Looking at the world through the lenses of Singapore A level Economics =D

The business model of bike sharing



Ever since Bike sharing entered Singapore, many have wondered “How exactly do these companies make money?”.

After all, they run numerous promotions in which the actual marginal cost of riding a shared bike is zero. And even when charges do occur, they tend to be rather low, like 1 dollar per half hour. So how can total revenue cover the total costs, which includes fixed/sunk costs like the cost of the bicycles and regular maintenance costs?

There have been various articles noting the perplexing nature of Bike sharing’s business model. An article by Fortune basically said that the business model was illogical and won’t pay off for investors.

The business is being defined by how much capital competitors can raise to spend on gaining market share.

The problem is, once they capture some, real profits may never be part of it. Beware of a future initial public offering.

I would like to offer a different perspective. The key to understanding Bike sharing’s business model is not in the marginal fares they charge for an hour or half an hour’s ride. But in the initial deposit they receive. Each new consumer for a bike sharing system will have to pay a deposit. This is for various purposes like to minimize destructive behaviour, i.e. the deposit will be forfeited if you are found to have damaged the bike.

The implication, however, is that the consumer has now made an interest-free loan to the bike sharing company. With this large amount of money, they can then use it for various investment and revenue generating purposes. And the magic of bike sharing is that the number of deposits is likely more than proportionate to the number of bicycles you have on the streets. One might say that it’s a deposit, which means the money does not truly belong to the bike sharing company. But the probability of consumers reclaiming their deposit is not high as long as they see some possible use for sharing bikes, regardless of how often they actually use it. This is kind of how banks work, they take your savings deposits and loan out a proportion of it, as you’re unlikely to ever wish to draw out all your money at one go. The only difference between a bank and bike sharing is that the bank will pay you monetary interest while the latter offers you a continued service in exchange for our deposit.

So yep this is my take on the business model of bike sharing. The more deposits they get, the more they can enlarge their network of bicycles, which will convince the existing consumers that it’s useful and convince potential consumers to take the plunge and pay the deposit to use the service. This generates more deposits and so on. These deposits are used to cover costs and make other revenue-generating moves. It remains to be seen how this will work out in the end. But perhaps there is indeed a method to the perceived madness.

Update: It seems that companies like OFO are bucking the trend by allowing deposit free bike-riding, probably to gain as much market share as they can before they think about monetisation. And they can do so without bothering with revenues because they have received massive funding from various sources, including Alibaba.


Sharing is Caring

Why buy a car if you could simply ride on someone else’s car, much like a taxi? Why live in hotels when you travel overseas when you could save costs by living in someone else’s home? Such are the questions that mobile applications like Airbnb, Uber and Turo have posed to users as they seek to develop a business around the concept of a Sharing Economy.

The Sharing Economy or Collaborative Consumption is built under the notion that access is more important than ownership. It bridges the gap between supply and demand but instead of transactions enacted by firms previously, most who offer their services are everyday individuals who have resources that they do not maximise.

For a quick introduction to the sharing Economy watch this short video done by my graduated students.

For example, California-based Airbnb lets people rent out their spare rooms to others for extra income. Turo allows others to rent your cars when you are not using them. Uber, already seen in Singapore, allows individuals not registered as taxi drivers to play similar roles, driving people around for a fee. Such peer-to-peer rental schemes provide extra income for owners and can be less costly and more convenient for consumers.

Snapshot of the Sharing Economy – Credits to PWC Consulting

The current digital technology has made it effortless to aggregate supply and demand. Smartphones and mobile applications make it easy for GPS satellites to track for the nearest room and car available for rental. Social Media and online rating systems make it easy to establish trust. Finally, the ease of internet banking allows quick and effective transactions. Such efficiency have created the “peer-to-peer economy” or the “sharing economy”.


It is no coincidence that many of these apps were made during the crisis years of 2008-2012. A sluggish economy encourages sharing as people search for alternative sources of income and aim to reduce costs. Moreover, it is also environmentally friendly as it encourages more efficient use of available resources, discouraging overconsumption. It is also no surprise that according to a study conducted by PWC consulting as shown above, those who are most excited about the sharing economy belong to the millennials. These individuals were born into the digital age and grew up with social media, thus their increasing involvement in the labour force is likely to impact the future of consumption. Increasingly, it may induce a shift from ownership to access.

Sharing economy sector and traditional rental sector projected revenue growth - Infographic

As seen from a study by PWC above, by 2025, the 5 key sharing economy sectors could generate revenues of up to a staggering $335bn. Airbnb totals more than 155 million guests annually, 22% more than Hilton Worldwide, a multinational hospitality company. Five-year old Uber already operates in 250 countries and its market capitalization as of 2015 was valued at a startling 41.2 billion, more than the market capitalization of American Airlines, Genting Singapore and United Continental. The point is that the sharing economy has massive potential, moreover the industry works under the veil of the network effect, the more users utilize such apps, the bigger its area of expansion.

