spex issue 31
TRANSCRIPT
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INCOLLABORATION
WITH
PROUDLYSUPPORTED BY
ISSUE 31
21 JANUARY 2013
- Revisiting internationalization of the Renminbi in 2013 (Part 1)
- The stalled growth dynamic and the way forward
- A commentary on Basel III and Asia
The Fortnight In Brief (7th January to 20th January)
US: The recovery of the housing marketThe US housing market rose to its highest level in three years with
combined purchases of new and existing properties hitting a 5.49 millionannual rate. 954,000 new homes were added in December, indicating thatthe housing market is contributing to economic growth. Retail sales alsosaw a 0.5% rise in December from the prior month, with car salesexperiencing a 1.8% increase. These optimistic figures come at a timeDemocrats and Republicans continue their squabbling over US debt
problem.
Asia Pacific ex-Japan: Hot Money Flows into AsiaChinas economy grew 7.9% in the last quarter of 2012 compared to 7.4%in the prior quarter. Though this is an improvement, the years overall
growth was 7.8%, the lowest in the entire decade. Meanwhile, Asiancurrencies experienced its fourth weekly gain, with the Bloomberg-JPMorgan Asia Dollar Index climbing 0.2% in the week, upon the release ofoptimistic economic data globally.
EU: A Long Drawn-out CrisisLast week, the Euro was trading near a 10-month high of $1.34 against thedollar. This raised concerns that export competitiveness might beadversely affected. The Euros rise is particularly worrisome for Germany,
where exporters are already saddled with increasing labour costs. In fact,
Germanys 2013 growth forecast has been cut to 0.4%, down from 0.7%last year. With Germany being regarded by many as a pillar of confidencefor Europe, many are concerned that a fall in exports will further hamperthe European economic growth. In addition, output in the 17-nation Eurozone has been flat to sinking since late 2011, with unemployment at analarming 16% in Portugal and 27% in Spain.
SMU Political-Economic
Exchange
AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION
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Revisiting the Internationalization of Reminbi in 2013 (Part 1)By Henry Chan and Tong Kah Haw, Singapore Management University
The year of 2012 didnt spell the end of the world as predicted by the Mayan Calendar, but it
did end with an optimistic note that Chinas slowdown could be nearing its end. Chinas
official purchasing managers index (PMI) has held steady above 50 from October to
December, signaling an expansion of the factory sector. Furthermore, Chinas inflationary
pressure has remained relatively stable by hovering around the 2% range, providing the
macroeconomic stability that will allow Peoples Bank of China (PBoC) to conduct a more
flexible monetary and exchange rate policy. In such times where other major developed
economies are in doldrums, many welcome Chinas imminent recovery. In fact, Chinas labour
costs experienced an approximately 100% increase in the last 5 years, yet its export market
share of manufactured goods reached an unprecedented high. The inherent strength of the
Chinese economy took many analysts by surprise and indirectly supported many developing
countries on export performance of raw materials.
In the intelligence briefing for incoming President Obama prepared by National Intelligence
Council, called "Global Trend 2030", the US government admitted that Chinas GDP will exceed
that of the US a few years before 2030 in nominal term. Scenario analysis by the Asian
Development Bank and Professor Eichengreen all point to the same conclusion in their base
case barring any black swan type event. Hence, it is worthwhile to revisit the issue of
Renminbi (RMB) internationalization, especially when the current international monetary
system anchored by the USD as the leading international currency is plagued with so many
underlying problems.
RMB internationalization means the acceptance of RMB to function as money by other
countries. Generally, economists have defined three functions of money. Firstly, it has to be
the medium of exchange. This means that RMB will be used in global trade and service
settlements. Secondly, RMB will be used as the unit of account in commodity pricing. Thirdly,
it has to function as a store of value and standard of deferred payment. This means that RMB
loans and deposits are not only used by the central bank as reserve to meet import needs, but
also by the public worldwide.
