The riddle of GIC’s performance and CPF funds
Ok let’s try to talk about something other than Dr Patrick Tan’s national service. GIC released its annual report last week. Unlike most investment funds, GIC doesn’t provide year-on-year performances. It reports its performance in the form of a rolling annualised 20 year rate of return in USD. So there’s no way to know, unlike for Temasek Holdings, how much GIC lost or made in a single year. So we make do with what we have.
Now most people, including myself is under the impression that CPF monies are managed by GIC which invests them overseas. Call this the CPF-GIC model. I recall reading a book by Rodney King, The Singapore Miracle which says that GIC is barred from investing in the domestic market because it is feared that its large size may destabilise the markets with its investment moves. True or not, I’ve no idea. But what’s particularly interesting is GIC’s performance as reported.
In its 2011 report, for the first time GIC also reported its performance over a 5, 10 and 20 year period. It also compares its performance against alternative hypothetical portfolios with different mixtures of equity and debt instruments, but let’s ignore that for now.
Now the above figures are reported in terms of annualised, not compounded returns over the stated periods. So a question one might ask would be, what are GIC’s returns if they were converted to SGD? GIC reports its performance in terms of real annualised returns over global inflation, but that is quite irrelevant if the main concern is over whether GIC is able to generate sufficient returns to pay interest on CPF deposits. The USD-SGD exchange rate (as well as Singapore’s inflation rate) matters more than the global inflation rate (however that is calculated) since ultimately interest CPF deposits are credited in terms of SGD.
Is GIC able to pay off CPF deposits solely by its reported investment returns? Let’s take a look.
Take the five year period. The reported annualised nominal rate of return in USD is 6.3%, which implies that GIC’s enjoyed a 31.5% return over a period of 5 years. A check with Google Finance showed that from 31st March 2006 to 31st March 2011, the USD fell from S$1.6183 to S$1.26, or a depreciation of 22.14%. That means over the past five years, the nominal rate of return in SGD is 31.5% – 22.14% = 9.36%. This equates to a nominal compounded growth rate of merely 1.8% over the last 5 years.
Now the minimum CPF interest rate as mandated by the CPF Act is 2.5%. How is GIC going to pay off interest on CPF deposits given its below par performance in terms of SGD? Not to mention the fact while the interest on the CPF Ordinary Account is 2.5%, the other CPF account pays a higher rate of interest at 4%.
Since GIC provided the numbers for their rolling annualied 10 and 20 year rate as well, one can perform the same set of calculations to yield the following numbers. GIC’s CAGR in SGD for the 10 and 20-year period period is 3.7% and 3.89% respectively. Historical forex rates may be found here. From this it looks like over the years, the strengthening Sing dollar has made it more difficult for GIC to credit interest on CPF deposits through overseas investment returns alone. (Note: The interest rate on CPF OA was fixed at 2.5% since 1999; it was higher in the earlier 1990s, see data here)
Strengthening the dollar has long been Singapore’s only means of fighting inflation, but yet doing so inevitably makes it difficult for the state to provide a decent return on retirement funds. I’ve long wondered why the Singapore government has never seriously considered indexing CPF returns for inflation. With this in mind, it looks doing so would have made it doubly hard for the state to combat inflation while also being able to provide adequate returns on CPF, if it is indeed the case that GIC manages CPF monies.
This complements the traditional explanation for why Singapore has been reluctant to strengthen the SGD. The traditional explanation was that doing so would have made Singapore exports uncompetitive with the strong dollar. However this explanation is insufficient for a few reasons; firstly Singapore is a price-taker on the international markets hence manufacturers are unable to set higher prices on the world market in the first place so there’s little reason to fear pricing competitiveness. This point was made by MTI economists in a paper here:
This is indicative that manufacturers are unable to sufficiently raise export prices in line with increases in domestic costs. In other words, manufacturers are unable to pass on most of their domestic price increases to their foreign customers. This finding is entirely consistent with the notion of Singapore is largely a price-taker on the international market.
Secondly assuming most exporters are foreign MNCs who would repatriate most of their profits to their home country anyway, a strong Sing dollar might not affect them as much as it is assumed (though it would hurt domestic exporters by diminishing their profit margins).
When the MAS was first set up, like most central banks it was widely expected to be chaired by an economist which should be independent of the ruling party rather than the Finance Miniser. However, Goh Keng Swee then rejected the idea, believing that the ruling PAP would always be able to balance its books and run budget surpluses and not resort to inflationary financing. Now of course the question now becomes whether GIC and MAS would be able to balance their conflicting goals of fighting inflation while also delivering decent returns to CPF depositors.
The question now is whether the CPF-GIC model is sustainable if Singapore values keeping the cost of living low more than being able to pay interest on CPF deposits by its overseas investment returns. This might also explain why the Singapore government seems intent on forever making it harder and harder for depositors to withdraw their CPF savings through the introduction of innovative policies such as CPF Life, and Minimum Sum. This is especially true when one considers that the baby-boomer generation of workers are nearing retirement and are would have withdrawn much of their CPF balances if it weren’t for these restraining policies.