Impact on Market Structures

The key impact on market structures is the reduction of barriers to entry for households with excess resources. But there is a paradox in the sharing economy. It both increases and reduces competition. For example Airbnb allows any willing person to rent out his/her room or whole home to outsiders, becoming a source of competition to existing hotels. This reduces the market dominance of big hotel chains and reduces prices to make the market closer to achieving allocative efficiency. However, the platform of Airbnb itself will becoming increasingly dominant because of the network effect and network economies of scale . Indeed Airbnb can be said to be a near international monopoly when it comes to short-term rental of private accomodation. For Uber, in Singapore, it is at least challenged by Grab, thus it may result in an oligopoly situation. Whatever the case, whenever there is innovation disrupting the relevant markets, the consumers win! So cheers! Sharing is indeed caring =).

Co-authored by Deng Quan and Gilbert


Entering the Negative Zone

Imagine a bank that charges negative interest. Depositors are charged for placing their money with the bank. The thought sounds crazy. But, in recent years, faced with long periods of low inflation, various central banks have used negative interest rates for the purpose of increasing aggregate demand and inflation.

On Jan 29, the Bank of Japan(BOJ) surprised markets by adopting a negative-rate strategy, cutting its benchmark interest rate to -0.1%. It joins the European Central Bank (ECB) as one of the few central banks which have resorted to negative interest rates.

Commercial banks hold reserves that are not lent out to the bank clients. A small fraction of the total deposits is held internally by the bank or deposited with the central bank. Minimum reserve requirements are established by central banks in order to ensure that the financial institutions will be able to provide clients with cash upon request. However, when a central bank charges a negative interest rate for parking its reserves with them, it is penalizing and charging commercial banks for leaving their reserves with the central bank. They are thus encouraged to lend it out, increasing AD (consumption and investment), spurring demand-pull inflation.

It is an unorthodox method to counter deflation and a rather desperate attempt to hit core inflation of 2% in which the BOJ has failed to achieve the target for extended periods of time. But, the extent of its impact is likely to be minimal.

How much good will it do?

  1. Animal Spirits – Liquidity Trap

In theory, interest rates below zero should reduce borrowing costs for households and firms thus increasing loans. In practice, however, the problem is not that banks are unwilling to lend out the money, it is simply that the market lacks investors willing to borrow money from banks – i.e. it’s a credit demand problem and not a supply issue.

Since the property bubble burst in the 1990s in Japan, corporate savings have been massively rising in Japan. Some have used the term balance-sheet recession to refer to Japan’s crisis. A balance sheet recession occurs when the private sector faced by the burst of a nationwide debt-financed bubble becomes a net saver as it aims to pay off the bad debts it has accumulated during the bubble years. The money supply must be grown in tandem with the number of private debts to successfully raise investment and consumption. Unfortunately, interest rates have reached near zero levels but loans have not picked up, coining the term a liquidity trap. With confidence so low, it is unsure whether the negative rates will truly be a problem-solver for the ageing economy.

  1. Why should you keep your money with the banks if you can keep it under your mattress?

In theory, interest rates below zero should reduce borrowing costs for households and firms thus increasing loans. In practice, however, if banks charge depositors for keeping their money with the banks, cash may go under the mattress.

In layman terms, why should you keep your money with the banks if you can keep it under your mattress since both do not give you a return? In fact, placing it under your mattress is safer since you dun have to spend time actually retrieving money from ATMs and you can spend it anytime with you. In economic terms, it is often referred to as the liquidity-preference theory.

This perceivable danger has yet to surface as most commercial banks have yet to penalize depositors except Julius Baer which began to charge large depositors. But, if banks were to begin to charge for deposits, massive numbers of depositors may decide to extract their deposits, it will become a bank run and pose a systematic threat to the banking system. The BOJ and ECB knows the underlying possible of a bank run thus they should cautiously.

A few key points to note:

  1. Japan was actually experiencing negative real interest rates before the BOJ chose to break the negative barrier. Although nominal interest rates were mildly positive(0.01%), inflation was mildly positive(1%). Nominal IR – Inflation Rate = Real IR
  2. Markets are affected by expectations. QE and negative interest rates are meant to be an unorthodox ‘secret’ weapon that the central bank can use as a ‘last resort’ monetary policy. However, the BOJ has been enacting such monetary easing since the 1990s after the property bubble. By now, market expectations have calibrated themselves to such monetary easing. Its effectiveness will dampened over time as investors become accustomed to the use of QE. Analogically speaking, a ‘secret’ weapon is not so powerful if you keep using it and your enemy starts to anticipate it.


