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AN
SMU
ECONOMICS
INTELLIGENCE
CLUB
PRODUCTION
-
China
3.0
-
GST
in
Malaysia:
Promotes
taxation
efficiency,
burdens
the
poor
-
Simplicity
versus
complexity
(Part
1)
The
Fortnight
In
Brief
(13th
May
to
26th
May)
US:
Will
they
or
wont
they?
Federal
Reserve
Chairman
Bernanke
testified
before
lawmakers
last
week,
defending
the
central
banks
monetary
policy
amid
speculation
of
whether
its
asset
purchasing
will
be
tapered
following
favorable
employment
jobs
numbers
in
the
past
m onths.
10-year
treasury
yields
broke
above
2%
for
the
first
time
since
March
as
the
Chairman
warned
that
taper
talk
could
occur
in
its
next
few
meetings
if
the
US
economy
showed
signs
of
a
sustainable
recovery,
but
stressed
that
monetary
policy
would
remain
highly
accommodative.
New
home
sales
reaching
its
second-highest
in
nearly
five
years,
coupled
with
gains
in
housing
market,
autos
and
orders
for
U.S.
durable
goods
is
expected
to
lift
the
economy
in
the
second
half
of
the
year.
Asia
Pacific:
Pessimism
Floods
Chinas
Economy
Pessimism
continues
to
spread
about
Chinas
economic
prospects
as
UBS
cut
its
2013
GDP
forecast
from
8%
to
7.7%.
This
m ove
follows
in
the
steps
of
Goldman
Sachs,
JPMorgan,
Royal
Bank
of
Scotland,
the
World
Bank
and
IMF.
A
combination
of
factors,
including
wage
growth,
weak
consumption
and
tepid
exports
amongst
others,
has
contributed
to
the
pessimism.
HSBC
flash
PMI
for
China
fell
to
49.6
in
May
from
50.4
in
April.
This
is
the
first
time
the
index
has
fallen
below
50
since
October
2012
and
could
put
pressure
on
the
Chinese
government
to
cut
taxes
and
increase
spending
to
revive
its
economy.
EU:
Germany
takes
bilateral
paths
to
tackle
EU
jobs
crisis
Germany
is
banking
on
bilateral
deals
to
fight
record
youth
unemployment
in
the
euro
zone,
agreeing
to
cooperate
with
several
countries
to
bypass
pan-European
bureaucracy.
Youth
unemployment
has
reached
a
record
42
percent
in
Portugal
and
57
percent
in
Spain
as
governments
implement
austerity
measures.
Berlin
is
also
about
to
announce
a
joint
plan
with
Paris
to
address
unemployment,
following
a
deal
announced
with
Spain
last
month
to
channel
money
from
private
investors
into
credit-starved
small
and
m edium-sized
businesses.
Policymakers
in
Berlin
are
frustrated
by
a
lack
of
urgency
at
the
European
Commission,
commenting
that
efforts
to
help
such
companies
are
held
up
by
EU
state
aid
rules
meant
to
prevent
unfair
competition.
1675
312
IN COLLABORATION WITH
PROUDLY
SUPPORTED
BY
MSCI
AC
Asia
Ex.
Japan
S&P 500
1665
1655
1645
China
3.0
By
Adam
Tan,
Singapore
Management
University
The
Chinese
character
(number
eight)
has
always
been
associated
with
prosperity
and
good
luck
in
Chinese
culture.
However,
eight
has
increasingly
been
a
growth
figure
out
of
reach
for
the
slowing
Chinese
economy.
Fund
managers
and
analysts
had
recently
admitted
that
it
is
now
becoming
a
growth
ceiling
instead
of
a
floor
for
the
next
decade.
Tepid
recovery
from
the
United
States
and
the
on-going
Eurozone
crisis
is
not
helping
the
export-oriented
Asian
giant
either.
So,
what
can
China
do
to
keep
their
admirable
growth
engine
going
at
a
sustainable
rate?
Lets
explore
the
different
possible
routes
available
to
them.
Structural
Reform
Over
the
past
years,
words
of
hard
landing1
of
the
Chinese
economy
have
been
going
around
whenever
the
market
starts
to
turn
bearish.
Some
claim
that
these
are
just
noise
and
are
of
no
genuine
concern.
However,
since
the
turn
of
the
year,
the
newly
selected
administration
has
acknowledged
the
need
for
structural
reform
to
pursue
quality
growth.
This
led
to
market
speculation
in
small
capitalization
technological
and
services
sector
stocks
listed
in
Shenzhen
forming
a
possible
asset
bubble.
This
speculation
is
mainly
driven
by
two
fundamental
reasons:
1)
reduction
of
fixed
capital
to
drive
growth,
and
2)
shift
away
from
the
low
value- add
export
to
services
export
model.
