Singapore shares were down 20% on the MSCI Index through September as the economy tipped into quarterly recession and the area wildfire haze threatened a further blow to construction, tourism and retail sales which had offset lagging exports to China.

Singapore Haze

Two years ago, the smog caused millions of dollars in losses and this episode will be aggravated by the worst El Nino dry spell in two decades.

At the same time, Prime Minister Lee Hsian Long, after a landslide re-election victory where the ruling People’s Action Party took all but six of parliament’s ninety seats, convened a task force to chart the island hub’s future in light of global conditions and domestic demographics posing “severe challenges” to traditional manufacturing and financial services strengths.

The committee will focus in particular on raising small business innovation and productivity, which lags despite the number two ranking in the World Economic Forum’s Competitiveness Report across a range of education, infrastructure and technology indicators.

In the region, Hong Kong was also in the top 10 and Malaysia was 18th overall, and they have been more directly in the spotlight of recent financial market hazard, but Singapore has also been stuck in credit and real estate bubbles and rigid currency policy unnerving investors.

It is one of the last remaining AAA-rated sovereigns with huge current account and fiscal surpluses, and government debt under 50% of GDP. However, the recent passing of independence visionary Lee Kuan Yew, the prime minister’s father, underscored the population’s rapid aging, and income inequality has also become an issue the past decade.

This fiscal year, the government shifted course to increase health and social spending for the elderly and poor, and funded it with a 2% marginal income tax rise to 22%.

Business sentiment soured as measured by Dun & Bradstreet’s optimism index on the redistribution drift at odds with the founders’ commercial laissez-faire tendencies.

Critics assert that such “welfare state” drag will contribute to anemic 2 % GDP growth for 2015, but lackluster cross-border ASEAN commodities and capital markets activity are likewise to blame as sudden obstacles.

Agricultural trading house Olam was also caught in alleged misreporting that damaged the sector’s reputation, and provoked doubts about general corporate governance practice.

The main ongoing wobble has been from two consecutive years of falling house prices, after banking restrictions were imposed in 2013 to cap the borrower debt/income ratio at 60% and stamp duty was hiked. Values were off around 7% from the peak as of end-June, and the benchmark SIBOR as the mortgage reference rate is at a post-2008 high.

Bank credit soared 55% since the crisis and is now at 155% of GDP, with household debt alone at 45%. Offshore lending has also been brisk to Greater China, Japan, Korea and Southeast Asia at over $150 billion, and overall non-performing assets are still low but recently reached 1%.

The government may loosen the loan/income limits if price decline deepens and can also remove property supply from the market, and it may be pushed in this direction as the re-election afterglow fades.

Monetary policy may also be eased to stimulate growth through realignment of the complex exchange rate regime, with formulas for bands and sloping curves against major currencies, and the Singapore dollar’s single-digit drop against its US counterpart could then worsen.

Critics argue that the approach should be replaced with a simpler more flexible mechanism for interest rate signaling without overwhelming control from Monetary Authority technocrats.

Foreign exchange reserves at S$350 billion, along with sovereign wealth fund holdings, are ample enough to allow for experimentation, but the new economic task force is not charged with examining the issue.

The state-run Temasek investment arm has also come under scrutiny for heavy mainland China exposure in several asset classes, and the stock exchange has angered investors by courting questionable frontier market listings from Burma and elsewhere.

While the forest fire air may eventually lift, the real estate credit and competitive haze linger to choke confidence into the Lee family’s repeat term.

Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.

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