The higher costs of borrowing for homes, cars and business investments may mean stronger downside risks for the Singapore economy.

Singapore has experienced the almost unprecedented scenario of a double whammy – high inflation and interest rates.

The Consumer Price Index is expected to reach six per cent – a two decade high – for the entire year, according to the latest report of the Consumer Price Development. Rapid economic recovery, like that following the Global Financial Crisis when inflation hit 6.6 per cent, tend to see markets flushed with cash produce elevated price levels. The inflation rate in 2007 reached 2.1 per cent, surged to 6.5 per cent in 2008 and then came back down to 2.1 per cent the following year.

Singapore banks have increased interest rates, as most loans are based on the Singapore Overnight Rate Average (SORA) or the Singapore Interbank Offered Rate (SIBOR) which moves historically in tandem with the interest rates set by the US Federal Reserve. The Fed has raised rates four times this year. Singapore banks have also been incentivised to follow suit in the competitive fight for deposits, with UOB raising the maximum rate to a shocking 7.8 per cent.

From buying cars to houses, borrowing costs have surged. Local banks including DBS, UOB and OCBC have raised the interest rate on fixed rate mortgage packages to 4.5 per cent interest.

Perfect storm for inflation and rising interest rates

Current conditions have created the perfect storm for inflation for countries worldwide. Largely a price-taker in global economics and finance, Singapore is exposed to these same shocks, developments and trends.

The reality is that countries have over-compensated in pre-emptively trying to precent a collapse of confidence during the pandemic. As governments hurriedly pushed out financial assistance to businesses and a slew of handouts to keep households afloat, this aggressive expansionary fiscal stimulus created excessive liquidity in the economy, with the US alone estimated by Moody’s to have pumped almost US$5 trillion (S$6.7 trillion) to avert a catastrophic loss of jobs.

The subsequent lifting of Covid-19 restrictions, accompanied by revenge spending, led to an explosion in demand for goods and services, with manpower shortages unable to keep up initially.

Such shortages were worsened by supply side shocks: Covid-19 related restrictions, factory closures and slower port operations, coupled with Russia’s invasion of Ukraine which choked up supply chains and multiplied bottlenecks, pushing up prices of everything from electronics to food globally.

To combat inflation, central banks worldwide have embarked on a contractionary monetary policy. These are primarily aimed at curbing consumer demand and raising the costs of doing business by hiking interest rates, with the US Federal Reserve raising benchmark interest rates from near-zero in March to nearly 4 per cent today.

Here in Singapore, the Monetary Authority of Singapore (MAS) sought to shield the economy from higher prices by appreciating the currency in five rounds of monetary policy tightening. This reduces the cost of imports, which is particularly important for an import dependent country.

We can expect interest rates to remain elevated, requiring firms and households to fork out higher loan repayments while challenged by rising costs of living and doing business arising from inflation.

Will this lead to massive defaults in Singapore in the same way the collapse of the US housing market triggered off a wider financial crisis in 2008 with the cascading effect of loan defaults in the wider economy? We are cautiously optimistic that the Singapore economy will escape relatively unscathed compared to the rest of the world given the policy moves to shore up and stabilise the banking system.

Helping first-time homebuyers

This fear of a fragile housing market souring and the potential for contagion is understandable when the residential property market forms a huge proportion of the net worth of most households. Currently, residential property assets make up around 43.9 percent of total assets owned by Singapore households. Mortgage loans make up 71.7 percent of the total amount of households’ liabilities.

New homebuyers will be hit hard with higher mortgage payments, the result of rising inflation and interest rates. . The private housing market has seen a 3.4 per cent surge in prices in the third quarter, while the HDB resale price index has climbed for 28 consecutive months.

Aspiring homebuyers like newly-weds will find it tough to enter a hot housing market to purchase a new home. They will have to wait for years for an HDB Build-to-Order flat if they cannot afford a resale. The worry is that the elevated costs of homeownership might push more to delay starting a family, putting pressure further on Singapore’s low fertility rate of 1.12.