Conventional wisdom focuses on the opening of Chinas capital account as the signpost of
RMB internationalization. Yet, Chinas view is apparently different. In the "Report on theInternationalization of RMB 2012" released by the International Monetary Institute of Renmin
University, it suggested China should focus on growth and to expand its GDP share in the
world economy as the primary driving force to promote RMB internationalization. It also
acknowledges the weakness of the Chinese financial sector and urges the country to adopt a
creeping RMB internationalization approach.
Pertaining to this, IMF has formally declared that retaining some capital controls rather than
achieving full capital account convertibility are deemed to be more strategic. The institute
also formulated the RMB international index (RII) to measure the extent of
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internationalization of RMB. The index increased from 0.02 to 0.45 in a span of two years,
validating its phenomenal growth (Figure 1). In contrast, the USD international index
remained high and unchanged at 54.18 (Figure 2). The report suggested that by 2030-2040,
the RII will grow to 20+ and the international monetary system will then be dominated by
three major currencies the U.S dollar, the Euro and the RMB. The view of Renmin seems to
concur with the adopted view of the Chinese government at the moment.
Figure 1: Renmin University - RMB Internationalization index (RII) from 2010 Q
Year RII
2010-1Q 0.02
2010-2Q 0.02
2010-3Q 0.10
2010-4Q 0.23
2011-1Q 0.26
2011-2Q 0.40
2011-3Q 0.43
2011-4Q 0.45
Figure 2: Renmin University - Major Currencies Internationalization Index 2011
Internationalization
Index
2011-1Q 2011-2Q 2011-3Q 2011-4Q
USD 51.81 53 53.76 54.18
Euro 27.27 26.27 24.86 24.86
Yen 3.86 4.03 4.58 4.56
Sterling 4.73 4.21 4.34 3.87
There are various proponents arguing for and against RMB internationalization. Proponents
claim the increasing size of the Chinese economy in the world, unstable USD, and benefits
such as seignorage and geopolitical power projection provide the incentives for RMB
internationalization. Detractors argue that Chinas weak financial systems, underdeveloped
bond market and multiple capital market interest rates render China vulnerable and unable to
buffer against capital flows should RMB be allowed to internationalize. All these factors will
be examined in closer detail below.
1. Diversification away from the dependency on the Dollar
Even though the US has confirmed its role as a safe haven despite the financial crisis in 2008,
concerns about the booming US debt due to huge federal spending and trade deficit has been
growing. The US national debt for 2012 currently stands at an astounding $16 trillion. Some
have alluded this to the paradox of the Triffin Dilemma1, which states that a country has to
run current account deficit in order for its currency to function as reserve currency status.
Worries about potential USD devaluation due to continual Quantitative Easing2, the debt
ceiling impasse in 2011 and a potential replay next month has caused reserve managers to be
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wary of the systemic risk associated with holding USD. Consequently, IMF data in Figure 3
shows that reserves held by foreign central banks have been rapidly increasing, but shares of
reserves in USD has fallen to about 60.7% in recent years.
Figure 3: Decreasing Percentage of Total FX Reserves in USD
Hence, another credible reserve currency to reduce the reliance of the greenback is in the
interest of international financial stability, and the likely replacement is the RMB.
2. Size Of Chinese Market Economy and Share In ExportsFor RMB to be an international currency, it has to fulfil several requirements. It must first
satisfy the requirement of a large economy with huge trade volume. By the end of 2012,
Chinas GDP will be around USD 8.4 trillion or 11% of the worlds total.
Figure 4: Countries Share of World GDP
2006 2007 2008 2009 2010
China 5.43 6.16 7.14 8 9.27
US 26.83 25.05 23.44 22.06 23.6
Eurozone 21.89 22.37 22.39 19.4 21.3UK 4.91 5.05 4.37 3.4 3.64
Japan 8.94 7.99 8.1 7.85 8.7
China is also the biggest exporter with 11.6% of the worlds market share and second bigggest
importer. It is projected that at the end of 2016, China will overtake the United States to
become the worlds largest trading country.
