CRACKING UNDER PRESSURE? ASSESSING SINGAPORE S ECONOMY AND REAL ESTATE SPECIAL REPORT. 08 September 2016

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1 08 September 2016 CRACKING UNDER PRESSURE? ASSESSING SINGAPORE S ECONOMY AND REAL ESTATE The city state has seen better days economic data have been worse than expected in recent months. Non-oil domestic exports are in double digits contraction, industrial production is still declining, and retail sales ex auto are also recording negative growth. The latest increase of Zika cases just adds to the already weak sentiment. The question is whether Singapore is resilient enough to withstand the shocks of weak global demand, low commodity prices and now the Zika virus. To answer this question, we analyze the fundamentals of Singapore s economy and project its outlook in the coming year. We also examine how structural issues such as demographics, wage, supply, interest rates and policy impact the real estate market. Trinh Nguyen Tel trinh.nguyen@ap.natixis.com CORPORATE & INVESTMENT BANKING INVESTMENT SOLUTIONS & INSURANCE SPECIALIZED FINANCIAL SERVICES Ce document est distribué aux Etats-Unis. Merci de lire attentivement l'avertissement en fin de document..

2 Singapore: exposed to trade and China Despite having a rather diversified economy, Singapore s performance has come under stress in recent years. Global demand is weak, dragging down prices of commodity and manufacturing. Added to the woes is Singapore s increased exposure to China through higher trade and tourism exposure, making up 20% of GDP (See: Assessing China s soft power with the rest of Asia). As a result, Singapore export-oriented sectors are hurting, from petrol to transport equipment. Even after stripping out oil and non-domestic exports, shipments still declined by double digits in July 2016 (Chart 2). Consequently, the manufacturing sector has not contributed much to growth since H And outlook is not bright into H either, given still subdued China demand and lackluster imports elsewhere. Added to the burden is an expensive SGD, which has eroded external competitiveness. For example, Chinese tourist arrivals into Singapore already contracted in July to - 1.5% YoY. While manufacturing has played a significant role in the economy, making up 20% of total production, services have become a key anchor of growth in recent years. Chart 1 shows that service-producing industries make up about 65% of total production. Within services, business services, wholesale and retail trade, finance and insurance, and transport and storage make up the bulk of the total, 15%, 14%, 12%, and 7% respectively. Construction is 5% of GDP, ownership of dwellings and accommodation and food services make up 4% and 2% of the economy, respectively. Services: affected by spillovers from trade Although the sector has been the key support for the economy, it is also cracking under pressure as declining trade income is spilling over to services. Chart 4 shows services decelerating in Q Its contribution to YoY GDP growth declined (grey column). Whether it is business services, wholesale and retail trade, finance and insurance, or transport and storage, declining trade activity is feeding through into the service sector with a lag. For example, the banking sector is experiencing higher non-performing loan ratios, especially from sectors that serve oil-related firms such as Swiber Holdings Ltd and Ezra Holdings Ltd. Given subdued confidence, retail sales have been rather sluggish, especially after excluding auto sales (Chart 6). The lack of income growth in the trade sector is spilling over to retail sales through weakened confidence in future prospects. Even as wage growth exceeds overall headline CPI, households are still not convinced, as core inflation remains sticky. And as corporates feel a pinch from relatively high 2

3 wages, their profit margins are squeezed, deteriorating competitiveness. households. For example, it recently announced changes to the refinancing rules under the Total Debt Servicing Ratio (TDSR) framework to allow borrowers who bought their properties after the introduction of TDSR more flexibility in managing their debt obligations. Outlook not bright but there is policy space In the short-term, we do not expect GDP growth to stage a rebound. The economy is expected to decelerate in H2 to bring full year 2016 growth to 1.9%. Credit growth should continue to contract despite improvement of liquidity conditions (Chart 8). And other high frequency indicators will not be improving. Structurally, Singapore faces labor shortages, exacerbated by low fertility rates and an aging population. The share of working age population to total is declining, putting pressures on Singapore s competitiveness. The number of working age population in Singapore will peak in 2020, according to United Nations estimates, and contract rapidly by 2% per year thereafter. The pace of contraction will accelerate rapidly. This is one of the reasons for wage growth, although slowing, to exceed overall inflation in the economy, which has been negative this year (and in 2015). This erosion of wage competitiveness will put pressure on Singapore to raise productivity or loosen immigration policy. Singapore real estate Singapore property, like everywhere else, is affected by shortterm and structural macroeconomic conditions that impact demand, inventories, investment alternatives and government policy. We have already discussed that economic growth will likely be meagre in the short term and the hurdle to outperform this in the medium term is high given its adverse demographic profile and increased competition. That said, the Singaporean government has plenty of policy space, thanks to its generally prudent stance. Additionally, households have plenty of savings. This means that real estate outlook is not necessarily dire, dependent on policy. In this section, we will analyze features of Singapore real estate such as construction activity and inventories, financing and credit terms, and price trends and outlook. The good news is that Singapore has policy options. The Monetary Authority of Singapore (MAS) has recently chosen to let the currency weaken, as we expected, to support the economy. Due to high savings rate helped by a large current account surplus and still decent relative yield, liquidity conditions are also improving (Chart 8). Thus, the MAS is trying to manage a delicate dance between low interest rates and trying to keep the currency competitive (although still expensive in our opinion). Interest rates will likely remain low to support the domestic sector. The MAS, too, will begin to loosen macroprudential measures to help the housing market and 3