Services (%) of GDP
90% 80% 70% 60% 50% 40% 30%
25%
20%
15%
10% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 CN US JP
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
CN US JP
Source: CEIC
As seen on the chart on the left, China leads the United States and Japan (the largest and 3rd largest economy in the world) in terms of fixed capital as a percentage of GDP by more than double. This is not a good sign given that most economic growth for the past decade were driven by the coastal provinces and cities (Shanghai, Beijing, Zhejiang and Guangdong). Deleveraging from reliance on fixed capital towards the levels of the United States and Japan will be a point to note for interested investors in the long run.
The chart on the right shows the contribution of the services sector towards overall GDP. This chart provides the ideal solution for Chinas lack of alternative growth drivers. The large gap between the United States/Japan and China signifies huge growth potential as China eventually matures into a first world economy. However, caveat to this lies in how marginal Chinas services sector has grown (39% to 43%) over the past decade and whether they will be able to actually fulfill this potential. The key driver to services growth will be correlated to how quickly the middle class disposable household income growth will be, which brings me to my second point: policy reform. Policy Reform One major problem faced by leaders of many developed countries these days seems to circle around income equality and their Gini Coefficient2. This problem is not unique to China but is a key issue that the Chinese leaders need to address before it gets blown out of proportion. Chinas latest Gini Coefficient estimate in 2012 placed them in one of the top three (at 47.4) slightly behind Brazil and Mexico. This number worsens from the previous estimate of 42.5 back in 2005. This may be a statistical proof to the saying that 80% of the income is made by 20% of the population as evidently the income gap has widened between the top and bottom over the years. The urgency to push forward the implementation of a nationwide minimum wage law before 2015 should command the same priority as the need to tackle graft and corruption in the current administration. Only when gains trickle down from the top of the pyramid to the middle class, will their disposable income increase and help drive growth in the services sector.
Gini Coefficient
Brazil Mexico 48 47
55
China
USA Russia
41
40 36
UK
Long
Arduous
Journey
Ahead
Resisting
hot
money3
inflow
and
the
real
estate
bubble
are
other
challenges
in-progress
for
the
current
administration.
However,
setting
the
stage
right
for
the
future
by
making
the
hard
decision
of
implementing
structural
and
policy
reform
prudently
will
yield
greater
growth
and
prosperity.
Quoting
the
late
Chairman
of
the
Communist
Party
of
China,
Deng
Xiaoping,
the
current
administration
needs
to
cross
the
river
by
feeling
the
stones.
1
Hard
Landing
An economic state wherein the economy is slowing down sharply or is tipped into outright recession after a period of rapid growth, due to government attempts to rein in inflation. 2 Gini Coeeficient A measurement of the income distribution of a country's residents ranging between 0 and 100. 0 signifies perfect equality and 100 signifies perfect inequality. 3 Hot Money Flow of funds from one country to another in order to earn a short-term profit on interest rate differences or exchange rate shifts. Due to its fast moving nature, it can potentially cause market instability. Sources: 1. Bloomberg 2. The Financial Times 3. Investopedia
questions
than
answers.
There
are
improvements
that
needs
to
be
done
before
the
GST
can
be
rolled
out
in
Malaysia.
One
such
improvement
that
the
Malaysian
government
should
consider
is
to
exempt
daily
necessities
such
as
food,
utilities,
and
accommodation
from
GST
for
3
to
5
years,
ensuring
that
the
savings
of
low-income
households
are
not
adversely
affected
in
the
short
run.
Singapore
comes
into
mind
when
Malaysians
debate
the
impact
of
GST
on
their
consumption
and
savings
pattern.
As
the
Malaysian
Ministry
of
Finance
continues
to
crunch
numbers
in
search
of
the
ideal
GST
rate
(current
research
has
concluded
that
the
GST
rate
should
be
between
4-6%
although
it
is
unconfirmed),
Singapores
version
of
GST
offers
something
to
ponder
on.
One
way
is
for
the
Malaysian
government
to
slowly
adjust
the
GST
rate
to
7%
over
a
period
of
at
least
ten
years.
Singapore
introduced
the
GST
in
1994
starting
at
3%,
which
held
on
for
nearly
9
years
before
being
increased
to
4%,
and
subsequently
to
the
current
rate
of
7%
on
1st
July
2007.
This
slow
adjustment
of
the
GST
rate
has
not
only
made
it
easier
for
households
to
cope
with
higher
living
costs,
but
has
also
helped
Singapore
reduce
its
reliance
on
direct
taxes,
especially
corporate
tax.
This
scheme
allows
the
Singapore
government
more
room
to
cut
direct
tax
rates,
ensuring
that
Singapore
remains
competitive
in
attracting
international
capital
and
labor
to
grow
its
economy.
