SMU Political-Economic Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION -Japans Lost Decades Continues -Foreign Direct Investment (FDI) in Indian Retail (Part 1 of 2) -Perils of a Dollarised Cambodian Economy (Part 1 of 2) The Fortnight In Brief (14th August to 27th August) US The FOMC has given its clearest indication yet of a strong consensus for action on its easing policy. Unless the economy turns significantly for the better, we could possibly expect the Fed to engage in QE3. US trade deficit continue to narrow for the third straight month in June to US$42.9 billion due to higher goods exports and lower goods imports. Consumption increased as nominal retail sales bounce back by 0.8%m/m in July. Asia: A Tale of Faltering Exports and Unsustainable Household Debts in East Asia Japan posted a trade deficit of $6.5bn for the month of July due to falling exports to the EU, a strengthening yen, and large imports of foreign oil needed to power the country. In Korea, unsustainable household debt levels have resulted in anemic consumer growth of 1.4% in the first 6 months of 2012. The need to boost growth and reduce high levels of household debt makes monetary policy decisions especially tricky for the Bank of Korea. EU France's Constitutional Court paved the way for the acceptance of the fiscal compact treaty as it ruled that the treaty did not require a change to the constitution. Latest GDP figures also revealed no surprises the growing gap between the core and periphery nations. German GDP rose 0.3% q/q, France GDP stagnated, while Greece and Portugal contracted 6.2% and 1.2% respectively. Due to the weak euro, the EZ recorded its highest trade surplus of 14.9 billion in June. Meanwhile, France's central bank forecasts GDP growth of 0.1% q/q in Q3 and Q4, implying that France would officially join Italy and Spain in recession. ISSUE 23 27 AUGUST 2012

IN COLLABORATION WITH

PROUDLY SUPPORTED BY

Japans Lost Decades Continues

By Adam Tan, Singapore Management University
21 years has gone by since Japans asset price bubble first burst in 1991 due to a period of rapid monetary expansion fuelling unsustainable inflated real estate and stock prices. The term lost decade1 was subsequently coined by renowned economists as the aftereffects of this crisis continue to plague one of the greatest post-industrial economies. With paltry growth rate that followed for the past twenty years and the rise of China surpassing Japan as the worlds second-largest economy, lets examine what near term challenges lie ahead for the land of the rising sun that can prolong this debacle. Mounting External Challenges Innovation and cutting-edge technology used to be one of the main drivers of Japans exportoriented economy that allowed companies such as Sony, Toyota and Toshiba to dominate their respective industries during the late 20th century. The tide has since turned against these Japanese conglomerates as the emergence of competitors such as Apple, Samsung and Volkswagen threatened their position as global market leaders. The dreadful situation is further exacerbated by the eroding competitiveness of Japanese exports due to the strength of the Japanese Yen () after 2007. The Japanese Yen, being the only free float G10 currency from Asia, is seen as risk-off2 assets at the macro level. The Yen usually strengthens due to global demand following uncertainty in the macro growth environment, as observed after the Great Financial Crisis of 2008 in Figure 1 below.

Figure 1: USDJPY exchange rate from 1998 to 2012 Source: IMF Earthquakes off the Pacific coast of Tohoku in 2011 resulting in the closure of all nuclear power plants in Japan add insult to injury at a time when the cost of importing energy is high. This increases production costs for many of these Japanese conglomerates and losses mount as production orders are delayed. However, every cloud has a silver lining; innovative solutions to these external threats have been put in place by some of these Japanese giants such as moving their production facilities to lower cost emerging economies and hedging against volatile currency movements through currency forwards or options. However, this 2 Copyright 2012 SMU Economics Intelligence Club

does not solve the underlying issue of surrendering decades of market leadership to emerging competitors. Japanese conglomerates need to dig deeper and find new ways to re-establish themselves ahead of the pack before the gap becomes too big to fill. Brewing Domestic Issues An aging workforce seems to be one of the mega trends that Japan has yet to find a solution to and it poses a serious problem in the near term. Looking at Figure 2 below, pension costs have been increasing consistently over the past decade to as high as 15% of national income. In addition, the ratio of retirees (over 65 years old) to the current workforce (between 15 to 64 years old) seems to be on a worrying uptrend.

