Parliament: DPM Tharman on why assets as investment buffer not a reserves drawdown

SINGAPORE - The Government's net assets, that it relies on to back the interest rates paid on CPF savings, are Singapore's reserves, said Deputy Prime Minister Tharman Shanmugaratnam on Monday.

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DPM Tharman's Response to Parliamentary Question on SSGS Obligations

Question from Mr Gerald Giam Yean Song, NCMP: To ask the Deputy Prime Minister and Minister for Finance (a) whether the buffer of "net assets" that are used by the Government to ensure that Special Singapore Government Securities (SSGS) interest rates are paid to the CPF Board even in years when GIC's returns are weak refers to (i) past Government reserves requiring Presidential assent for drawdown (ii) current Government reserves or (iii) current or past reserves accumulated by GIC or MAS; and (b) what limitations apply to the use of these net assets.

Answer:

Mdm Speaker, I thank Mr. Gerald Giam for his question.

2. Let me first reiterate the basic framework that enables the Government to ensure that SSGS obligations are met. The CPF Board invests CPF members' savings in SSGS, which are guaranteed by the Government. This assures that CPF savings are safe, regardless of financial market conditions. The interest rates on SSGS also match those on CPF savings, so that CPF members will receive the annual interest rates that they are promised, including the minimum 4-5 per cent interest on SMRA balances and 2.5-3.5 per cent interest on OA accounts that they receive even when market interest rates fall to low levels.

3. The Government pools the SSGS monies with the rest of its funds, such as proceeds from issuing Singapore Government Securities (SGS) in the markets, as well as unencumbered assets that reflect past government surpluses and receipts from land sales. These comingled Government funds are first deposited with MAS as government deposits. A major part of these funds, being of a longer-term nature, are then periodically transferred to GIC to be managed over a long investment horizon.

4. Before GIC was formed in 1981, the Government's monies including those derived from SSGS were managed by MAS. MAS continued to manage a good part of the monies especially during the first decade after GIC was formed, while GIC built up its capabilities for long-term global investment in diverse asset classes. Currently, GIC manages a major part of the Government's funds including those derived from long-term liabilities such as SSGS.

5. Importantly, GIC is not managing SSGS or CPF monies on their own, but a combined pool of Government funds including a significant sum of unencumbered assets. This is why the GIC's mandate is to take calculated investment risks aimed at achieving good, long-term returns on the Government's funds, without regard to the Government's liabilities.

6. GIC has achieved good long-term returns to date. However, as investment markets are uncertain and volatile, GIC's returns over shorter periods could be low or even negative. The Government is able to absorb these short-term market risks, because it has a strong balance sheet. It has a substantial buffer of net assets that enables it to meet the obligations on its liabilities, including its SSGS commitments.

7. The Government's net assets, or its assets in excess of its liabilities, are the Government's reserves as defined under the Constitution. The bulk of the Government's reserves are those accumulated during previous terms of Government, also known as its Past Reserves. It is the Past Reserves that the Constitution seeks to safeguard, especially through the powers vested in the President.

8. In particular, the Constitution guards against profligate spending, which can draw down Past Reserves. The President can withhold his assent for the Supply Bill if the Government intends on its annual Budget to spend more than its Current Reserves, i.e. reserves accumulated during the current term of Government.

9. The Constitution also enables the President to state and gazette his opinion if he considers that the Government has entered into liabilities that will likely draw down Past Reserves. This scenario could for example arise if the Government were to set interest rates on SSGS at artificially high levels, without reference to market interest rates, and above what can reasonably be expected to be earned in investment returns on the Government's funds over the long-term. This would run down the reserves systematically and deliberately. The President has not been put in a position where he has had to state such an opinion. CPF and SSGS interest rates are set with reference to returns on similar market instruments, and are both fair and sustainable.

10. The scenario of entering into liabilities that will lead to a systematic and deliberate drawdown of reserves should not be confused with the fluctuations in the value of the reserves due to market volatility and cycles, that happen all the time. Volatility and cycles are part and parcel of the investment world. Indeed, the GIC's mandate is to take risks aimed at achieving long term returns, in full knowledge that the Government's portfolio will be exposed to market risks that could mean weak returns or even declines in value on a mark-to-market basis for a time, before cycles reverse and values rebound.

11. Hence, although GIC's returns over the last 20 years ending March 2014 have averaged 6.5 per cent in USD terms, or 5.3 per cent in SGD terms, it has experienced several years where its returns were low or negative. To take the most recent episode, the Global Financial Crisis led to a significant reduction in GIC's annualised five-year return ending March 2013- to just 0.5 per cent in nominal SGD terms. But moving just a year forward to March 2014, its 5-year annualised return rebounded strongly. This volatility was also seen in comparable market portfolios.

12. The President and the Council of Presidential Advisers (CPA) have full information about the size of the reserves and all of the Government's financial assets and liabilities. What matters in determining if there will be a likely draw on Past Reserves is whether Government has entered into liabilities that are sustainable and will not result in a systematic erosion in the reserves. It is not the short-term fluctuations in investment returns due to market risks that matter here - even if these ups and downs in investment returns, taken together with the Government's SSGS and SGS obligations, imply fluctuations in the value of net assets. A decline in investment returns or a drop in the market value of assets in the course of market cycles is not considered a draw on Past Reserves that the Constitution seeks to guard against, because any strategy of investing the reserves for long-term returns must mean taking investment risk and will involve ups and downs in market value of the portfolio - not just from one year to another but very frequently within the year. The only way to avoid fluctuations in the value of our reserves is to avoid taking investment risk, for example by investing all of our assets in cash-like instruments. However, this will mean accepting low returns over the long-term, and indeed returns that would likely fall below the interest rates on SSGS and even SGS over the long-term.

13. To summarise the point, what the Constitution guards against are actions that lead to a systematic erosion of reserves, not the investment of reserves in order to gain long-term returns - which must involve investment risk and fluctuations in market value.

14. Let me return to the basic features of the system. The Government's strong balance sheet enables it to take investment risks and ride out the market cycles that are inherent in investing for the long-term. It has a significant buffer of net assets, with important benefits for Singapore. These net assets enable the Government to guarantee CPF savings, and pay fair interest rates on CPF savings despite financial market cycles. The Government's significant net assets, on which we expect to earn long-term returns, are also why we have a significant stream of investment income in the form of NIRC (Net Investment Returns Contribution) on our Budget each year, which can be used to meet important spending priorities.