4 Features of the Singapore real-estate market Residential property, although directly has a small share of GDP, is an important cornerstone for the economy as its wealth effect filters through to affect consumption and investment. As a whole, when including construction, ownership of dwelling, and food and accommodation, it makes up about 11% of GDP. This is without considering the indirect effects it has on other sectors such as retail and wholesale as well as financials. Within listed firms, real estate makes up 23% of the total market capitalization. To put it simple, real estate is rather important for Singapore economy and even more key for financial markets. Singapore s total population is 5.6 million people, of which, 3.4 million are between the ages of 20 to 59. A staggering 90.5% of Singaporeans own a home a rate that is higher than Hong Kong, which has only about 51% ownership rate and elsewhere (Chart 9). Chart 10 shows the composition of residential properties in Singapore in 2015: 74% of total is Housing and Development Board (HDB) flats, while private flats are only 19%. Given the high ownership rate and declining working age population in four years, additional demand for housing for fundamental needs is likely low. However, real estate purchases for investment purposes may still be in high demand given high savings rate and cultural affinity for hard assets. Residential Property: Private Housing 23% Residential Property: Public Housing 22% Source: CEIC, Natixis Chart 12 Composition of household assets Pension Funds 1% Currency & Deposits 20% Shares & Securities (SS) 9% Life Insurance 8% Central Provident Fund (CPF) 17% Chart 11 Housing composition of Singapore in 2015 (%) Private houses 6% Others 1% Private flats 19% Total Unit (000'): Source: Department of statistics, Natixis HDB flats 74% Chart 11 and Chart 12 show Singaporean households exposure to real estate through their assets and liabilities, respectively. Residential property makes up 45% of total household assets. Meanwhile, households are not too exposed to financial assets, which make up only 9% of total. This means that the wealth impact of financial assets is likely indirect through investments of their retirement fund. They hold a high proportion of their assets in cash 20% of total. The rest are channelled into pension and central provident fund and life insurance. In other words, the bulk of household assets are in real estate and cash. The net surplus of household balance sheet shows that despite high housing ownership rate, demand for real estate may still be solid for investment purposes should government policy prove supportive. Chart 11 shows household liabilities most are with mortgage loans with financial institutions. As most liabilities are with mortgage loans, either through financial institutions or the HDB, the MAS certainly has an incentive to alleviate household burdens in time of economic slowdown. For example, on 1 September 2016, the MAS announced that the refinancing rules under the Total Debt Servicing Ratio (TDSR) framework will be fine-tuned to allow borrowers more flexibility in managing their debt obligations. This is in response to feedback from some borrowers who are unable to refinance their existing property loans owing to the application of the TDSR threshold of 60 per cent. The central bank stated that The TDSR framework and threshold will continue to apply to new property loans. The refinements being introduced for refinancing of loans will enable borrowers to better manage their existing debts 1. Please see Table 2 at the end for a list of cooling measures imposed by the MAS that may be relaxed, such as the TDSR recently on 1 September 2016, should the residential real estate market continue to remain subdued. 1 Visit this website for more details: Releases/2016/TDSR-Rules-on-Refinancing-Fine-Tuned.aspx 4

5 Chart 12 shows that housing loan growth, short-term rates, and 10-year government yield. Housing loans contracted in 2015 but is gradually rebounding. That said, the rate of increase is slow. The government is trying to ease burden on household through keeping short-term interest rates stable at about 1 percent. Mortgage rates in Singapore are generally pegged to the 3-month SIBOR (about 1% higher). We believe that the MAS will likely keep interest rates low at about 1% to support households. Construction activity, supply and prices Why do prices fall? Simply put, more supply than demand. We have already discussed the uninspiring economic backdrop of the city-state and its subdued outlook. Weak global demand is already spilling over to the real estate sector, especially, industrial rentals, shop, retail space and private residential. Chart 14 shows rental prices declining across the board. Real estate prices, whether residential or non-residential, have been dropping in Singapore (Chart 15). Investment in real estate is slowing but past capital expenditure is still suppressing prices. Chart 18 shows that incoming supply of units is slowing. However, supply rose rather rapidly in the past several years. Given high existing supply and weak demand, the occupancy rate has deteriorated across the board. The only area where it is rising is office space. Looking ahead, we believe the worst is likely over for the residential sector but good news isn t forthcoming just yet. Higher vacancy rate and still large supply will cloud outlook so the pace of price contraction is likely slowing. The nonresidential sector industrial sector, however, is likely bracing for more headwinds ahead as outlook for global trade remains weak, aggravated by weak import growth from China. Regarding recent development of Zika virus cases, we expect the direct impact on tourism and the hotel industry to be immediate but temporary. Chart 20 shows that foreign tourist arrivals already slowed before the Zika incidence. One respite is that tourism does not make up a large share of GDP for Singapore and the sector is already suffering from shorter visits and more frugal tourists. This trend will continue in the months ahead with sharper dips, lasting likely only several months. Korea had similar incidences with MERS and its impact, although immediate, was temporary. In Singapore s case, the economy is already vulnerable and the virus scare only highlighted structural weaknesses of a strong SGD, deteriorating competitiveness of wage costs, and high exposure to China. More worrying is the Zika impact on Singaporeans behaviour, which would likely be more cautious. For the overall real economy, only if Singaporean sentiment deteriorates significantly as a result would we see consequential impacts on GDP. The good news for Singapore is that the government has policy space to mitigate the downturn. Households, too, have plenty of buffers, which suggests that the propensity to consume and invest is really about sentiment and expectations. This is why we expect growth to slow to 1.9% in 2016 and 2017 rather than collapse. Please see Table 1 for a summary of top firms my market cap performance and Table 3 for a summary of key macro and real estate indicators. 5