Figure 2: Japanese National Income Spending for Pension and Population Ratio Statistics Source: Japan Ministry of Health, Labour and Welfare This is just the start of the cycle of Baby Boomers3 retirements with the first batch retiring in 2011, and an estimated 7 million more in 2012. The time bomb for health care is set for 2017, when the Baby Boomers enter their seventies. This will soon put unbearable pressure on the fiscal foundations of the welfare system that was instituted at a period when demographics were completely different. The near term solution by the Japanese government to boost sales tax4 from 5% now to 8% in 2014 and 10% in 2015 to rein in Japans huge public debt and rising welfare costs was only made possible through promising early elections by the ruling Democratic Party of Japan (DPJ). The short term solution was politically costly for the ruling coalition with 50 lawmakers leaving DPJ in protest. This leads to increasing political instability, and comes as no surprise to many political analysts. After all, Japan remains the only country that is notorious for having 5 different Prime Ministers over the past 5 years. What Lies Ahead for Japan The challenges highlighted above have been echoed by professionals and renowned economists such as Paul Krugman over the past years. Structural reforms to tackle these pressing issues through a top down approach in both the public and private sectors will determine how the current and next decade will pan out. A stable ruling coalition that may emerge after early elections coupled with inflation targeting monetary policies in the near term could inject much needed confidence and stability. Only a stable, business-friendly 3 Copyright 2012 SMU Economics Intelligence Club

environment can help the muted Japanese corporations re-evaluate their faltering strategies and regain the pole position through what they are best known for - Innovation.
1

Lost Decade: The Lost Decade is the term coined to describe the period from 1991-2001, in which the Japanese economy grew very slowly despite extremely low interest rates 2 Risk-off: A general term to describe a bearish period when investors in aggregate feel pessimistic about the global economy and do not want to take risks 3 Baby Boomers: A person who was born during the demographic Post-World War II baby boom between the years 1946 and 1964 4 Sales Tax: A tax paid by the consumer for goods and services that contributes to the overall tax revenue of the government

Sources: Bloomberg, Forbes, Reuters, the Wall Street Journal

4 Copyright 2012 SMU Economics Intelligence Club

Foreign Direct Investment (FDI) In Indian Retail (Part 1 of 2)

By Rounak Agarwal and Tejas Kumar Ahir, Entrepreneurship Development Institute of India
Part 1 of this article gives readers an introduction to the Indian retail scene and analyses the pros and cons of introducing FDI into this sunrise industry. Part 2 will give readers a deeper look into policies and changes put in place to regulate and encourage FDI in Indias retail industry. Opening the gates for FDI in Indian retail raises the expectations of generating immense employment opportunity in organised retail right from procuring the goods to marketing. But the possibility of hitting the domestic sectors by the above measure may compel the government to watch their steps before unlocking gates. In India, the retail industry marks its presence in both the organised and unorganised sectors. Organised retailing involves trading activities undertaken by licensed retailers who pay sales tax, income tax, value-added tax, etc. The unorganised sector includes retailers like the kirana shops (traditional family-owned stores), corner grocery stores, and small shops on the small and big roads or at the complexes of residential areas. Currently the organised retail constitutes only a small share, while the kirana shops hold almost 95 per cent of retail trade. Retail turnover in India is estimated at Rs.4000 billion, accounting for 10 per cent of Indias GDP. Interestingly, although with very few players in the organised retail sector, the sector is still expected to grow five per cent per annum. In total, there are approximately 12 million organised and unorganised retail outlets in India. Currently in Indian national laws, FDI is not permitted in multi-brand retail outlets, but allowed in 100 per cent foreign-owned investment in wholesale cash- and-carry operations, and 51 per cent in single-brand retailing. Recently, the Indian retail sector has been identified as the sunrise sector by economists and retailers alike, and India has been identified by US management consulting firm A T Kearney, in its 2012 Global Retail Development Index, as the fifth most attractive retail investment destination in the world. The government is also gradually allowing FDI in the retail sector, as per Indias international agreements. Much investment opportunities have arisen in India port-liberalisation in the retail-industry. On the political front, there has been constant opposition in India from various political parties towards FDI in retail. This could be mainly attributed to myopic reasoning on the grounds of profit sharing interests. On the other hand, there has been a constant push from international retail agencies world-wide to invest in India. The following points, gathered by the writers of this article, highlight the advantages and disadvantages of FDI in retail for India: Advantages: 1. Development of efficient supply chain management skills. 2. Eradicating the role played by the middlemen and the extra cost they impose on businesses. 3. Benchmarking of local product to international products, ensuring higher quality. 5 Copyright 2012 SMU Economics Intelligence Club

