Capital market-economic growth nexus essential to Singapore’s finance centre, entrepreneurial hub ambitions
Note: I first posted this piece on LinkedIn. It retreads prior developements from previous pieces and amalgamates in from a new angle, about the lack of a finance-growth nexus in Singapore.
In the post-COVID world, Singapore’s efforts to sustain its commercial-finance centre and entrepreneurial hub ambitions, underwritten by significant economies of scope and ecosystems, will fall short unless it establishes a capital markets-economic growth nexus (finance-growth nexus).
There is a clear relationship between the development level of capital market sub-components, involving mutual/pension funds, corporate bond, stock and government bond markets, and broader economic growth.
The capital market ecosystems of Hong Kong, Tokyo, New York, Seoul, Sydney, London, Amsterdam and other global cities have a cointegrating relationship between equity capital market development and economic growth, with a strong interdependence and asymmetrical effect on economic growth.
Capital market sub-components involving mutual/pension funds, corporate bond, stock and government bond markets support capital market development, which drives economic growth.
Moreover, this underwrites robust entrepreneur-enterprise ecosystems, with investors, early staff and entrepreneurs able to benefit from the strong liquidity of equity markets, with retail investors, pension funds and other stakeholders able to capture an equitable share of corporate wealth.
The economic history of Taiwan, Japan, South Korea and Germany highlights how pension assets in capital markets stimulate economic growth; support the growth of globally competitive domestic multinational corporations (MNCs); and establish a positive feedback loop between capital markets and the real economy. This highlights how Singapore’s public sector needs to better allocate government surpluses and foreign reserves to reinforce the domestic economy.
Capital market ecosystem flows
In a healthy equity capital market, pension assets and other large institutional investors underwrite and sustain market liquidity on a long-run basis. Healthy public equity capital flows enable robust enterprise financing for businesses and facilitate healthy exits for investors, with post-IPO firms driving employment growth and expanding the overall tax base.
Such scale-up enterprises are engines of job creation. This virtuous capital cycle facilitates a capital market-economic growth nexus, with a major indicator of such growth being a robust market for initial public offers (IPOs), a domain where Singapore lags Hong Kong, Sydney, Bangkok and others due to a lack of a comparable finance-growth nexus. While the city-state has evolved its startup ecosystem, it also needs more vibrant private markets as well as public equities, to make it self-sustaining.
In 2020, listed companies on the Singapore bourse declined to a low of 697, following 26 corporate delistings. 2020 is the second year where more businesses left Singapore public markets than joined it. Despite its strengths as a financial sector, its central banks focus on the growth of the banking and finance sector arguably comes to the detriment of its domestic equities.
It also has implications for its financial centre and its corresponding international appeal. The bourse faces the same challenges as Tokyo, which has seen the loss of foreign issuersin its equity markets and attempted to ameliorate since 2007.
Even with its ambitions to attract Asian IPOs and deep liquidity, the last decade of efforts by Tokyo has seen limited success in attracting foreign issuers. It is also reflective of its comparative decline as an international finance centre.
Furthermore, this de-equitisation creates both political and socioeconomic risks. Besides imperilling Singapore’s entrepreneurial hub ambitions and stature as a global financial centre, excess corporate delistings can eventually give rise to anti-business sentiments, according to a 2016 study by Alexander Ljungqvist of the Stern School of Business.
There are pros and cons for any enterprises staying private or going public. But unlisted enterprises tend to have a higher cost of capital. This impacts investment, innovation, growth, job creation and various other processes. Though this cost-of-capital gap is shrinking in private equity.
It’s the broader social effects, with retail investors (i.e. household sector) missing out on the wealth creation of growth companies and their allocation of corporate profits. The outcome is that wealth inequality widens. This then drives reductions in public support for shareholder capitalism.
Declining stock market participation and privatisations affects incentives for the general public to support parties that commit to business-friendly policies. Delistings reduce public exposure to their share of corporate wealth creation, worsening the wealth gap as these profits accrue to professional, accredited and institutional investors in the private equity domain.
This drives reductions in aggregative investment, productivity and job creation, impacting the household, public and private sectors in the long run. In Singapore’s case, these corporate profits are concentrated among a smaller pool of listed corporates, many of them government-linked corporations (GLCs).
This market environment is a net negative for the city-state, as enterprises with such market power often have outputs below the social optimum. They can extract additional profits by raising prices; suppress wage growth; and inhibit competition. This also reduces investment and productivity, as there are limited incentives to improve systems or products.
This suggests a compelling need for reform in Singapore’s Central Provident Fund (CPF) system, overall public sector allocations and its capital markets ecosystem by extension.
There is negligible allocation to domestic equities, distorting the mutual/pension fund subcomponent of its capital markets ecosystem. Singapore’s securities market have all the foundational elements to be globally competitive but are held back by ecosystem dysfunction and public policy.