Besides
committing
to
a
no
increase
in
tax
rate
for
a
number
of
years
before
readjustment,
offset
packages
were
also
offered
to
households
to
help
allay
the
short-term
shock
of
increased
living
costs.
Although
the
GST
faces
stiff
opposition
from
the
public
and
particularly
Malaysias
opposition
parties,
the
tax
if
implemented
properly,
would
serve
as
a
great
tool
in
reining
in
Malaysia's
public
debt
and
reduce
its
reliance
on
income
through
direct
taxes.
With
its
ASEAN
neighbors
such
as
Singapore
and
Vietnam
undergoing
economic
reform
to
address
their
domestic
concerns,
it
is
high
time
that
Malaysia
gets
its
GST
implementation
right,
in
order
to
remain
competitive
in
the
region.
1
Tax
Exemption
To be free from, or not subject to, taxation by regulators or government entities. A tax exempt entity can be excused from a single or multiple taxation laws due to various reasons. 2 Public Debt Public debt is the debt owed by a central government usually used to finance a government deficit (a difference between government receipts and spending). 3 Debt Limit The maximum debt a government is allowed to hold. Sources: 1. News Straits Times 2. Ministry of Finance Malaysia 3. Royal Malaysian Customs Department 4. FreeMalaysiaToday.com 5. The Malaysian Insider 6 Copyright 2012 SMU Economics Intelligence Club
Simplicity
versus
complexity:
What
are
the
limits
of
structured
financial
products?
(Part
1)
By
Shane
Ai,
Singapore
Management
University
The
Parable
of
the
Prodigal
Son
tells
a
story
of
a
son,
who
squanders
his
inheritance,
only
to
realize
his
folly
and
return
home
to
his
fathers
welcoming
arms.
Similarly,
structured
products,
once
heralded
as
the
peak
of
financial
innovation,
have
suffered
tremendous
backlash
in
recent
years.
Till
today,
opinions
between
regulators,
issuers
and
investors
on
their
credibility
remain
divided.
While
addressing
the
limits
of
structured
products1,
perhaps
a
more
pertinent
question
would
be:
Should
they
be
welcomed
back
at
all?
A
familiarity
with
their
origin
will
help
in
tackling
this
issue.
Investment
banks
began
with
engineering
these
products
for
institutions,
which
were
essentially
vanilla
instruments2
wrapped
into
highly
customized
payoffs.
This
proved
to
be
win-win
for
both
clients
and
issuers,
as
firms
could
issue
cheaper
debt
and
banks
enjoyed
higher
margins.
Another
significant
development
dates
back
to
2000,
when
the
dotcom
bubble
burst.
Heightened
risk
aversion
led
to
retail
investors
wanting
to
participate
in
higher
returns
without
the
risk,
so
issuers
offered
Capital-Protected
Notes
to
the
public,
among
others.
Further
fanning
their
proliferation
were
technological
advances
and
favorable
market
conditions.
In
line
with
investors
insatiable
desires
to
have
their
cake
and
eat
it
too,
financial
engineers
created
products
that
occupied
the
middle
ground
between
the
impossible
trinity
of
return-seeking,
premium-resistant
and
risk-averse
behaviors.
Before
examining
the
2008
crisis
fallout,
structured
finance
should
be
understood
on
a
deeper
level.
Conventional
innovation
provides
direct
utility
to
its
users,
with
or
without
cons.
Proponents
of
financial
innovation
have
extended
this
contention
to
finance,
which
is
too
simplistic
at
best.
While
certain
forms
of
financial
innovation
does
make
lives
easier
(think
ATMs),
it
remains
unclear
if
easier
credit
confers
any
utility
at
all.
To
illustrate
this
point,
the
benefits
of
owning
a
watch
are
certain,
but
securitization
simply
allows
for
credit
to
be
obtained
in
newer
ways.
Whether
this
leads
to
overall
positive
outcomes
depends
on
economic
agents
involved.
Pre-2007,
severe
incentive
misalignment
and
unsound
risk
assessment
plagued
the
entire
US
mortgage
securitization3
chain.
What
is
apparent
now,
in
hindsight,
is
that
the
actions
of
economic
agents
catalyzed
the
crisis,
not
the
innovation
in
itself.
The
economic
benefit
of
securitization
is
primarily
the
distribution
of
risk
to
a
broader
investor
base.
Ironically,
risk
concentration
occurred
instead,
as
financial
institutions
were
easily
able
to
lever
up
their
exposures
to
this
asset
class.
Subsequently,
when
the
soundness
of
subprime
mortgages
was
questioned,
a
CDO
fire
sale
was
triggered,
resulting
in
write-offs
on
bank
balance
sheets
and
a
system
with
little
liquidity.
It
is
safe
to
say
that
structured
products
have
found
their
limits
in
the
potential
for
abuse
in
securitization.
