These were the questions I asked DPM Tharman Shanmugaratnam on 4 August 2014 in Parliament regarding the Government’s “net assets” and how the returns from the reserves managed by GIC make their way back to CPF members. The DPM’s answers and my supplementary questions are below.
Mr Gerald Giam Yean Song asked 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.
The Deputy Prime Minister and Minister for Finance (Mr Tharman Shanmugaratnam): Mdm Speaker, I thank Mr Gerald Giam for his question.
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 Special Singapore Government Securities (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% to 5% interest on SMRA balances (Special Account, Medisave Account, Retirement Account balances) and the 2.5 % to 3.5% interest on the Ordinary Account balances, that they receive this even when market interest rates fall to low levels. So, the interest rates on SSGS match these interest rates on CPF savings regardless of financial market circumstances.
The Government pools the SSGS monies with the rest of its funds, such as proceeds from issuing Singapore Government Securities or SGS in the markets, i.e. the tradable securities in the markets, as well as unencumbered assets that reflect past Government surpluses and receipts from land sales. These co-mingled 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 the GIC to be managed over a long investment horizon.
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.
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. It is precisely because the GIC is managing a combined pool, which includes a significant amount of unencumbered assets, that it is able to invest for the long term, take risk in expectation of long term returns, without regard to the government specific liabilities.
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.
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.
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, in other words, reserves accumulated during the current term of Government.
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.
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.
Hence, although GIC’s returns over the last 20 years – ending March 2014 – have averaged 6.5% in USD terms, or 5.3% in SGD terms, it has experienced several years where its returns were low or negative – several years during that 20 year period. 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 – i.e. as of a year ago – to just 0.5% in nominal SGD terms. But moving just a year forward to March 2014, its five-year annualised return rebounded strongly. This volatility is part of the market. It was also seen in comparable market portfolios.
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.
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.
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.
Mr Gerald Giam Yean Song (Non-Constituency Member): Thank you, Madam. I thank the Deputy Prime Minister for the answers. I have three supplementary questions. GIC has reported that over the 20-year period ended 31 March 2014, the GIC portfolio has generated an average annual real return of 4.1%. Does this figure take into account the interest payable to CPF for the SSGS?
Second question: can the Deputy Prime Minister explain what is the mechanism by which the investment returns from GIC are transferred back to the Government and then to CPF? Does the GIC only return the NIRC to the budget and then leave it to the Government to disperse the SSGS principle plus interest to CPF using net assets?
And third question: specifically on the eight years in the past 20 years where GIC’s investment returns were below what the Government pays on SSGS, were these shortfalls funded from the Government’s net assets or from the GIC’s assets?
Mr Tharman Shanmugaratnam: First, let me explain that GIC is managing Government assets. It is not GIC’s assets. GIC is a fund manager, so the assets are assets on the Government’s balance sheet, rather than on the GIC’s balance sheet. When the GIC reported that it has earned a real return over 20 years of 4.1% on an annualised basis, it is referring to the return on the total assets that it is managing for the Government.
The NIRC which enters the Government’s budget is computed after netting off what is payable on the Government’s liabilities, SSGS and SGS. That is already netted off. So, what enters the Government’s budget, which is up to 50% of the expected investment returns, is after Government has paid what is necessary on the liabilities.
And as for the eight years within the last 20 years, which was what I had stated in response to Mr Gerald Giam’s question at the previous Sitting – just to reiterate, that is eight years in the previous 20 years ending 2013 – that is when in fact the GIC’s returns on the total assets that it is managing fell below the SSGS rates. That by definition would have meant that net assets would have been lower than otherwise because the Government has fixed obligations on its liabilities, and because of the fluctuations in returns on its assets.