3. Tremendous benefits of RMB as Global Reserve Currency
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It is no doubt that the US derives many advantages when the Dollar is used as the reserve
currency. Governments that print reserve currencies benefit from seignorage, a term coined
to represent the revenue differential between the cost of printing and the face value of goods
purchased. They also stand to gain exorbitant privilege, meaning that they will never face a
Balance of Payment crisis since they can always pay for imports in their own currency. By
internationalizing the RMB, China can also gain other benefits including cheap financing,
greater power status recognition and accelerating the reforms needed for its weak financial
system a step necessary for its thriving businesses and enterprises.
Despite such advantages that stand to be reaped, there are obstacles that will hamper the pace
of RMB internationalization. These obstacles will be further discussed in our next issue
Sources:
1. Renmin University International Currency Research Institute, Beijing - Report on theInternationalization of Renminbi 2012
2. Economist.com - Climbing Greenback Mountain3.
BIS Papers No 11 - The development of bond markets in emerging economies
4. Zhou Xiaochuan - Chinas corporate bond market development: Lessons Learnt5. Alsosprachanlyst.com - Interest Rates for Underground Credit in Wenzhou Surge6. Foxbusiness.com - China Plans to Tighten Banks Corporate Bond Underwriting Rules7. Standard Chartered - Singapore is worlds second largest offshore RMB centre8. Business Times, 8th Jan - Move to boost yuan business of HK banks
Triffin Dilemma is a theory that when a national currency also serves as an international
currency, there will be a trade deficit due to the countrys willingness to supply the world with an
extra supply of currency to fulfill world demand.
2 Quantitative Easing is a government monetary policy occasionally used to increase the money
supply by buying government securities or other securities such as mortgages from the market. Itincreases the money supply by flooding financial institutions with capital, in an effort to promote
lending and spending.
3 Shadow banks are unregulated non-financial intermediaries that provide similar services to
traditional banks.
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The Stalled Growth Dynamic and the Way Forward
By Kenneth Ho, Singapore Management University
After the 2008 great recession, many drew from their past experiences of previous recessionsand were expecting a quick V shaped economic recovery. Three years on however, therecovery has been elusive and painfully slow. Unemployment in the United States only
recently fell below 8% while Europe continues to be mired by structural issues because of theEuro currency and its debt crisis. Compounding this, larger emerging markets like China arealso showing signs of slowing down.
Against this backdrop, we ponder why the growth dynamics are so different this time around.
Two key questions come to mind - (1) why has the recovery been so slow? and (2) what is the
way forward?
(1) Why has the recovery been so slow?
A. Lack of policy options to support growth in the developed world
One major reason for the slow recovery in the developed world is the lack of available tools tostimulate growth in these nations compared to the past. The fact is that developed nations
have run out of tools to stimulate growth to fuel the recovery!
From a monetary policy standpoint, interest rates are already at the zero-bound in the US,
UK, Japan and Europe and there has been little room to stimulate demand by lowering
interest rates. Policymakers have turned to unconventional and unproven monetary methods
such as Quantitative Easing to try and stimulate growth but there have had little visible
impact. In fact, if history is any guide, Quantitative Easing might not be as useful as policy
makers hope. Japan was the first country to turn to Quantitative Easing back in 2001 and after
their repeated attempts to stimulate the economy has fallen flat. Japan has been in a
deflationary spiral1 since the early 1990s and growth has been anaemic despite their
unconventional methods.
The same could be said of fiscal policy. The government sectors of these developed nations
are burdened by significant amounts of debt thus making expansionary fiscal policies unlikely.
Conversely in fact, these developed nations will soon have to deal with fiscal tightening to try
and reduce their budget deficits and slowdown their public debt accumulation. One of the
biggest talking points today is the US fiscal cliff, a reduction of government spending
scheduled for the end of 2012 that is predicted to lower growth significantly if the politicalstalemate between Democrats and Republicans is not resolved.
B. Emerging markets trading off growth for lower inflation
In the larger emerging markets, priorities of policy makers have been changing. After a decade
of blistering growth, policy makers are prioritising inflation management over growth. In
China for example, much of the slowdown has been self-imposed. In a bid to cool inflation and
prevent a property bubble, the government raised the Reserve Ratio Requirement2 four times
in 2011 and allowed the RMB to appreciate against the US dollar.
