Effects of a Shrinking Gdp on Singapore's Economy

In a recent article by Channel News Asia dated 13 July 2012, it was reported that Singapore's GDP contracted by 1.1% on a Quarter-on-Quarter seasonally-adjusted annualized basis, compared to the 9.4% expansion in the preceding quarter.

The weakened growth momentum in Q2 was mainly due to a sequential contraction in the manufacturing sector. The sector declined by 6.0% reversing the 20.9% expansion in the preceding quarter.

Annex A

Singapore is an open economy with high trade to GDP ratio of 2.3 times (GDP 2011 was $326B, whereas total trade value in 2009 was $747.15B) and is exposed to many external factors, especially economic development in a main export market.

Our main trading partners are:

- Malaysia - 11.9%

- China - 10.4%

- Euro zone - 11.1%

- USA - 6.5%

- Indonesia - 9.4%

These 5 regions accounted for 50% of Singapore's total trade, of which the US, Euro zone and China contributed 28%. Any negative economic news in these 3 regions will have sizable impact on our economic development.

The US economy grew at a lower 1.5% in Q2 compared with 1.9% in Q1, which establishes the fact that the US economy is growing at an anaemic rate.

In addition Singapore's second largest trade partner the 27-nation European Union (EU) is currently in recession and does not have the ability to purchase the same amount of Singapore's goods and services as they did before (demand declines).

From the article, it can be inferred that demand for our exports has decreased.

The cause can be attributed primarily to 2 main reasons;

1) The weakening of the economies of our trade partners

2) The strengthening of the SGD

The strength of the SGD has also contributed to Singapore's declining exports. In this aspect it is making export prices uncompetitive. (For the same $ spent, fewer goods could be purchased)

Conversely a strong currency allows for higher purchasing power which would lead to an increase in imports. Exports to the EU totalled SGD$48.1 billion last year, while imports from the EU reached SGD$57.9 billion, official data showed.

Singapore's Economy has been resilient amid the global economic slowdown by diversifying across a range of sectors including oil and gas, pharmaceuticals and electronic.

More importantly, Singapore's long term objective of going into high value-added industries such as medical, biotechnology, geno-technology and nano-technology has also supported the resilience in our economy.

In the past 10 years, ASEAN has developed to become a significant and sizeable trading zone within itself besides, NAFTA and Euro zone. It provides countries like Singapore and Hongkong the opportunity to lead the ASEAN effort as the more successful Asian economies.

Although from the article it can be seen that the simultaneous surges in the electronics and pharmaceutical production that increased GDP growth in Q1 are not sustainable amid global demand weakness. (Manufacturing sector declined by 6 %)

Which brings to mind 2 questions when aggregate demand falls what is the possible effects on our economy and how will that affect us? And what is the relationship between aggregate demand and GDP?

I shall demonstrate the r/s using graphs

At the current price level of 110, producers are willing and able to sell $100 billion worth of Product.

Given, the current situation with our trading partners, our trading partners do not have the ability to purchase $100 billion worth of products; however, they may still be able to purchase a small amount at a lower price of $90 billion.

When this happens the demand curve shifts leftwards as there is a fall in demand, because of this the Price level also falls to meet at the new market equilibrium (Real GDP 90, Price Level 100)

What does this mean domestically in Singapore?

When demand declines while production output remains unchanged an economy-wide market surplus is created.

Faced with a build up of inventories, producers either lower production output or induce sales by lowering the market price.

When producers lower their prices they earn less revenue, to offset this lost of income producers would have to lower their cost of production by lowering their overhead costs like labour. This could lead to unemployment in the economy.

Recognizing the extenuating factors, The Monetary Authority of Singapore (MAS) has lowered GDP growth forecast for Singapore and increase inflation for the rest of the year.

A slower economic growth does not normally lead to higher inflation. The converse is normally true. Slowing down of demand tend to lead to lower demand for raw materials and thus a fall in material prices. Then why is our inflation level so high?

Annex B

MTI released our June CPI, which is inflation

The number was 5.3%, compared with 5% in May and 5.4% in April.

Singapore (MAS) manages its currency against a trade-weighted basket of currencies of Singapore's major trading partners and competitors. When inflation is high, the SGD is allowed to strengthen.

As can be seen from the data, inflation remains stubbornly high due to high Housing and Transportation costs. This is caused by high COE prices due to a systematic reduction in number of COEs.

And high property prices and