The technical recession is nearly upon us: DBS

As the economic woes in the developed economies continue to unfold with risk of a global recession rising, small and open economy such as Singapore is probably most at risk. The economy has already contracted by 6.5% QoQ saar in the second quarter. With talk of a technical recession in the air, the third quarter advance GDP estimates as well as the policy decision from the Monetary Authority of Singapore next Friday will be closely watched.

So much has been said about the risk of a technical recession but data has been mixed. Retail sales growth continues to head north (10.7% in Jul11).

Unemployment rate remains low at 2.1% in 2Q11, with wages rising at about 6.0%. In addition, a strong 28% YoY increase in bank loans also does not seem to suggest a recession in the pipeline. Even the externally driven manufacturing sector, probably the weakest link in the equation, seems to be holding up. The latest August industrial production surprised with a solid 21.7% YoY expansion.

More importantly, whether the economy will indeed fall into its second technical recession in three years will much depend on the sequential change in industrial output. On that front, a 3.9% MoM rise was reported, up from a revised 0.4% in the previous month. As long as industrial output level does not fall by more than 4.3% MoM sa in September and that the growth momentum in the services sector remains positive, the economy will avert a technical recession. Indeed, we maintain our view that the economy will expand by a modest 2.0% QoQ sa (6.0% YoY) in the third quarter, narrowly avert a technical recession. It’ll be a close shave.

But importantly, we expect a rough patch ahead for the economy. The biomedical segment is the only factor keeping the manufacturing sector afloat amid the decline in global demand. This segment grew an average of about 96% YoY between Jul-Aug and such a robust trend in biomedical, particularly pharmaceutical production may not persist. Some plants are due to shift to different product mixes within the next 2-3 months, which would require temporary shutdowns in their productions. This will surely impact overall manufacturing growth. Indeed, current production level is way higher than normal, implying even higher risk of a pullback in production in the near term. This industry is highly cyclical.

Furthermore, if not for the strong boost from the biomedical segment, the manufacturing sector would have contracted by an average of 8.4% YoY or 5.0% on a MoM sa basis between July-August. The fact that the biomedical segment is the only factor keeping overall industrial production afloat is not particularly comforting.

Against the backdrop of a deteriorating external outlook, ex-biomedical manufacturing production will most likely continue to decline, judging from the broad-based decline in global PMIs. The impact of the recent fire at the Shell refinery will also be manifested in the headline manufacturing growth figure in the fourth quarter.

In short, even if the economy managed to avert a technical recession in the third quarter, the risk of it falling back into the red in the fourth quarter cannot be ruled out.

And plainly, the risk is weighed more on the growth outlook for 2012. While we’re maintaining our current full year GDP growth of 5.6% for 2011 and 5.0% for 2012 for now, we do note that downside risks to growth are stacking up.

In view of the weakening growth outlook and higher than normal inflation (5.7% in Aug11), the MAS is expected to maintain its policy stance of a gradual appreciation of the Sing NEER but with a slower pace of appreciation. Specifically, the slope of the Sing NEER policy band will most likely be lowered to mitigate potential risk to growth while keeping a lid on inflation.