Stumbling Dragons

A few months ago, the Chinese financial sector experienced numerous setbacks as it experienced unprecedented depreciation of its currency and a tumbling stock market.

The Shanghai Composite Index, China’s main benchmark, closed 6.4% down at 2,749.79 on Jan 26 and the plunge does not seem to be stopping.That was the index’s largest one-day percentage loss since the Chinese government got rid of a “circuit breaker” mechanism on Jan. 8. The system, put into place at the beginning of the year, was blamed for sparking rather than stopping volatile trading.

Weakness in the Chinese Economy

The major fall in China’s index can be attributed fundamentally to its weakening economy. After more than 30 years of rapid economic growth, labour wages are rising. Investment rate-of-returns are rapidly falling. China’s voracious demand for commodities is slowing down as seen from the crash of nearly all commodities prices. Moreover, during the boom years, over-investment was seen in major core industries such as steel, construction and property. Although such investment pay not have an effect in supply over a short-run, over the long-run as we are experiencing right now it will generate spare capacity, further placing downward pressure on prices. This has jump started the massive selling of China’s stocks as economic growth has revised downwards.

Besides its weakening economy, the increase in interest rates in the US has sparked massive capital flight from China. Although China sets up capital controls, leakages still occur within the system resulting in hot money to flow from China to the US. Outflows jumped in December, with the estimated 2015 total reaching a record $1 trillion, more than seven times higher than the whole of 2014 based on Bloomberg Intelligence data dating back to 2006. Such leakages have resulted in an increase in the supply of Yuan in the global market which places downward pressures on the Yuan.


From its historical low of 1 USD to 6.20 RMB, the RMB has depreciated to its current level of 1 USD to 6.5777.  The PBOC(central bank of China) has made major effort to defend the Yuan to ensure currency stability. It has used its hoard of foreign reserves to buy up Yuan, increasing demand and reducing supply to prevent further depreciation. It is doing so for 3 major reasons:

  1. Capital flight results in a reduction in loanable in banks. This has a contractionary effect on the economy as the decreased supply of funds puts upward pressures on interest rates and increases the cost of borrowing. This reduces investment and consumption, reducing AD while the economy is already experiencing a structural slowdown.
  2. In Nov 2015, the IMF has decided to add the Yuan into its special drawing rights currency basket. The development is key to ensuring that the Yuan becomes internationalized, expanding its financial sector and breaking the monopoly currently held by the USD. But to do so, the Chinese government needs to maintain confidence on the Yuan and needs to show discipline in ensuring a stable exchange rate. A rapidly depreciating Yuan is not what foreign investors will like to see as a possible future global currency as it affects their expected rate-of-return.
  3. A depreciating currency reduces the value of assets in terms of foreign currency. Thus, a depreciating currency may spark further capital flight as investors shift their money out to maximize returns. It turns into a vicious cycle where capital flight triggers a depreciating currency that further encourages more hot money to escape. Although the PBOC currently has a large amount of foreign reserves at its disposal, it needs to ensure it stop gaps the panic flight before its reserves amount gets threatened.

With the $107.9 billion drop in December, Beijing’s foreign-exchange reserves have fallen every month but one since May. Tough times loom ahead for the Chinese economy as the US may potentially further raised its interest rates later in the year which may sparked further capital flight.

The road ahead

The truth is that China’s golden opportunity to reform its financial sector may have disappeared. Previously, cheap credit from around the world flowed to developing countries thus funding their development and investment. Exchange rates were relatively stable as seen from the gradual and modest appreciation of the Chinese Yuan. A stable exchange rate and ample capital made it favorable for financial reforms to take place since markets were stable and massive capital flight was unlikely.

However, much has changed. Global economic growth has decreased. China’s economy faces dire spare capacity in its key industries. Most importantly, the Federal Reserve has ended QE, raised the short-term interest rates in December 2015 and probably intends to further normalize interest rates in the days ahead. This has exasperated capital flight from developing countries, especially China.

Just as China attempts to open up its financial sector and relaxes capital controls, the global conditions will only encourage further capital flight and put further threat on its economic stability as it faces a depreciating exchange rate and a sluggish economy.

Contrary to popular belief, the better short-term solution is perhaps to increased capital controls to stabilize the Yuan and prevent further capital flight. When the market stabilizes after the series of rounds of interest rates rise by the Federal Reserve, China can then make use of the opportunity to gradually open up its financial sectors in selected areas such as Shanghai and Beijing.

China’s Fragile Financial Sector

What is causing the volatility in the financial sector?