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In fact, unlike the developed world, China retains many policy tools that can spur growth. It
simply chooses not to utilise them right now. Chinas one year lending rate is now 6.0% and
the RMB can be depreciated to improve competitiveness and boost exports. Furthermore, the
Chinese government is flush with cash to implement expansionary fiscal policies if needed.
While inflation has cooled since 2011 and the Chinese government has relaxed some policies,
it is unlikely to target higher growth just yet. They seem to be aiming for the Goldilocks
point where growth and inflation are at sustainable long term levels. Its growth target for this
year is only 7.5% versus historical double digit growth.
C. Ageing population and other structural changes are additional headwinds
Longer term, ageing population issues and other structural changes3 in many economies are
likely to be additional headwinds to the economic recovery.
Globally, and especially in the developed world, populations are ageing as the baby boomers
age and enter retirement. This is likely to have a profound slowing effect on global growth
since the baby boomers are expected to consume less and invest less as they age. Studies have
shown that the baby boomers were the key driver of economic growth in the 1980s and
1990s. The reversal of this key demographic trend is likely to be accompanied by structural
slower growth globally.
Additionally, there are many structural challenges in many countries that need to be sorted
out before we can turn more optimistic. Europe for example, will have to sort out its debt
crisis. The most likely solution to this problem is a structural shift to deeper fiscal integration
among nations. However, agreement on this issue will take many years given the extremely
political nature of the problem.
Accordingly, these issues are likely to pose longer term headwinds to the economic recovery.
(2) The way forward The Next 11
While the growth outlook in the developed world and larger emerging markets remains bleak,
there is some hope in the next wave of emerging nations that could drive global growth over
the coming decades just as the BRICs nations did in the 2000s. Jim ONeill, the chairman of
Goldman Sachs Asset Management, has identified the N11 (Next 11) nations that is the BRICs
equivalent of this decade.
To identify these nations, Jim ONeill screened out nations that had large, young and growingpopulations. In fact, this is the same methodology to identify the BRICs nations back in 2001!
The Next 11 nations consist of Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan,
Philippines, Turkey, South Korea, and Vietnam. These nations exhibit macroeconomic
stability, political maturity, openness of trade and investment policies, and good quality of
education. Accordingly, they are poised to become the worlds largest economies in the
coming decades.
These nations have large, young and growing populations. Their developing economic
architecture will likely help grow and develop a rising middle class. The twin drivers of
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population growth and increasing GDP per capita are likely to boost the GDP of these nations
to rival even the G7. It is clear that the N11 nations will be an important source of growth and
opportunity in the coming decades.
(3) Conclusion
In summary, the growth dynamics since the 2008 great recession have been markedly
different from the past. While recoveries used to be swift and V shaped, this recovery has
been agonizingly slow and intermittent.
Much of this can be attributed to the changing global landscape. In the developed world, there
is a lack of policy options to support growth since policy makers have exhausted traditional
monetary and fiscal policy tools. In the emerging markets, priorities have changed and leaders
are trading off lower growth for lower inflation. Finally, longer term, ageing population issues
will likely be a headwind to economic recovery as the baby boomers retire and spend less
money.
Amidst this gloomy economic outlook however, the Next 11 emerging markets provide some
hope. With their large, young and growing populations with a rising middle class, they may
come to rival the G7 in the coming decades and be a source of opportunity and growth for the
world.
Sources:
1. Dominic Wilson and Anna Stupnytska, The Goldman Sachs Group. The N-11: More Than anAcronym
2. Raghuram G. Rajan. Fault Lines: How Hidden Fractures Still Threaten the World Economy
1 A deflationary spiral is a situation where decreases in price lead to lower production, which in
turn leads to lower wages and demand, which leads to further decreases in price.
2 The reserve ratio requirement is a central bank regulation that sets the minimum fraction of
customer deposits and notes that each commercial bank must hold as reserves.