4. Increase competition between domestic and international companies, thereby improving efficiencies and competitiveness of the economy. 5. Transfer of technology, so as to increase the efficiency or labour. 6. Increase in employment. 7. Availability of variety of products. Disadvantages: 1. Higher handling & storing costs at the multinational chains may pass on to higher prices for consumers. As shown in the graph below, Indias inflation rate is at a 5-year low period and risking this could upset the countrys economic growth prospects. 2. If foreign retailers captures 20% of the Indian retail market, displacement of existing small retailers will occur, creating a situation of joblessness for them around 8 million jobs could be lost. 3. Unfair trade practices may result if regulations are not made proper. 4. Due to an influx of FDI, real estate prices may spike, rendering it difficult for private entrepreneurs to break into retail market.

Thus, in order to foster a FDI-friendly Indian retail sector, the government should have an unbiased view towards organised and unorganised retailers and seek to foster and regulate them as a whole. As India is a vast country with a huge population, there stands a noticeable difference in terms of the regulation and efficiency between organised retail market and unorganised retail market. With such a huge market and economic potential, the government should recognise that FDI in retail can be a winning situation for all, and possibly usher in a new period of economic prosperity for the millions of retailers in India.
Foreign Direct Investment: Investment made by a foreign entity into a local company in order to enable some control over the company to realise improvements in the company in order to generate greater economic returns. Sunrise Industry: An industry that is expected to see a high rate of growth and has a growing body of start-up companies. Wholesale cash-and-carry: A form of wholesale operations that involves customers (usually retailers and professional companies) visiting the premises of the wholesaler and purchasing products using cash and arranging for their own delivery of their purchased products.

Sources: Tradingeconomics.com, A T Kearney and Indian Express 6 Copyright 2012 SMU Economics Intelligence Club

Perils of a Dollarised Cambodian Economy (Part 1 of 2): The vulnerable and precarious position of the poor in Cambodia
By Eugene Lim, Singapore Management University
Part 1 of this article shall look at an introduction to the Cambodian economy, the growing trend of using United States Dollars (USD) in its everyday transactions as well as what is driving this trend. Cambodia Real GDP Growth Rate (%)