  1. Retail Investors and Herd Behaviour

China’s financial sector is new and unstable which has created increased volatility in the financial market. Unlike most developed countries such as USA and UK where the majority of stocks traded are by institutional investors, or large companies such as Blackrock, the majority of investors in China are retail investors. Retail investors are investors who invest with their own money and not for other parties. Given their low capital compared to large corporations, they are more prone to bubbles and panics.

A simple analogy can be extrapolated from vehicles. Small vehicles have the flexibility of being able to move faster and turn easily while large vehicles often have to be driven with more care since their size prevents them from last minute reversal or turnings. In other words, the flexibility that allows retail investors to react quick due to their low capital increases the risk of panics and unrealistic rise in value in stocks.

The more retail investors there are, the higher the volatility since they are more prone to such trends. On the other hand, large investment funds are price-setters. Their large capital forces them to diversify their risks across a broad based of investment products to minimize risk while maximizing profit. Thus, often a reduction in value in a few stocks will not severely affect their total returns thus they are in no hurry to enter nor exit the market. Moreover, given their capital, they also possess more information that allows them to hold a long-term view as compared to retail investors. They prefer stability to sudden but short burst of profit.

This acts as a stabilizing force thus until China’s financial sector gradually matures, volatility is here to stay.

2. Mishandling the Stock Market

Recent threats to the China’s stock market has placed serious doubts on the Chinese government’s will to pursue further economic reforms in its financial sector. Its series of policies have had the negative impact of causing more panic instead of solving the root cause to the problem.

Previously on 4 Jan 2016, the Chinese government introduced a circuit breaker to the stock market to prevent volatile movement.

The circuit breaker works as follows – the proposed mechanism will be tied to the benchmark CSI300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, where a move of 5 percent in either direction from the index’s previous close will trigger a 30-minute trade suspension. Meanwhile, a 7 percent rise or fall in the CSI300 Index will prompt a trading halt in the Shanghai and Shenzhen stock exchanges for the rest of the day. This works pretty much like the circuit breaker you have at home that will cut off the power supply once there is a short circuit to prevent a fire, the stock market circuit breaker is meant to calm down stock markets after a massive nosedive or unrealistic surge in prices to prevent bubble formation or panic attack.

Circuit breakers are meant to stabilize stock exchanges by calming down the public after a massive buy-in or a massive sell-off. They thus act as stock exchange stabilizers and prevent panic selling or flood buying. They are actually frequently seen in other exchanges such as the New York Stock Exchange where there are three levels set mainly at 7%, 13% and 2o%.

In a newly developed financial sector such as that of China, it is indeed a good idea given its mass number of retail investors. However, the circuit breakers introduced by the Chinese government were badly designed. The trading curbs set were too low and the difference in percentage between the circuit breakers were too low thus instead of reducing panic, the circuit breakers escalated the fall in the indexes. By the second day where the circuit breakers were introduced, the indexes has already fallen to the first level of 5%. This triggered a 30 – minute trade suspension which induced massive panic.

Nothing wrecks the heart more than the unknown and the temporary shut down of the stock exchange merely encourage investors to fire sell their holdings in stocks. By the time the exchange reopened, the index has fallen more than 7% and the second level of circuit breaker is activated, ending the day’s trade.

The circuit breakers were badly designed as no circuit breaker in any exchange has set a maximum trading limit change of 7% – most are designed to be at least 12-17%. The stock market is one that is volatile, especially 1 flooded by animal spirits, thus to place a 7% price change cap is unrealistic and will only induce further panic.

The circuit breakers have since be stripped but it reflects the incompetency of the Chinese government in managing its new booming financial sector and it brings into question of whether it can successfully resolves its massive debt problems and develop a substantial financial sector.

Closing Thoughts

The Chinese government needs to reckon that its attempt to prop up the stock market is misguided. Unlike the US where funds in the stock exchange nearly constitutes 80% of GDP, the China’s stock exchange is small at only around 10% as compared to the massive size of its GDP. In other words, volatility in the stock market is unlikely to affect consumer demand and wealth. It will be better to gradually allow the stock exchange to flow freely and allow market sentiments to do its work. At this important crossroad where it move towards internationalizing the yuan, it must stay wary in any intervention of the financial sector especially in a global environment that is unfavorable.



How impossible is the impossible trinity?

Our previous post looked at the reasons for Singapore’s decision to choose a managed exchange rate and free capital flows over a sovereign monetary policy. However, we received questions about why it is impossible to achieve the 3 conditions below and thus we’re attempting to give you a brief understanding of the theory.


Let’s assume hypothetically that USA attempts to have all 3 of the following economic options at its disposal. Let’s say the government is experiencing a downturn in the business cycle. Given that the government has a sovereign monetary policy at its disposal, it will attempt to stimulate the economy by using expansionary monetary policy.

