistic. There has been a fiscal drag in the US in recent quarters already. I think with Draghi in the ECB (European Central Bank), I'm much more positive now about the proactiveness of the ECB now than I was a few months ago. But even if there is an orderly transition, that is still going to be a huge drag on the European economy.

Vikram: With broad consensus that we will have a slowdown, how best can the Budget support businesses?

Wei Zheng: It will definitely be less of a counter-cyclical budget. You can tell from the PM's tone: let's take it in our stride. Pain is unavoidable in a restructuring phase. Some pain in the right areas. But I think the government will do what it can to reduce the pain in some areas not related to restructuring per se. Things like labour costs you have to take it. It's part of the overall objective.

Ramkishen: And given that in terms of unemployment, the downturn hasn't really shown up yet, it makes sense to wait and see.

Hong Beng: We feel the Budget has to be a combination of long-term strategic objectives, coupled with short-term measures to help businesses in a difficult time and prepare for better opportunities. Rising costs, margins thinning, rising competition - these affect the SMEs. They are complaining and even the bigger companies are complaining about escalating costs.

Cutting foreign worker levies runs against the grain of push for productivity. What businesses are looking forward to is something done previously, the Jobs Credit Scheme, as that will have a direct impact on cashflow. I believe this time round it could be more targeted, possibly targeted at older workers and more at Singaporeans. Previously it was for all employees, Singaporeans and PRs.

Of course the question is, is it too premature? Nothing needs to be rolled out for the entire year during the Budget, there could possibly be off-budget measures. Everyone is hoping for a modified Jobs Credit, but realistically I am not so sure.

Wei Zheng: Looking at the overall job numbers there are still 50,000 job vacancies at this stage of the cycle which tells you how severe the labour shortage situation is in some sectors. It's not a situation where you're going to see firing en masse.

Also, Jobs Credit encourages labour hoarding, so that may delay the impetus to automate, raise productivity and so on - it's counter-productive to the broader objective.

Mohamed Ismail: We are in a new normal after the elections, the thinking behind policies is now 'Singaporeans first'. I totally agree that the Jobs Credit is unlikely. We have not seen a crisis, how do we justify breaking the bank for millions? The danger here is also that SMEs are going to be dependent on the government every time there is a slowdown.

But I will not be surprised if something is tweaked to be very Singaporean first. To further incentivise the hiring of Singaporeans or older workers, there may be some kind of credit.

Wei Zheng: The government runs a balanced budget over its term of government. Usually this means it will run a surplus in the first year, but in this environment I think it won't run too large a surplus.

Hong Beng: They have some leeway, they can recognise up to 50 per cent of profits from the sovereign wealth funds.

Wei Zheng: Yes, I think they probably haven't reached that. My rough guesstimate is that they can raise that by another $2 to 3 billion. Right now it's $7.8 billion.

Ramkishen: The other way to run a small surplus, is to be very conservative with estimates of tax revenues. It's fiscal marksmanship.

Vikram: The productivity initiatives which have been rolled out so far - have they been effective? What more is needed?

Mohamed Ismail: I'm very happy with all these productivity schemes, but to be very frank, we've not taken advantage of many.

To take charge of productivity, you put your brain and time and effort and it doesn't come free, so you have to think, as an SME how much do you dare to put aside to do these things?

It depends on the type of business too, if you're buying machinery etc, it's easier to utilise. But if you're in the service industry, there are limitations.

Wei Zheng: The two main productivity initiatives are the Productivity and Innovation Credit scheme and higher foreign worker levies. Are these working? My sense is probably not. In the long run they probably will work, but how long is that long-run?

In the next one to two years, apart from cyclical productivity gain, I don't think these will have worked. And as a result of that, businesses will face a pretty significant escalation in unit business costs, which will probably feed into inflation at some point.

Hong Beng: The understanding of the tax incentives, the PIC and so on, may not be well communicated to SMEs. I understand that, last I heard, the take-up rate was about 20 per cent of corporate tax payers.

Manu: What can a service industry buy that qualifies?

Hong Beng: Workers' training qualifies. I say we must move away from expenditure-basis tax deductions to value-creation.

Yes, it may be difficult to quantify, but each brand in the market has certain value, so why can't we have an independent valuation of the brand name, and offer tax-deductions based on the value-created, instead of asking SMEs to put in money so that they can get tax deductions.

Look at the value they've created in the market, monetise that, and empower the SME to go out to the market with additional cash that the tax cuts will give them. That will benefit a lot of people, who put their heart and soul into their businesses.

Manu: I think using fiscal tools to boost productivity is not the way. Businesses respond to incentives, the first incentive is really the P&L. When you increase price of labour relative to capital, construction companies which say they can't raise productivity will raise productivity.

Wei Zheng: But there will be pain.

Manu: There will be pain, but unfortunately because we chose not to take the pain earlier, we delayed it, so we take the pain now.

Wei Zheng: And it's a bad time to take the pain.

Manu: It's the payback for postponing these policy decisions. Take the construction sector for instance. Singapore's productivity is a fraction of that of countries' where best practices in construction are used.