To support these new homebuyers, the Singapore government has a few policy tools that it can leverage but should proceed with great care. One key instrument lies with the HDB. With more than 80 per cent of Singaporeans staying in public housing, decisions involving HDB instruments would directly impact most homeowners.

In times of rising inflation and interest rates, HDB policy has provided much needed stability and financial security for homeowners. Despite the increase in mortgage rates by commercial banks, the concessionary interest rate offered by HDB remained unchanged at 2.6 percent throughout the year.

Most households in Singapore should be well positioned to ride out the double whammy of high inflation and interest rate, owing to the slew of macro prudential policies adopted by the Monetary Authority of Singapore (MAS) throughout the years. This includes lowering the total debt servicing ratio (TDSR) to limit mortgage borrowers to devote a maximum of 55 per cent of one’s gross monthly income to total debt repayments, which includes car, home and credit card loans, and imposing a lower loan-to-value (LTV) limit of 75 per cent, restricting the amount people can take relative to the cost of a home.

Leaner and more efficient businesses

With the heightened costs of borrowing, the days of cheap money are over for businesses which will see lower profits, fewer new projects as interest rates outstrip returns on investments and potentially a greater risk of default.

The strong Singapore dollar has mitigated these to some extent, in controlling the costs of imported materials and managing the costs of production for the manufacturing and industrial sectors. But there is no running away from this stricter environment of financial discipline.

We would urge businesses looking for additional financial assistance to take advantage of government assistance to relook their processes to reap additional costs savings. An environment in which money is not cheap can be good discipline and encourage continued transformation, the adoption of new IT solutions and process improvements to increase productivity through programmes like the Singapore Government’s Enterprise Development Grants or the NTUC’s Company Transformation Committees.

By leveraging existing public policy and initiatives to find new markets, lower costs and build business resilience, the most future-oriented businesses will come out of this episode leaner and more efficient.

Well capitalised banks

A third worry lies in whether Singapore’s banks are sufficiently well capitalised, ensuring the stability of the overall financial system.

Like most of their counterparts all around the world, banks in Singapore have benefited from higher interest margins and enjoyed higher rates of returns on deposits. Singapore’s three largest banks, DBS Group Holdings, Oversea-Chinese Banking Corporation (OCBC) and United Overseas Bank (UOB) all reported record profits in the third quarter of the year.

The danger for banks lies in the risks of borrowers defaulting on loans, potentially damaging confidence in the banking system and fuelling a run on the bank as depositors withdraw deposits and consequently straining the banks’ ability to cover withdrawals with existing reserves.

But there is a very low likelihood of this scenario materialising as banks are well capitalised. Consumer and business confidence in Singapore’s major banks remain strong, with long queues for promotional fixed deposit rates at banks.

Policy Implications

The twin factors of high inflation and high interest rates exerting downward pressure on the Singapore economy will undoubtedly hurt groups with tighter budgets than others – including retirees and low-income households. A targetted approach to redistribute financial support, such as the recently announced S$1.5 billion support package to fight inflation, will be a key item many will look out for in the Singapore Budget next year.

The challenge also lies in striking a balance in pulling specific policy levers and understanding the implications of tweaking one part. There have been calls to raise the CPF rates to ensure retirement incomes for the elderly keep pace with inflation on the back of the Government’s announcement that interest rates for CPF accounts will remain unchanged in the first quarter of 2023.

But the public should bear in mind that adjusting one could have knock-on effects for other segments of society. HDB loan interest rates are currently pegged at 0.1 percentage points above the CPF Ordinary Account Interest rates, and raising the latter means homeowners who have taken an HDB loan will have to pay higher interest rates.

In the final analysis, it turns out that high interest rates and inflation have complex effects that go beyond their immediate impact on the cost of living and doing business in Singapore. The attendant policy remedies involve turning the wheel on another part of a national superstructure, hurting a different segment of the population.

The article is an edited version of the first one published in The Straits Times.