Thus, the central bank will intervene to increase the money supply through possibly open market operations – purchasing of government bonds or affecting the liquidity ratio. This reduces interest rates, achieving the purpose of reducing the cost of borrowing thus increasing investment through higher expected rate-of-return and consumption on big ticket items.

However, since interest rates has decreased as compared to the world and the country allows FREE CAPITAL FLOW, investors have an incentive to shift their capital from USA into other countries with higher interest rates. In economic terms, hot money flows out of the country. As investors exchange USD for foreign currency, the supply of USD increases in the forex market which places depreciation pressure on the USD. (Recall that exchange rate markets can be thought of just like other goods market with a demand and supply graph, as supply increases, price of USD in terms of foreign currency decreases)

Now, for the country to control exchange rates, the central bank will have to intervene in the forex market to appreciate the currency. It will use its foreign reserves to intervene in the market, purchasing USD from the forex market with foreign currency. This has the effect of decreasing the supply of USD in the forex market. However, by reducing the supply of USD, effectively, it is also a reduction of the money supply (which would cause interest rates to increase) and this is in contrary to the purpose that the central bank wanted to achieve at the beginning to acquire an expansionary monetary policy.

The result is that as the money supply decreases, interest rate return to the original equilibrium. The central bank and government failed to achieve its original purpose and merely allowed investors to benefit from carry trade.

At this point, you finally witness how impossible it is to achieve all 3 conditions in the impossible trinity. Empirical evidence based on historical backgrounds have proven that any attempts to break the impossible trinity (open economy trilemma) often lands in disaster.



The Impossible Trinity and Singapore’s monetary policy

While the impossible trinity is not in the A level assessment syllabus, it is a very useful framework to understand a key part of the syllabus – which is why Singapore uses exchange rates instead of interest rates to engage in monetary policy.


The above graph illustrates the conditions of the impossible trinity (also known as the open economy trillema). In a nutshell, it’s impossible for any economy to achieve free capital flow, fixed exchange rates and sovereign monetary policy (control of interest rates) at the same time and each economy will have to pick 2 out of 3. Note that Singapore is basically ‘a’ – free capital flow + control over exchange rates. Singapore IS NOT having a fixed exchange rate system but a managed float, which still means having to exert a degree of control over exchange rates.

Free capital Flow in Singapore

Let’s apply this model to Singapore. We decided to have free capital flow (mobility) – meaning that there are no restrictions to the flow of capital in and out of Singapore. This can include short term capital flows (hot money) and long term capital flows (foreign direct investment).

The benefits of Foreign Direct Investment (FDI)

Why did we chose this? Mainly due to the nature of our economy and our pursuit of growth and development. As a small country with minimal natural resources, making it easy for foreign capital to flow in and out of Singapore makes it easier for multinational corporations to do business in Singapore, i.e. more FDI flows into Singapore. This then stimulates the investment component of our aggregate demand (AD), creating jobs and actual growth. Not to mention the MNCs will build factories, import production machines/technology (capital goods accumulation) which will then help increase Singapore’s productive capacity aka long-run aggregate supply (LRAS). The employees of these MNCs will also learn soft skills like management techniques, systems of production, marketing etc. raising the quality of labour in general, further increasing our productive capacity. Note that free capital flows is not enough to attract FDI, we also had tax incentives, political stability and other factors in our favour.



Interest rates vs exchange rates

The importance of exports and imports

Since free capital flow is in a sense a non-negotiable for an international finance hub like Singapore. Based on the impossible trinity theory of only being able to have 2 out of 3 of the conditions as stated above, we now pit interest rates vs exchange rates. Again looking at the nature of our economy, it simply does not make sense to control interest rates while giving up control of exchange rates. Singapore is a small and open economy which relies on imports for daily necessities/luxuries and raw materials for domestic/export production.  Net exports (x-m) is also the most important driver of Singapore’s growth since we can take advantage of the global market. As such control of exchange rates is a lot more important to us than interest rates.

The importance of imports in particular also leads to imported inflation (a form of cost-push inflation) being generally the main cause of inflation in Singapore. As such, control of exchange rates – slow and gradual appreciation of the Singaporean currency – is crucial in controlling imported inflation in Singapore and interest rates can’t help at all in this regard.

In a nutshell STABLE exchange rates is important for importers and exporters for their planning and operational purposes, hence Singapore prefers to control its exchange rates via a managed float.

The problem of free capital flow and a relatively small monetary base

Singapore is a “price taker” for interest rates, sometimes also known as interest-rate taker. This means we have little control of our interest rates due to the fact that we have free capital flows. The following short video illustrates the issue using the loanable funds diagram.