Hong Beng: Productivity and Innovation are foreign to many SMEs. Some think the credits are meant for the high-tech companies, who in turn think the 400 per cent deduction capped at $4,000 is not huge. So perhaps it needs to be tweaked to make it more attractive to the target companies.

Hong Beng: Our tax incentives tend to be very precise, for instance in the financial sector, the incentives target a very precise, exact activity to support.

Once cast in stone, the market moves, people engineer new instruments - that delays the expansion and hence relevance of the scheme. There is a sandwiched class of SMEs too, who have grown out of schemes and no longer qualify, but could still do with some help.

Manu: One main criticism of these schemes is that in being micro-targeted they become so complicated. As a micro-business, nothing in the whole list of schemes applies to me. And I actually don't want government help, I just want to do things on my own.

What I need is for the government to take care of my costs - that's a macro thing that I have no control over. If costs can rise 50 per cent in a downturn, there is really something wrong.

Property and staff are my two main costs; I have a policy that I only hire Singaporeans if I can. There are Malaysians willing to work for me who will take a much lower salary, but on principle, I hire Singaporeans.

Mohamed Ismail: Most SMEs have problems hiring Singaporeans. A lot of fresh graduates, their aspiration is to work for an MNC, not SME and in today's market, they feel that the SME should pay them a premium to MNC.

We get all the scraps, bottom 20 per cent of graduates, the kind who went for 2 or 3 interviews, didn't get any, still want to negotiate 'Why should I work for you?'.

But our biggest problem is retention. They have aspirations and will want to explore. You're not an MNC with the ability to give them overseas postings and so on. So our stress is turnover, we have a tough time managing expectations.

Ramkishen: Productivity is just output per worker, so if you raise output and the number of workers are intact, by definition productivity goes up. From an economic perspective, something has to give. Unless something significantly changes, you can't be thinking of growth of 3 to 5 per cent and at the same time clamp down so significantly as they have been doing in the near term on foreign labour.

Vikram: What about the government's encouraging M&As to encourage Small enterprises to become Medium ones?

Manu: Small by definition is small. The solution to the SME problem is to make the Ss Ms? You'll always need SMEs, they make for a dynamic economy. When you have an economy that makes it difficult for these enterprises to flourish then you have a problem. Somebody has to do a real in-depth study as to why the cost structure in Singapore is so high.

Hong Beng: Why can't we have a Singapore fund? A fund created to tap onto the wealth of Singapore to invest in some of these SMEs.

Vikram: What about, at a more mundane level, cash flow?

Hong Beng: At the moment we have this tax credit for SMEs, so if they are not paying taxes, $5,000 is credited to the companies. Not a big sum, but it's useful definitely, many hope it will carry on. It's not to encourage losses, but if you're in a loss-making situation, you will get the cash grant. And it is possible that they may raise it.

Manu: The longer-term issue is the cost structure in Singapore. We've become very expensive in the past few years. Much of it is really the property sector - land prices are high, which feed into the cost of the property, and eventually affects rentals.

Mohamed Ismail: It has to do with the structure here. The minute you go into Reits, where else can you run? The only way they can milk the return on Reits is the rental. So they will keep on increasing rents. That model, it's got to be looked at.

Vikram: What about personal income tax rates?

Hong Beng: Should we align the top personal tax rate to the corporate tax rate? It's a big question mark, especially because of the widening income gap. I think it's a taboo subject. But we do think it's possible to move the lowest income tax bracket up, it will not change the revenue collected much, but many more will be exempted.

Manu: There's also a need to look at it as a whole, how much tax is the household paying? Including indirect taxes?

Hong Beng: For the sandwiched class, maybe we can look at how to increase the quantum for the relief deduction for earned income for spouses. If you're talking about foreign maid levy reliefs, you can only claim if your wife is working. So perhaps this can be made more palatable to the sandwiched class.

Ramkishen: But in the sense that they are trying to raise the labour force participation rate, the disincentives for wives to stay at home make sense. I understand why there are exceptions, but at the macro level it does make sense.

Vikram: What about social safety nets? Should there be more resources there? What can and should they do?

Wei Zheng: Workfare looks good in principle, but the problem is, the way it is being implemented right now, I'm not sure it makes much of a difference. The maximum payout is around $200 a month, of which a maximum of $78 is in cash, if I did my calculations correctly. It's a measly sum. There is space for this to be expanded as a quick-fix.

And while I don't think this is needed now, in the event that the jobs situation worsens, is there a possibility of creating something like a hardship account in the CPF? One that you can draw on when out of a job for a limited period.

What's missing now in our system of social safety nets is some form of unemployment insurance, which is predicated on the assumption that if you can't find work, it's because you're not bothering to try. I don't think that's a very fair assumption.

Ramkishen: Perhaps there are ways to tie some form of unemployment insurance to finding a job. Perhaps the jobless can register with a government agency, which could then work with companies to try to match people to jobs.

And in the process of finding a job, you can be provided some kind of insurance. So then if the person can't find a job, either there is something wrong with his skills or with the economy.

For some, the argument against this would be that the government shouldn't have this kind of hand-holding role. But with the Singapore government involved in the economy in so many ways, I don't see any problem.

Mr Tay: Why can't we have a Singapore fund? A fund created to tap onto the wealth of Singapore to invest in some SMEs