For instance, end-2019 saw about 35 per cent of Hong Kong’s Mandatory Provident Fund (MPF) invested in domestic equities, with the stock market being a crucial driver of its economic development, alongside being a mainland Chinese gateway. This is further supplemented by the Shenzhen and Shanghai stock market links, with the Shanghai bourse alone having a retail investor population estimated between 120 million to 200 million.
Meanwhile, European pension funds also recognise the importance of this finance-growth nexus and the mutual/pension fund subcomponent in capital market functioning. Many maintain a strategic allocation of their pension assets to domestic equities ranging from six to 12 per cent, benefiting the domestic equities market in Frankfurt, Zurich, Stockholm and Amsterdam.
This aligns with the resounding evidence for this in Euronext countries and OECD nations. It benefits smaller states like Portugal and Romania; major global economies Germany and Japan; and emerging markets like Turkey and Botswana. This highlights the key role of domestic equity pension funds in capital market ecosystems and their vital contribution to sustaining the finance-growth nexus.
Creating a capital markets-growth nexus
Even with the implementation of Hong Kong’s national security law in 2020, Singapore equities will be unable to compete with the equity markets of Hong Kong and other financial centres until it establishes its growth-finance nexus.
Adapting its CPF system to enable greater household investment in equities via investment savings accounts is one possibility, though this can be fraught with political costs for policymakers. The alternative is adopting and adapting the ETF purchase scheme implemented by the Bank of Japan (BOJ).
The injection of state funds into domestic equities would be a game-changer. Institutional investments from state investors generate positive market signals; augments market liquidity; and has the potential to enhance minority shareholder protections. Such investors can have a key control as a control device in protecting minority shareholder interests. And high levels of trading activity by these institutions can favourably affect broader market liquidity.
Observed in the dynamics of the markets of Australian securities and Japanese equities, the improved corporate governance that minority shareholder safeguards imply also serves to boost stock liquidity. This is also seen to be the case in Malaysia and Thailand.
Sweden’s Investeringssparkonto (ISK) system is a compelling option, which grew the share of listed corporate wealth held by Swedens’ household sector. “The Promise of Market Reform: Reigniting America’s Economic Engine”, a 2018 Nasdaq white paper, noted increased longer-term savings and contributed to the substantial growth of IPOs in Nasdaq Stockholm in 2014–2016 period.
Closer to home, the Thai stock market’s success as the most liquid in Southeast Asia — it aims to surpass Singapore’s market capitalisation in 2023 — through most of the 2010s is linked to capital flows from Long-Term Equity Funds (LTFs) and Retirement Mutual Funds (RMFs), coupled with broad investor literacy.
Different LTFs and RMFs managed by Thai asset managers, distributed directly or through affiliated bank branch networks, expanded investment exposure for the Thai public. This has underpinned its economic developmentthrough the late 2000s and 2010s.
Singapore’s central bank, the Monetary Authority of Singapore (MAS), can also intervene. One option is to adapt the Bank of Japan’s (BOJ) ETF purchasing scheme to support liquidity in its domestic equities, with the Japanese central bank posting gains of US$56 billion gain in 2020 due to its equity investments.
BOJ pursued this policy of asset purchases to lower equity risk premia and manage inflation, in order to drive growth, though this approach may not be appropriate for Singapore. It was also aimed at creating a ‘wealth effect’ that put more funds into the household sector, which could then in turn spur consumer spending and stimulate the economy.
The BOJ, as the trustor and beneficiary, appointed trust banks and created a money trust, with which ETFs and J-REITs are purchased as its trust property. These purchases were conducted by the trustee pursuant to a standard prescribed by the Bank, as needed. These policies by the BOJ also underpin a dynamic equity ETF market.
This ETF purchasing served to boost the Nikkei 225, buying ETFs when the market is weak and selling when strong, boosting returns. However, the impact on Nikkei 225 stock returns became smaller over time despite the growing purchases, with indications the BOJ was excessive in its approach. Concerns were raised over how it distorted corporate governance and market function.
The MAS can adapt the policy of its managed float of the Singapore dollar float within an undisclosed bandwidth to building and sustaining securities turnover on Singapore’s domestic equities. This can go to managing and maintaining equity market liquidity within a specific band, maintaining parity to peers like Bangkok, Taipei, Frankfurt, Zurich, Sydney and London.
By purchasing equity index funds that can broadly lift its domestic equities market and maintain parity within a band against a basket of peer securities markets, it resolves the perennial liquidity question, at least as it applies to securities turnover, and can also boost overall valuations, another criticism of Singapore equities.
Adopting an ETF purchasing scheme and working with local banks to issue and manage them, seeding and enabling the growth of an ETF cluster in Singapore equities, it also ensures its equity capital markets remain competitive. Such a solution also sidesteps the politically sensitive matter of CPF capital being allocated to the Singapore bourse, given local investor sentiment and lack of education on the benefits that it yields.
Data from the Sovereign Wealth Fund Institute (SWFI) suggests that as of end-2020, Singapore’s state funds, Temasek Holdings and GIC, its central bank (MAS) and the CPF Board collectively manage ~US$1.5 trillion in assets. It’s not a lack of funds, but rather a lack of political will and long-term commitment to its equity capital markets by policymakers at this point.