Doesn’t the scenario mentioned above apply to other economies?

Every country has a different monetary base which is directly correlated to the size of its economy. An analogy would be to think of the monetary base like water bodies. USA’s monetary base is like the sea, it would take A LOT of “water” (hot money flow) to cause a perceivable rise or fall in sea level. Singapore however is perhaps more like a puddle of water, where relatively a lot less “water” (hot money flow) is needed to cause an obvious change in the water levels. Furthermore, there are cases like China, which although having a huge monetary base, nevertheless restricts capital flows to allow more control over their interest rates.

Manipulating interest rates causes Exchange rate volatility

As mentioned above, due to our free capital flow status, hot money flows in and out of Singapore freely whenever there are interest rate changes. Before hot money enters or leaves Singapore however, they must go through the foreign exchange (forex) market. So taking the scenario in the video above, if hot money enters Singapore, that money must be changed into Singapore dollars (SGD) first. This hot money comes from all over the world, USA, China, Eurozone countries, India etc. So this means that they would have to use their currency to BUY Singapore dollars., thus increasing the demand for SGD and causing the currency to appreciate. On the other hand if Singapore were to reduce interest rates, hot money flows out of Singapore. But before it can flow out into other countries, the SGD must be converted/exchanged into foreign currencies. This means that the investors would SELL SGD for other currencies. This increases the supply of SGD and depreciates the Singapore currency.

Given the various reasons stated above, Singapore has thus decided on Free capital flow + controlling exchange rates while relinquishing control over interest rates.



Looking at the graph again here are some examples of a, b and c.

a – Singapore: Controls exchange rates (NOT fixed but managed) and allows free capital flow – gives up control over interest rates

b – USA: Controls interest rates and allows free capital flow – gives up control over exchange rates

c – China: Controls both interest rates and exchange rates – restricts capital flow.

Can you think of other examples of a, b or c? Do post your examples and comments/queries below. Thanks!


Winter is Coming…

Winter is coming (PUN INTENDED). As the world approaches the Christmas season, a storm is brewing in the financial world.

On Dec 16, the Federal Open Market Committee will hold a meeting that may signal the end of cheap credit in the financial world. Unemployment is dropping, wages are rising and the US economy seems to show signs of finally emerging from the historical crisis in 2008. Given the positive local climate, all eyes are on Janet Yellen, chair of the Federal Reserve, as she may potentially raise interest rates to prevent future inflation.

This week, we look at what exactly is the rate hike? Why raise rates now? What is its impact to the world economy? How will Singapore be affected?

What rate are we referring to?

The rate simple refers to the raise of short-term interest rates. in USA. Interest rates in the US have been close to 0 since the outbreak of the global financial crisis in 2008.

Federal Reserve Funds Rate
By pushing the rate to historically low levels, it increased the money supply and also encouraged banks to lend out enthusiastically to raise consumption and investment. The Feds also intervened to lower long-term interest rates through Quantitative Easing(QE), printing artificial liquidity and buying long-term mortgage securities and treasury bonds to lower borrowing costs. It spurred borrowing and lending, a stock market boom and the Fed contends that it was pivotal in pulling the economy out of a depression.

Why raise interest rates now?

The US economy seems to be picking up from the crisis that erupted in 2008. The Feds decision of whether to raise rates are dependent on key factors such as unemployment figures, real GDP growth, inflation and wage rises.


Unemployment rates have fallen to below 5% which is widely seen as a benchmark of low unemployment thus a reflection of a buoyant economy and efficient usage of resources.


US average hourly wages have also seen the most significant increase in percentage in the month of October. Conventionally, if you recall the AD-AS model, rising wages are a reflection of a gradual dwindling of spare capacity in the economy as firms experience an unplanned decrease in stocks and bid up factors of production, including labor to keep up with the economic growth. Since one of the central bank main objectives is to ensure sustainable low inflation of around 2%, the rate hike appears to be justified.


However, the US inflation rates are at historically low levels. Moreover, the Fed’s favoured inflation measure, the index of personal consumption expenditure(PCE), is at near zero and far below the target of 2%.

Nonetheless, markets expect rates to be rising by this December.  “Inflation is not a problem now, but zero rates are a recipe for excess inflation down the road. The longer the wait, the higher the risks. If inflation does break out, the Fed will be forced to tighten aggressively, causing far more damage to the US and global economy than starting now,” says Deutsche Bank’s chief economist David Folkerts-Landau.

Secondly, a rate hike can remove much of the market volatility that has been pre-existing since news of the tapering of QE emerged. Investors have been frightened by the repeated news of possible rate hikes that have fueled massive ‘hot money’ outflow. The gradual rate hikes will signal a reversion back to conventional monetary policy and set the tone for future stability.

