Returns On Reserves And Government Spending

Date: 23 March 2009

Question No. 950 (by Mr Gautam Banerjee, Nominated Member of Parliament):

To ask the Minister for Finance what are the additional amounts available for Government spending included in the revised estimates for the year ended 31 March 2009 and the budget for the year ending 31 March 2010 as a result of the constitutional amendment in October 2008 that now allows the Government to spend on the basis of total returns on relevant assets.

Question No. 951 (by Mr Gautam Banerjee, Nominated Member of Parliament):

To ask the Minister for Finance with regard to investment returns on our reserves (a) what are the key assumptions in computing the expected long-term real rate of return on relevant assets for the purpose of determining the total returns on these assets; and (b) how does the “expected long-term real rate of return” compare with the actual historical long-term real rate of return.

Question No. 952 (by Mr Gautam Banerjee, Nominated Member of Parliament):

To ask the Minister for Finance with regard to investment returns on our reserves, how he has satisfied himself with the reasonableness and fairness of the assumptions inherent in the computation of the expected long-term real rate of return on the relevant assets.

Reply by Finance Minister Tharman Shanmugaratnam:

Mr Gautam Banerjee asked about the additional amounts available for Government spending for year ended 31 March 2009 and year ending 31 March 2010 under the new Constitutional framework for spending from investment returns.

The new framework for spending will take effect from 1 April 2009. It hence does not affect the amount of investment income taken into the Budget for spending for the fiscal year ending 31 March 2009, which continues to be based on the earlier framework on actual interest and dividend income alone. For this fiscal year which is ending soon, the Government took in a Net Investment Income Contribution of $3.7 billion.

For the coming fiscal year ending 31 March 2010, the Net Investment Returns Contribution (NIRC) was estimated in the Budget to amount to $7.7 billion. The figure was reflected in the Budget Statement in January 09. Compared to the Net Investment Income taken in last year, the NIRC of $7.7b is an increase of about $4b - or about 1.6% of GDP.

Members would know that this Net Investment Returns Contribution (NIRC) starting with the coming fiscal year is based on the new framework of spending out of long term expected total returns, not limited to interest and dividends. The framework applies to expected returns on the reserves managed by GIC and MAS. There is no change in rules for spending out of Temasek’s returns, which continues to be based on actual dividends.

The process for determining the long-term expected real rates of return of the reserves invested by GIC and MAS has been rigorous. The rates, which refer to the expected real returns over the next 20 years, were proposed by the Boards of GIC and MAS respectively, based on detailed study and assessments by investment professionals in the two agencies. The GIC and MAS teams first projected the expected returns on each individual asset class (such as bonds or real estate). This was followed by aggregating the expected rates of return on the individual asset classes into the overall rates of return on the GIC and MAS portfolios, which takes into account their respective asset allocation strategies.

The GIC and MAS took into account both historical trends, and a forward-looking analysis of the investment outlook, before reaching their best judgments. The methodology did not in any instance involve a mechanical extrapolation of past trends. In making their assessments, they also took account of projections of future returns on each asset class by their peers amongst institutional investors.

The Ministry of Finance undertook a thorough review of the methodologies used by the GIC and MAS, and was satisfied that their approach was sound and the estimated long term rates of return were reasonable. As Minister for Finance, I therefore proposed these rates to the President for purpose of Budget 2009. President obtained the advice of the Council of Presidential Advisers as required under the Constitution, before concurring with the Government’s proposals.

Mr. Banerjee asked how the expected long-term real rate of return compared with the actual historical long-term real rate of return. The expected rates of return - which are estimates of the average returns expected over the next 20 years - reflected the GIC and MAS Boards’ assessment that the future investment environment is likely to be less benign than over the last 20 years. The expected rates of return for the individual asset classes over the next 20 years are in fact generally lower than their historical rates. However, the expected rates on the GIC’s overall portfolio also reflect the fact that it is now considerably more diversified across a range of risk assets than it was 20 years ago.