Alternatively, forming a joint agency with the CPF Board to oversee and manage a strategic allocation of CPF assets for domestic equities — underwriting investments in index funds tracking the FTSE ST All-Share Index, FTSE ST Catalist and FTSE ST Large & Mid Cap Index — could add additional liquidity in terms of securities turnover to its equity market. There is no lack of options for policymakers to explore and implement, nor lack of capital to deploy.
The other option, if the pension assets held by the CPF Board are perceived to have an excess political cost, is to allocate a strategic allocation of official foreign reserves to its domestic equities, ranging from 2 per cent and capped at 11 per cent. A strategic allocation of even 1 per cent of the S$474 billion in CPF balances or US$379.75 billion in official foreign reserves to domestic equities can send strong market signals, enhance securities turnover and investor confidence considerably.
Historically, a lack of public support saw the failure of the Bangkok Stock Exchange in the 1970s, which saw limited attention and low annual turnover. This was compounded by Thais’ limited understanding of the equity market. The situation with the Stock Exchange of Thailand (SET) is markedly different. Bangkok has its sights set on surpassing Singapore’s market capitalisation by 2023. It displaced Singapore as Southeast Asia’s most liquid equity market in 2012, with daily securities turnover averaging US$2 billion through the 2010s.
Without strong public sector support and a growth-finance nexus, there are negative long-run consequences for Singapore’s economic stature. Continued de-equitization will compromise its ambitions to be an Asian entrepreneurial centre, worsen its stature as a financial centre and heighten domestic socioeconomic disparities.
By not addressing the root issues of a dysfunctional capital markets ecosystem enabled by the failure of policymakers to act, Singapore cannot compete. Contenders in the region for Asian hub statuses like Bangkok and Jakarta have much larger talent pools, large domestic consumer markets, cost structures and scale economies Singapore cannot match.
Even its ambition to supplant a troubled Hong Kong potentially in terminal decline — an ambition assisted by the security laws implemented in 2020 that compromise its legal system, financial flows and overall long-term viability — cannot hide the public sector neglect of its cash equities. Hong Kong’s equities market is far deeper and vibrant, with greater securities turnover, mainland China connectivity and with an arguably well-adapted capital markets ecosystem, at least for the moment.
Equities finale?
Singapore’s public sector policymakers need to adopt a strategic perspective and be far more committed than the lacklustre attempts to date. Insights can be gleaned from the strategic decisions that drove Nokia’s decline in mobile telephony, as well as the contrast between nations like Italy and Russia.
Nokia’s decline was rooted in what Yves Doz is an Emeritus Professor of Strategic Management at INSEAD, explained in a 2017 piece: “Management decisions, dysfunctional organisational structures, growing bureaucracy and deep internal rivalries all played a part in preventing Nokia from recognising the shift from product-based competition to one based on platforms.”
“Nokia’s mobile phone story exemplifies a common trait we see in mature, successful companies: Success breeds conservatism and hubris which, over time, results in a decline of the strategy processes leading to poor strategic decisions. Where once companies embraced new ideas and experimentation to spur growth, with success they become risk-averse and less innovative. Such considerations will be crucial for companies that want to grow and avoid one of the biggest disruptive threats to their future — their own success,” he added.
In the realm of international politics, the international stature of Italy, the “Least of the Great Powers”, is another object lesson. Despite being a part of great power concerts — it is a constituent and founding member of the EU trio alongside France and Germany, the NATO Quint, the G7 and G20 — it fails to have the same influence as Russia on the international stage.
Italy GDP (Green) vs Russian GDP (Blue). Data from CountryEconomy.com
Despite possessing a greater national nominal GDP and GDP per capita — Italy had a 2019 GDP of US$2 trillion while Russia had a US$1.7 trillion economy — Italy fails to be relevant on the global stage. Beyond its nuclear weapon capability, this is because Russia has developed a strategic culture and a shrewd approach that enables it to asymmetrically compete with other Great Powers and be perceived as a near-peer threat to the US, which had a GDP of US$21.43 trillion in 2019.
And amid the global pandemic, Japan also offers parallels. The bureaucratic timidity and inaction by Japanese policymakers has seen the country become reliant on overseas suppliers for vaccines despite established pharmaceutical and biotechnology infrastructure. This vaccine gap exists because of a policy gap, with neglibile momentum to support development, purchasing or stockpiling.
Fundamental reforms to build and sustain a self-sustaining finance-growth nexus are critical. Global socioeconomic dislocations and competition from rivals mean reforms to Singapore’s capital markets ecosystem are essential. The post-pandemic period offers a key opportunity for meaningful recalibration and reform.
Without developing a strategic culture or finance-growth nexus, a declining financial centre and an equities gap draws parallels to Nokia’s decline in mobile telephony. Inaction will see Singapore become an “Italy” of financial centres, rather than a hub able to contend with the likes of New York, Shanghai and London.