Given the evidence put forward, we believe a rate hike is necessary and inevitable. The follow up question one must ask is thus who will catch a frostbite? Who will brace the cold with few worries? Who may potentially end up like Ned Stark?


Are we heading towards an Icelandic Meltdown?

This week we look at a question posed by Forbes contributor, Jesse Columbo, 2 years ago as he predicted the eventual bursting of a property bubble that was emerging in Singapore and a subsequent meltdown akin to the breakdown of Iceland’s banking crisis in 2008.(Check out the article above). While not all of his points are valid, the writer does make certain intriguing observations of the potential risk that Singapore suffers from as a financial center in Southeast Asia.

What happened in Iceland?

In 2008, after the sub-prime mortgage crisis and the shrinkage of short-term debt financing, the three Iceland banks – Glitner, Kaupthing Bank and Landaski – experienced severe shortages of liquidity. From the 1980s to 2000s, Iceland emerged from a small fishing state to an economy that averaged nearly 8% growth every year.


Its rise was largely a result of a property bubble boom that was fueled by massive credit expansion. From the 1980s to 2000s, as a result of the ‘Great Moderation’, the opening up of China, the world experienced long periods of stable low inflation and high GDP growth. However, there was also a dropping of long-term interest rate yield across the developed nations. In the case of America, it was largely a result of a global savings glut central in Asia while in the case of Iceland, much of the capital came from the Eurozone, especially Germany due to its close relations to the Euro. Low interest rates did not fuel productive investments but were instead concentrated in the property sector. It is quite blatantly obvious in the graph below that housing prices increased up to 300%,

Given the profitability of mortgage loans, the financial sector expanded indefinitely. Cheap credit from abroad was pumped into real-estates with banks acting as intermediates. It led to an delusional rise in wages, tax revenues and consumption that further fueled the credit boom and the housing market. The three big banks seemingly profited from this dangerous feedback loop.


They massively expanded their balance sheets and by the end of 2007, their total assets were nearly 12 times the country’s GDP. Thus, with the bursting of the bubble in US, it triggered a chain reaction of liquidity shortage and a banking crisis in Iceland. Leverages were so high among Icelandic banks to the extent that the Central Iceland Bank(CIB) could not intervene to bail them out and were forced to allow them to default on their loans. What followed was an extended period of high unemployment and low standards of living.

 Is a housing bubble emerging in Singapore?

The question to ask is thus whether a housing bubble is emerging and to what extent is the financial sector exposed to such a threat.


The residential property index(Good indicator of property prices) is showing quite a dangerous rise in property prices since 1975. The rise was especially significant after 2008 as a construction boom fueled property prices. As stated by the writer, this was largely a result of QE enacted all over the world which resulted in the fall of long-term interest rates.  


The Singapore’s interest rate(SIBOR) is close pegged to the US inter-bank funds rate. Thus with the introduction of quantitative easing, rates have hovered below 1% from 2010 to 2014.

With property prices rising nearly 3 times since the 1990s(identical to the Icelandic situation), we should thus be worried about a potential bubble formation. However, the government has made conscientious effort to deflate any further formation of a property bubble. SIBOR has crept back to 1.5% which is likely to depress private property prices.Every percentage point increase in interbank rates raises repayments on a S$1 million property by 12 per cent, assuming an 80 per cent loan-to-value ratio and a 25-year loan duration, according to Maybank Kim Eng Securities.

Moreover, unlike what the writer claims on the Fed’s decision to raise rates only in 2017, it is highly likely the Fed Reserve led by Janet Yellen will raise the Fed’s inter-bank rates by this Dec. Thus, expect the SIBOR to rise further which will depress prices significantly. Turbulent times lie ahead for the property sector but from a macro-economist perspective, the gradual fall in property rises is to be welcomed..

What are the measures taken up by the Singapore government? How effective are they? 

Though due to the different reasons, both Singapore and the eurozone countries do not have the freedom to set interest rates. Thus, macro-prudential policies play and important role in ensuring the controlled expansion of the economy. The term seems complex but just think of them as policies/laws such as capital ratios, loan requirements that aim to control credit expansion within the economy. The difference between Iceland and Singapore is simply that the Singapore government has played a more active role in controlling property prices.