3 A structural change refers to a long-term, macro level shift in the fundamental structure of an
economic system.
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A commentary on Basel III and Asia By Leslie Tay, University of Hong Kong
Basel III in a nutshell
Following the global financial crisis, the Basel Committee of Banking Supervision (BCBS)
sought to improve the supervision of banks and actively shaped policies to reduce systemic
risks1
within the financial sector. The result was a set of guidelines released in December2010, known as Basel III, and was set to be implemented in 2013. Basel III was a follow-up
from Basel 2.5 but comprised stricter standards and innovative counter-risk measures, with
the goal of achieving financial stability using the lessons learnt from the financial crisis.
Basel III includes the following key features:
Enhanced quantity and quality of capital with higher capital ratios and additional capitalbuffers (Figure 1)
Enhanced risk coverage by imposing higher capital requirements for securitized positions,derivatives and trading accounts
Reduction of systemic risks through counter-cyclical capital buffers and higher capital andliquidity requirements for SIFIs (Systematically Important Financial Institutions)
Enhanced leverage and liquidity requirements Enhanced monitoring of the shadow banking sector2 and derivatives markets
Figure 1: Basel III Capital Ratios
Source: Moodys Analytics
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Asia takes the lead
Asia has taken the lead with a number of countries (Singapore, Hong Kong SAR, India, China
and Japan) starting to implement Basel III early this year. Asian banks, being better
capitalized (many Asian banks already have capital ratios higher than Basel III requirements)
and less leveraged than their European or American peers, will clearly see a smoother
transition to Basel III. Monetary authorities and bank regulators in Asia generally agree that
the benefits of early implementation outweigh the costs. With robust economic conditions, the
consolidation of financial capital should not impose a huge burden to financial institutions. As
financial markets in Asia mature and as trades in more complex financial instruments
increase, the implementation of Basel III is highly timely by improving the soundness and
sustainability of the financial sector. Nonetheless, there are key issues with regards to Basel
III that regulatory bodies and banks should continue working on. Simply implementing Basel
III without further considerations is not a sufficient condition for financial stability in Asia.
Issues concerning Basel III on Asia
a. Liquidity
Under Basel III, two new liquidity rules will be introduced. The first ratio, the Net Stable
Funding Ratio (NSFR) ensures that banks have funding requirements over a one year period
of extended stress. The second ratio is the Liquidity Coverage Ratio (LCR) requires banks to
hold sufficient high quality liquid assets (HQLA) to cover net cash outflows stemming from 30
days of severe stress.
One implication of liquidity rules is that banks may be less willing to lend out and this may act
as a brake to the growth of Asian economies. Small and medium enterprises, an essential
source of growth for developing Asian economies, will need to compete for loans or seek
alternative methods of financing. The 30 day assumption of the LCR also fails to reflect the
underlying scenario in Asia where bank runs, rather than wholesale funding shortage, is the
main source of liquidity problems. Bank runs are much shorter and more volatile in nature. As
such, the 30 day time framework may be too long for Asian banks.
The probability of bank runs may increase over time as banks seek to attract deposits which
are a source of stable funding to maintain liquidity and capital ratios, making traditional Asian
deposits less sticky than before as savers simply shop for the bank that offers the best
interest rate. On this note, regulators should ensure that liquidity rules are implemented in
stages to ensure that there will be sufficient stable funding in the economy for banks to meetthose rules.
A final concern with the new liquidity rules is the definition of what qualifies as a HQLA. Prior
to January 2013, only cash and government bonds qualify as Level 1 assets while government
bonds and corporate bonds rated AA- or higher qualify as Level 2 assets (Figure 2). The Basel
committee has since relaxed the Level 2 requirements to accept corporate debt with BBB-
rating and above. High quality mortgage-backed securities will also be counted. Nonetheless,
the key concern for most Asian regulators lies in Level 1 assets due to a shortage in domestic
government debt. Monetary authorities would thus need to consider how to adapt the rules to
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local scenarios. The Hong Kong Monetary Authority (HKMA), for example, is considering to
only implement liquidity rules on core financial institutions and to allow banks to hold some
US dollar liquid assets to counter the shortages of Hong Kong dollar assets since the HKD is
pegged to the USD. This measure will however contain foreign exchange risks. With regards to
Level 2 assets, one concern may be the lack of a transparent rating system of corporate bonds
in safe Asian markets (e.g. Singapore) which are often assumed to possess a high rating by
default. Regulators need to improve the transparency within the bond markets and provide
incentives for companies to rate their bonds.