Source: Indexmundi.com As seen in the graph above, between 2003 and 2007, the Cambodian economy has been growing at an average rate of around 10 percent on the back of political and macroeconomic stability. Runaway inflation has been contained to an acceptable average of 3.5% over the same period, although showing signs of rising levels in recent times. As Cambodia opens up its doors to foreign investors and trade, its economy is also increasingly dollarised. Ironically, as much as the dollarisation of the economy provides a stable anchor to other parts of the economy, it can adversely affect the poor and vulnerable. In terms of reduction in poverty, Cambodias poverty level fell from 47 percent in 1994 to 30 percent of GDP in 2007 (Menon, 2008). Nonetheless, one third of the four million Cambodians remain stricken with poverty (the poor is defined as people who have an income of less than US$1.25 (2005 prices) a day and are vulnerable due to exposure to high risks and lacks the ability to cope with them). The Dollarisation of Cambodian Economy The origin of dollarisation in Cambodia can be attributed to many historical events, namely the destruction of economic and financial institutions after the 1970s and the large US$1.7 billion inflow during the United Nations Transitional Authority in Cambodia (UNTAC) in the 1990s (Menon, 2008). To further develop its economy and not be too reliant on foreign currency risk, a partially dollarised economy such as Cambodias should rely more on its own currency (the Cambodian riel) as it grows. However, this isnt happening in fact, the 7 Copyright 2012 SMU Economics Intelligence Club

opposite is. This phenomenon is due to two factors: an increasingly open Cambodian economy and an urban economy that is growing faster than the rural economy. As the economy and society develop, Cambodia is becoming increasingly integrated into the global economy. Attracted by the economic prospects and potentially high rates of return, large amounts of inflow of foreign investment and currency (predominantly USD) has found its way into Cambodia,. In essence, the dollarisation occurs because of the absolute increase in the amount of USD, termed as volume effects. This means that the USD did not substitute the riel but is preferred in the transactional flows. This preference can be due to convenience or perceived lower risk. In essence, the USD is seen superior to the riel in terms of purchasing power and investment potential. With its accession into the World Trade Organization (WTO) in 2004, Cambodias trade boomed. Exports share rose from 30 per cent in 1998 to 70 per cent in 2008 and total trade flow amounted to 122 per cent of Gross Domestic Product (GDP) (Hill & Menon, 2011). Using USD for trade accounts hence became more rampant because of the dollars ease of exchangeability. Also, after UNTAC, increasing numbers of non-governmental organizations (NGO) and international aid organizations poured large amounts of aid denominated in USD into Cambodia to help in the reconstruction efforts of the country which are to be spent on various projects directly. In addition, most of these organizations also pay both foreign and local staff in USD. The Cambodian economy can be best described as one with two different path projections: one is an urban economy that predominantly uses the USD and the other is the agrarian rural economy that utilizes the riel. The former flourishes under the thriving garments and tourism sectors, as well as foreign direct investment and international aid. In the cities, the USD is used as the main medium of exchange, store of wealth and the unit of account in bookkeeping and trade. More than 90 percent of banking deposits in Cambodia are in foreign currencies, mainly USD (Economist Intelligence Unit, 2008). Unsurprisingly, due to the strength and stability of the USD, Cambodians high growth figures can be attributed mainly to the urban economy. On the other hand, the rural population (which contains of the majority of the poor) is largely agrarian and does not witness growth as rapid as the urban economy. With the main medium of transaction in the rural areas being the riel, the rural economy remains relatively stagnant and the ratio of USD to riel widens. Effects of Dollarisation that Threaten the Poor Due to the stability and strength of the USD, this has conferred onto the urban population an overwhelming advantage, enabling them to accumulate wealth. The rural population that consists of over 90 percent of Cambodias poor, undoubtedly, is being marginalized and left out of economic growth. As such, there can be three repercussions of dollarisation that affects the poor: the loss of autonomy to conduct monetary/exchange rate policy vis--vis dollarisation, the lack of development of financial, banking and monetary systems and the unavailability of microfinance. Firstly, as a result of a highly dollarised economy, the central bank, the National Bank of Cambodia (NBC) has very limited monetary instruments to intervene and fine-tune the economy. The steering of the economy via monetary policies is effectively surrendered to external players, i.e. the U.S. Federal Reserve that is in charge of U.S. monetary policy. Since 8 Copyright 2012 SMU Economics Intelligence Club