Since 2009, the government has released almost 9 rounds of property curbs to control the rise of property prices, a contentious issue during the 2008 General Elections. For example:

  1. In August 2013, the government shortened the maximum loan tenure to 25 years from 30 years, and reducing the mortgage ratio limit against the borrower’s salary to 30 percent from 35 percent previously, effectively making it harder to service mortgage debts.
  2. The Total Debt Service Ratio (TDSR) framework was also introduced on 23 June 2013 by The Monetary Authority of Singapore to impact all property loans granted by financial institutions (FIs) to individuals. This will require FIs to take into consideration borrowers’ other outstanding debt obligations when granting property loans. Simply put, banks only can lend you an additional 60% of your gross monthly income but this lending must include all existing loans including – student loans, credit card debts, car loans, any other forms of loans.

This series of property curbs were placed after previous 7 curbs already enacted which shows the resolve of the Singapore government at controlling property prices. However, it is worth mentioning,and worrying that property prices only started decreasing towards the end of 2013. The evidence suggest that while macro-prudential policies can aid prices control. It will appear that interest rates tend to have a more adverse impact on property prices. The fall in prices seems to coincide with the tapering of QE in the USA beginning in 2013. While it may be possible that the curbs take time to surface, evidence suggest that local property prices may be severely affected by macroeconomic policies enacted by large countries. Domestic property prices are increasingly affected by foreign macro policies.

How exposed is our financial sector?

It is undeniable that Singapore faces risk given its big banking sector region. Singapore’s financial sector is nearly 6 times its economy and its financial services industry grew 163% from 2008 to 2012. Its growing role as a banking hub in Asia has resulted in a gradual increase in the management of assets in Southeast Asia. Many of the Southeast Asia countries are developing countries which have experienced a commodity boom and a liquidity surge as extended periods of low growth and quantitative easing has resulted in ‘hot money’ to flow excessively to the region. However, with potential interest rates rising in US, the liquidity can easily dry up the region, resulting in volatility and asset repricing due to large cross-border financing.

Moreover, according to the IMF, “70 percent of local housing loans at variable rates, most of which reset every six months, the transmission from higher interest rates to higher debt servicing costs would likely occur swiftly. According to a MAS survey, if interest rates rose to 3.5 percent (about 200 basis points above current levels), the debt servicing costs of some 5–10 percent of households would rise above 60 percent of income.” The risk is thus present that given an expected rise in inter-bank rates in the next few months, we may see an increase in mortgage defaults that will pose a risk to local banks.


However, in a 2013 report(Table 5) by IMF that looked at the sustainability of local banks, the Singapore’s banking sector is well poised to handle the turbulent times ahead. Capital to risk-weighted assets, effectively a measure of the liquidity present to handle bank runs are above 16%, well above the Basel III requirements of 8%. Right before the crisis in 2007, Iceland had a ratio of 7.4%. Moreover, non-performing loans are only at 1.1% thus there is still space for maneuver.

Yet, we must be wary of Jesse Colombo’s words where it can be seen that Construction + Housing industry constitute up to 35% of bank loans. These 2 sectors are close knitted and a spike in housing defaults will increase the systematic risk of defaults across the whole real estate industry.

Fundamentally, he financial sector was always fragile. Acting as financial intermediaries that capitalize on short-term deposits to lend out for long-term profits always suffered from a possibility of liquidity shortages. Singapore made a conscientious decision to expand its financial sector despite knowing the risk that it may pose. Given the healthy labour pool and our enhanced infrastructure, the potential benefits of acting as a financial hub in Southeast Asia is too much to be foregone. Hence, we can see the importance of the MAS and the government in extending financial oversight to ensure that banks are well-versed to tackle a crisis.

What can we expect in the near future?

Quantitative easing has proven to be effective as a monetary policy in combating liquidity pressures in a severe financial crisis and we will expect this policy tool to be possibly becoming common in the days ahead. While policymakers have emphasized on it being a ‘last resort’ policy, market expectations may force them to adjust. While a fall in interbank funds rate previously entailed a expansionary response, investors now may increasingly view QE as a norm and thus reduce the long-term effectiveness of interest rate changes. This consequence remains to be seen.

But, it is clear that the artificial creation of liquidity posed serious threats to global economies. Easy credit has created property bubbles in the US and the Eurozone before 2008. Following the crash of the financial industry in the developed world, it shifted to developing countries and fueled massive credit expansion and dangerous debts financing. With the rate hikes ahead, they are likely to now shift course once more. Such free capital especially in a world of large investment banking can easily fuel property and credit bubbles that are unsustainable and detrimental to any economy.

Singapore, given its market openness and large financial sector is prone to such liquidity risks and we must constantly ensure a group of world-class leaders who are at the forefront of preventing the creation of such credit bubbles. Do expect to see the real estate industry to experience falling housing prices over the coming of years. The government is likely to relax property curbs gradually perhaps after the fall of another 20-30% in prices to ensure the wealth of Singaporeans are maintained. There is a delicate balance that must be drawn.

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