Business Times of 08 Nov 2006

By JOSEPH CHONG

I AM gratified by the encouraging response that I received from my Aug 30 piece titled 'A closer look at S'pore's reserves' in The Business Times. Interestingly, several respondents suggested setting up a state pension fund for the elderly, echoing a recent call by former NMP Dr Kanwaljit Soin. I understand that the official view is that Singapore cannot afford such a state pension fund. According to data from the Singapore Department of Statistics, there are about 300,000 citizens aged 65 and above as at the end of 2005.

Indeed, as from the beginning of 2006, the book value of our reserves has ballooned even further - by almost $12 billion, or about 6 per cent of GDP! I believe that we could afford such a pension scheme and it would be beneficial to the economy. Among other benefits, it would serve as an automatic demand instrument should the economy slow. However, we would need to be careful not to create a handout mentality. Issues such as who would qualify and how much the pension should be without creating the 'moral hazard' of an entitlement mentality would need to be studied.

Another interesting issue raised in the media is the future expected returns on our reserves. GIC officials have been recently quoted as expecting this to be lower than the 5.3 per cent real return over the past 25 years. I am inclined to agree with this expectation. Firstly, the past 25 years have seen two important seminal events: the taming of inflation in the US initiated by the Federal Reserve and the European Monetary Union. In both cases, bond yields fell almost continuously over two decades and corporations world-wide were forced to restructure to be more competitive. Global investors were the big winners.

Secondly, I believe the size of our reserves relative to the investible universe may be hampering performance - a common problem which large funds have to grapple with. Let me explain. According to media reports, about 45 per cent of GIC's portfolio is invested in global quoted equities. For the European markets (at 31 per cent of world global market capitalisation), this would be about $65 billion. Assuming investments are spread over 200 European companies, that would mean $326 million per stock. To avoid the 5 per cent threshold, these target firms would need to have a market capitalisation of more than $6.5 billion. This essentially means that one would be restricted to the top 300 names in Europe. A breakdown of the market cap distribution for the Eurofirst300, a pan European index of 300 stocks, illustrates that the 300th company has a market size of about $7 billion.

Another issue recently raised in the media by no less than Minister Mentor Lee Kuan Yew is the safeguards to our reserves. Constitutional safeguards and an elected presidency ('the second key') are meant to prevent or, at least, make it difficult for a hypothetical rogue government ('HRG') to raid the reserves. How safe is this? Unfortunately, I believe that developments in capital markets make it fairly easy for an HRG to circumvent current safeguards in order to 'raid' the reserves. One way is for an HRG to issue long-term S$ government bonds. For example, $50 billion due in 10 years at 4 per cent annual coupon - higher than the current market to attract investors. The HRG needs only to fund 4 per cent annually or $2 billion. This, an HRG can do by printing money. The expanded money supply will result in slightly higher inflation and a weaker local currency in the short term.

In the short term, however, the domestic economy will do well and voters will feel good if, say, 50 per cent of the $50 billion is aggressively injected into the domestic sector until the next polls - a giant Progress Package of sorts. Trying to defeat the HRG in such an exuberant atmosphere would be an uphill task. Indeed, the HRG could even boast that they have increased the value of the reserves as a weaker S$ would make our foreign reserves appear to increase in value. One way to prevent this is to increase the number of 'keys' from the current two.

I believe an HRG would find it more difficult to hoodwink the public if every citizen with a CPF account was allocated a fraction of the reserves. This could take the form of a Super Special Account managed by GIC whereby capital cannot be withdrawn but some of the returns will be paid out. We would then have not only two million additional key holders but watchful ones because people take most care when it is their money.

The author is CEO of financial adviser New Independent. He welcomes feedback at josephchong@ni.com.sg This article is for information only. Readers should seek independent advice before making any investment decisions.