Fundamentally,
it
is
nave
to
assume
that
there
will
be
an
inexhaustible
source
of
future
revenue
streams
to
pawn
la
MBS.
Since
the
crisis,
the
structured
credit
sector
has
undergone
significant
deleveraging
and
current
global
CDOs
outstanding
are
at
38%
of
their
2007
levels.
Tougher
lending
standards
and
regulations
have
also
led
to
issuer
phobia,
with
2011
new
issues
falling
90%
from
2007.
Hence,
current
systemic
damage
potential
from
7 Copyright 2012 SMU Economics Intelligence Club
securitization
has
largely
been
stemmed
and
it
is
unlikely
that
we
will
see
a
repeat
of
2008
vis--vis
structured
credit.
Moving
beyond
structured
credit,
it
is
crucial
to
scrutinize
the
post-2008
structured
product
stigma.
A
fallacy
of
composition,
the
structural
shortcomings
of
US
structured
credit
were
extended
to
all
structured
products.
Viewing
them
as
one
encompassing
asset
class
is
erroneous.
Besides
annuities
(including
CDOs),
structured
products
come
in
other
wrappers,
namely
insured
CDs,
notes
and
funds.
Issuer
risk
was
inconceivable
pre-crisis,
given
the
counterparties
were
financial
titans.
This
led
to
massive
public
outcries
in
Singapore
and
Hong
Kong,
where
investors
were
furious
that
their
Lehman-linked
notes
were
not
fully
Principal-Protected
as
believed.
Also,
structured
products
offer
not
just
protection,
but
variable
levels
of
investor
participation
as
well.
Thus,
the
flawed
products
and
their
imperfections
comprise
merely
a
small
subset
of
the
entire
product
universe.
Populist
notions
have
also
demonized
structured
products
by
claiming
that
financial
institutions
are
using
the
products
to
reap
high
margins
at
the
publics
expense.
Upon
closer
inspection,
this
proves
to
be
untrue.
Retail
income
only
accounted
for
one-third
of
total
income
from
structured
product
pre-crisis
sales.
The
importance
of
this
share
has
since
diminished,
with
the
majority
of
product
clients
being
private
banks
and
institutions.
Structured
products
have
become
the
second-favorite
(2010:
24%)
among
alternative
investments
for
Asian
HNWIs,
further
boosting
the
significance
of
this
client
segment.
Next,
regulatory
pushes,
like
further
product
pricing
transparency
from
Basel
III
and
Dodd-Frank
and
in
certain
jurisdictions,
extremely
stringent
product
approval
procedures,
have
led
to
greater
costs
and
compliance
complexity
for
structurers
and
distributors,
effectively
making
retail
sales
an
impracticality.
Given
how
heavily
distributors
were
penalized
in
2008,
this
issue
is
very
prevalent
in
Asia,
where
white-labeling
dominates
structured
retail.
Combine
this
with
how
global
on-exchange
volumes
have
declined
30%
from
2011,
and
it
is
not
so
ironic
that
activity
is
declining
despite
more
regulation.
Lastly,
issuer
reputational
risk
is
extremely
relevant
today,
given
ever
increasing
scrutiny
by
regulators
and
the
public.
Putting
this
into
perspective
is
how
retail
notes
took
4
years
before
reappearing
in
Singapore
post- Lehman,
with
only
one
offering.
Next
week,
Shane
continues
his
discussion
on
structured
products
and
their
viability
1
Structured
Products
A structured product is generally a pre-packaged investment strategy based on derivatives, such as a single security, a basket of securities, options, indices, commodities, debt issuance and/or foreign currencies, and to a lesser extent, swaps. 2 Vanilla Instruments The most basic or standard version of a financial instrument, usually options, bonds, futures and swaps. 3 Mortgage Securitization The turning of a mortgage into a security or a bond which represents a claim on the cash flows from mortgage loans.
Sources:
1. Europe's
Unemployment
Problems
Worsen,
published
by
World
Street
Journal
,by
Art
Patnaude
and
William
Horobin
2. Capgemini.
(2011).
Asia-Pacific
Wealth
Report
2011.
Retrieved
from
http://www.ml.com/media/114333.pdf
3. Mgge,
D.
(2009).
Tales
of
tails
and
dogs:
Derivatives
and
financialization
in
contemporary
capitalism,
Review
of
International
Political
Economy,
16:3,
514-526
4. Johnson,
S.
(2009,
April
18).
Financial
innovation
for
beginners.
Retrieved
fromhttp://baselinescenario.com/2009/04/18/financial-innovation-for-beginners/
5. Zeisberger,
C.
(2007).
Pervasiveness
of
structured
products
too
much
structure
too
little
strength?.
Retrieved
from
http://www.insead.edu.sg/asiafinance/documents/StructuredProducts_May07_JW.pdf
6. Enskog,
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(2012,
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