How Fed's movement can affect the Singapore business climate

With Janet Yellen as the new leader at Federal Reserve, investors are looking for clearer direction on the course of Fed’s action. With much anticipation, Yellen retained the current trend of reduction in the Quantitative Easing (QE) by another US$10 billion monthly, to US$55 billion from April 2014 onwards.

While the market has formed some expectation of a continual withdrawal of QE, stock market is still affected by the Fed’s movement. There are several reasons for such behavior.

While the US economy is healing and maintains moderate growth, the fall in unemployment rate is largely due to workers leaving the workforce, often categorised as the discouraged workers. This is not a positive sign coupled by the uncertain outlook in emerging economies that is often seen as a driver of the world economy.

Fundamental Value of Stocks

Global markets are affected by the Fed’s action; the correction should be viewed as a positive sign for investors as stock prices are falling back in line with the fundamental value of businesses.

The long period of stock prices’ growth fuelled by the QE has largely increased the Price/ Earning ratio (PE) of companies while the Earning Per Share (EPS) is lagging as operating revenue and income are not catching up with a rosier business climate.

This makes the current valuation of business less enticing for investors who are seeking potential acquisition for complementary growth.

Such correction is appealing for companies who are looking for acquisition target when stocks are more in line with the intrinsic value of their potential targets. However, there is also concern of higher financing cost for businesses in Singapore.

The reduction in QE means that inflow of capital will slowly reduce and the excess liquidity or cheap capital situation in Asia will slowly fade away. Bank and other financial institutions in the bid to seek for more capital will have to pay a higher interest rate to lure retail deposits.

As such, while stock prices have fallen which reduce acquisition cost, the potential rise in financing cost is a upside risk for business to take note. Banks are therefore in the race to attract retail deposit and may find it more costly to enhance their depository base. This may eventually erode profit margin for banks.

It is important also to note that with an anticipation of higher interest rate, consumers who have taken flexible mortgage repayment plan may expect higher financing cost. Banks will therefore have to ensure sound loans’ quality in their portfolio to ensure low default rate when interest rates start to climb upwards in the medium term.

Asia business climate

The expectation of a rise in interest rate is further supported by Fed’s suggestion of a possible rise in interest rate when QE is winding down. It is expected that within six months after the full withdrawal of QE, the interest rate is likely to increase.

Such pace appears to have an impact on investors’ expectation of future interest rate. The higher interest rate should be welcoming if a brightening of the world’s economy supports Fed’s movement.

However, there are a few dark spots in global economy that can have repercussion to Singapore’s economy whose export value is a multiple of its annual GDP.

The latest flash China’s Markit/HSBC Purchasing Managers' Index (PMI) fell to 48.1 for March 2014. This is compared to 48. 5 for February 2014. A figure below 50 indicates contraction in the sector.

This is indeed worrisome for China as figures suggest a weak domestic demand with the country initiating market reform to reduce its reliance on an export-orientated economy.

Indeed, as the world’s second largest economy experiences a slowdown in its growth momentum, countries like Singapore who depend on external trade for economic survival will experience headwinds and businesses have to remain agile and maintain vigilant outlook for their Asia business portfolio, not for the sole purpose of diversifying risk but tuned to achieve decent return of investment in times when emerging economies’ growth is showing sign of weakness.

The slowdown in China presents potential upside opportunities for Singapore business. In the course of stabilising the deceleration in the economy, there can be a relaxing of barriers to private business investment in the country, which is a welcoming sign for businesses in Singapore.

Preparing for a new business climate

As emerging and developed economies are shaping their internal economy to prepare for a normalisation of growth, Singapore business can continue to remain confident. The downside to growth in these economies is unlikely to lead to a recession.

The rise in financing cost should be viewed as a market re-allocation of efficient capital usage and new opportunities can arise as governments may introduce modest support to local economy.

Nonetheless businesses should not look forward to extensive stimulus to stabilise growth through monetary means seen as a source of inflationary pressure that took great effort and political cost for governments to contain.

On the contrary, fiscal policy looks to take on the gear as the next growth wave. For example, China may increase its domestic construction spending to stabilise domestic demand, which will have spillover effect to the peripheral region of the economy.

As Singapore businesses continue to upgrade productivity and move up the value chain of the supply and manufacturing network, there is no reason why we should view this transitional period as a gloomy one.

The economy and business climate in Singapore has grown to become more resilient and competitive in the changing global economy. There are potential for overseas growth for businesses as long as calculated risk is considered for the medium and long-term growth.

More importantly, businesses should continue to maintain their role as an important complementary growth node in the dynamic world economy.