6 Table 1. Top listed firms by market cap in residential real estate Company Q216 Capex (%YoY) Q216 Operating Income (%YoY) T12 Profit Margin (Q2 16) T12 Profit Margin (Q2 15) CAPITALAND LTD GLOBAL LOGISTIC CITY DEVELOPS UOL GROUP LTD FRASERS CENTREPO UNITED INDL CORP YANLORD LAND GRO GUOCOLAND LTD SINARMAS LAND LT WHEELOCK PROPERT HO BEE LAND LTD PERENNIAL REAL E OUE LTD WING TAI HLDGS OXLEY HOLDINGS BUKIT SEMBAWANG GL LTD SIM LIAN GROUP YOMA STRATEGIC ASCENDAS INDIA T Source: Bloomberg, Natixis: T12 means trailing 12-month. 6

7 Table 2. A summary of macro-prudential measures by the MAS to contain the market Macroprudential Measures to cool the real estate market in the past 14-Sep Sep Sep-09 Removal of the Interest Absorption Scheme (IAS) and Intererest-Only Housing Loans (IOL) Resinstating the Governement Land Sales Non renewal of assistance meassures for property developers. 20-Feb-10 Reduce of LT V limit for all housing loans provided by financial institutions regulated by MAS to 80% from 90% 30-Aug Aug-10 8-Dec-11 5-Oct-12 6-Oct Jan Jan Jan Jan Jun Jun-13 Increase the holding period for imposition of Seller's Stamp Duty (SSD) from 1 year -> 3 years. For property buyers who already have one or more outstanding housing loans at the time of the new housing purchase: increase the minimum cash payment from 5% to 10% of the valuation limit. Additional buyer' s stamp duty Restricted loan tenure limit of 35 years on the tenure of all loans for residential property. T ightening of LT V limits if the tenure exceeds 30 years or the loan period extends beyond the retirement age of 65 years. For these loans the LTV limit will be: 40% for a borrower with one or more outstanding residential property loans, and 60% for a borrower with no outstanding residential property loan. T ightening of LT V limits: -for second housing loans : 60% -> 50%, if the loans tenur is longer than 30 years (or goes beyond the borrower's retirement age) : 40% -> 30% Rise in minimum cash-down payment: - for second housing loans : 10% of the valuation limits to 25% - for third housing loans : 10% of the valuation limits to 25% Mortgage servicing ratio (for HDB and executive condos (ECs) only): - for loans granted by financial institutions: MSR capped at 30% of a borrower's gross monthly income. - for loans ganted by HDB: reduce of the cap: ABSD: -Rise in ABSD <> 5 and 7 percentage points across the board. -ABSD is imposed on permanent residents purchasing their 1st residential property and on Singaporeans purchasing their second residential property. Introduction of a T otal Debt Servicing Ratio (T DSR) framework for all property loans granted by financial institutions to individuals. Refinement of rules related to application of LT V limits Source: MAS Website, Natixis Table 3. A summary of Table key macro 2. A summary and real of key estate indicators indicators GDP, USDbn GDP per capita, USD 52,888 56,007 55,617 Unemployment Rate, % Macro CPI, %YoY, average Home ownership rate Housing Loan Rate SIBOR (3-month), average Loan-to-Value (LTV) Ratio 1st housing loan: 80% or 60% if the loan tenure is more than 30 years or extends past age 65. Macroprudential Total Debt Servicing Ratio 2nd housing loan: 50% or 30% if the loan tenure is more than 30 years or extends past age 65. 3nd housing loan: 40% or 20% if the loan tenure is more than 30 years or extends past age % Features of housing market Source, Bloomberg, MAS, CEIC, Natixis Housing Loans, % Wage, %YoY Household Debt (%of GDP) Residential Property Stocks Residential Property Incoming Stocks Residential Building Permits 2,948 3,658 7,039 10,114 Construction, % of total Employment Residential Prices, %YoY Rental Prices, %YoY

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