the predominant currency used in the economy is USD, the NBCs control over money supply is weak because it can only vary the amount of riel, which accounts of a small part of the monetary base in the country. This places the authorities under an extremely untenable position with limited capabilities to manage the economy and shield its people from financial risks. Secondly, as exogenous factors steer the monetary aspect of the Cambodian economy, there is a lack of emphasis in developing the financial sector in the country. The entire financial infrastructure was obliterated during the Khmer Rogue regime and attempts to rebuild a home-grown financial sector have been undermined by the dollarisation of the economy. The role of banking has since been taken up by foreign-owned financial institutions that are concerned with the commercial transactions carried out in USD, and not with riel-based loans for long term constructive purposes. Rampant corruption and weak rule of law in Cambodia further discourages the development of this sector that requires transparency and enforceability of contracts. Without a developed financial infrastructure with long-term domestic interests protected, the poor are deprived of adequate shelter to protect them from exogenous economic shocks. Thirdly, loans in the form of microfinance that have proven to be relatively successful in alleviating poverty levels in many countries (i.e. Grameen Bank in Bangladesh), are relatively unavailable to the Cambodia poor. Microfinance loans are relatively small amounts of credit given to the poor (at low interest rates) to generate self-employment and income. These loans also help the poor in consumption smoothing, asset building, investment in human capital through education and also tackle health/welfare problems (Latifee, 2003). In Cambodia, this sector of microfinance has not been sufficiently developed to serve the needs of the poor. The dollarisation of the economy has caused a physical lack of riel. The NBC is not willing to put more riel in circulation due to fears of rapid depreciation vis--vis the USD. To make matters worse, commercial banks (mainly based in the urban areas) mostly have their deposits in dollars and not riel. Since riel is the predominant currency used in the rural economy, the microfinance institutions (MFI) are chronically deprived of riel and this inhibits them from lending to the poor. Paul Luchtenburg, chief executive officer of Angkor Microfinance, a microfinance institution in Cambodia claimed in the light of increasing demand, the industry needed around 120 billion riel in 2011, which is much more than the amount available in the market (Postlewaite, 2010). In conclusion, the travails facing the Cambodian economy is not a lack of growth opportunities, but a lack of long-term planning and execution of economic development plans that enable equitable growth across its population, and a gradual phasing out of reliance on the USD in favour of a more stable and well managed riel.
Dollarisation: A situation where citizens of a country increasingly rely on the United States dollar (USD) as legal tender for conducting transactions and not its local currency. Exogenous economic shocks: Economic events that happen outside the country but also have effects (adverse or beneficial) on the country itself. Microfinance: The provision of loans (often in a small amount) to people living in poverty and who dont usually qualify for standard bank loans.

Sources: Economist Intelligence Unit, World Bank, indexmundi.com, aforementioned quoted papers. 9 Copyright 2012 SMU Economics Intelligence Club

The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents Ben Lim (Vice President, Publication) ben.lim.2010@smu.edu.sg Singapore Management University Singapore Tan Jia Ming (Publications Director) jiaming.tan.2010@smu.edu.sg Singapore Management University Singapore Vera Soh (Liaison Officer) Vera.soh.2011@economics.smu.edu.sg Singapore Management University Singapore Seumas Yeo (Editor) Seumas.yeo.2010@smu.edu.sg Singapore Management University Singapore Eugene Lim eugene.lim.2008@economics.smu.edu.sg Singapore Management University Singapore Tejas Kumar Ahir tejaskumar14@ediindia.org Entrepreneurship Development Institute of India Ahmedabad, India Herman Cheong (Vice President, Operations) Wq.cheong.2011@economics.smu.edu.sg Singapore Management University Singapore Fariha Imran (Marketing Director) Farihaimran.2010@economics.smu.edu.sg Singapore Management University Singapore Randy Lai (Editor) Tw.lai.2010@smu.edu.sg Singapore Management University Singapore Adam Tan adam.tan.2009@smu.edu.sg Singapore Management University Singapore Rounak Agarwal rounak14@ediindia.org Entrepreneurship Development Institute of India Ahmedabad, India

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