Figure 2: Definition of Level 1 and 2 Assets for LCR
b.Compliance and Risk Management
Basel III has seen a great deal more regulations and supervision efforts. It is important that
both banks and regulators continue to improve quantitative risk analysis. Banks need to fullyunderstand the technicalities within Basel III and keep abreast with regulatory developments.
Banks should continue to take ownership of risk management and not simply seek to comply
with market regulations. Risk and performance management need to be aligned. Asian banks
should also seek to improve data management as data serves as the seeds to effective
compliance and risk management. This should be done by embracing new technology and
data management system.
c. Derivatives Markets
Basel III has sought to move the clearing of over-the-counter (OTC) derivative3
contracts tocentralized exchanges or trading platforms and penalize non-centrally cleared contracts by
posing higher capital requirements for those contracts. A key concern in this area is the lack
of trading volume, hence liquidity, of derivative contracts in Asia as compared to Europe or US
(Figure 3), which will hinder the effective functioning of central counterparties (CCPs) with
the eventual result of higher margin and collateral requirements. The cost of trading
derivatives may increase, reducing the net benefits of hedging in the first place. In this light,
regulators in Asia should seek to cooperate and agree to have a common set of standards for
derivatives, with the possibility of consolidating the Asian OTC clearing space in one or two
CCPs, such as Singapore and Japan which have already taken the lead in clearing houses.
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Figure 3: Asia lags behind in volume of OTC derivatives to begin with
Source: Celent
Sources:
1. Wee, Ling Phua (May 2011), Basel III & Beyond: A View from Asia, University ofCambridge Judge Business School
2. Watanagase, Tarisa (Oct 2012), Impact of Changes in the Global Financial RegulatoryLandscape on Asian Emerging Markets, ADBI Working Paper Series
3.Hong Kong Banking Survey 2012, KPMG4. Chan, Albert et al (2011), Beyond Basel III: The future of high performance in Chinesebanks, Accenture
1 Risk inherent to the entire market. In finance, systemic risks are also known as un-diversifiable
risks.
2 Financial intermediaries involved in facilitating the creation of credit but are not subjected to
regulatory oversight. An example of a shadow banking institution is hedge funds.
3 Over-the-counter derivatives: Derivative contracts that are traded between two parties,
without any supervision of an exchange. Over-the-counter derivatives, as compared to centrallycleared derivatives, contain higher degree of credit or counter-party risk when either side
defaults.
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The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in
the United States. It has been widely regarded as a gauge for the large cap US equities market
The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country
indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand.
The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization
companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy,
Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kin gdom.
Correspondents
Vera Soh (Vice President, Publication)[email protected] Management UniversitySingapore
Ng Jia Wei (Vice President, Operations)[email protected] Management UniversitySingapore
Samuel Ong (Publications Director/ Editor)[email protected] Management UniversitySingapore
Shreya Chatterjee(Marketing Director)[email protected] Management UniversitySingapore
Yingyu Zeng (Liaison Officer)[email protected]
Singapore Management UniversitySingapore
Darren Goh Xian Yong (Editor)[email protected]
Singapore Management UniversitySingapore
Kenneth HoUndergraduateLee Kong Chian School of BusinessSingapore Management [email protected]
Henry Chan Hing Lee (Writer)PHD in Business (General Management)Lee Kong Chian School of BusinessSingapore Management [email protected]
Tong Kah Haw (Writer)GraduateLee Kong Chian School of BusinessSingapore Management University
Leslie TayMaster of Economics CandidateSchool of Economics and FinanceThe University of Hong Kong
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