Public Information Notice No. 05/56

REVISED -- Public Information Notice: IMF Executive Board Concludes 2004 Article IV Consultation with Singapore

April 28, 2005

On February 7, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Singapore.¹

Background

In recent years, Singapore's economy has been hard hit by a series of external shocks. These shocks—the Asian crisis, the bursting of the technology bubble, and the SARS outbreak in 2003—disrupted an economic expansion largely uninterrupted since the 1970s. The shocks have come at a time when Singapore is also facing increasing competition from regional low-cost economies. To facilitate an orderly adjustment to these changes, a wide range of structural reforms has been undertaken in the past few years.

Aided by supportive macroeconomic policies and improved external conditions, Singapore's economy has recovered rapidly since mid-2003. Lately, job creation has also gathered strength. The turnaround—mainly driven by exports, reflecting strong global electronics demand, and since early 2004 supported by domestic investment—delivered an unprecedented four straight quarters of double-digit growth from third-quarter 2003 through the second quarter of 2004. Since then, the pace has slackened as electronics exports and domestic consumption slowed. Despite this slowdown, GDP growth is expected to reach around 8 percent in 2004, recovering from 1.1 percent in 2003. Inflation has crept up, but remains low. The current account surplus has narrowed, reflecting higher imports as investment picked up.

With emerging inflationary pressures, the Monetary Authority of Singapore (MAS) announced a modest and gradual tightening of its monetary stance in April 2004, and maintained this position in last October's policy review. After having depreciated by 6½ percent since 2001, the trade-weighted exchange rate index (as calculated by the IMF) appreciated by 1¼ percent in 2004, although it moderated in the latter part of the year.

The current fiscal stance is broadly neutral. The fiscal surplus was over 6 percent of GDP in FY2003, much higher than expected due to lower-than-budgeted capital spending. This year's budget also contains a large planned capital outlay, which, combined with an increase in the goods and services tax rate, aims at keeping the fiscal stance broadly neutral. The budget also includes several measures to support private enterprise and to attract investment, particularly in the wealth management industry.

The financial sector remains robust. Bank profitability and capitalization are strong, and nonperforming loans are low. Local banks have responded to increased domestic competition with the entry of foreign players by consolidating at home and expanding abroad. In June 2004, the minimum capital requirement for local banks was lowered from 12 percent to 10 percent.

An array of structural reforms has been undertaken in the past few years. In response to increasing competition from low-cost regional economies, the government adopted the recommendations of the Economic Review Committee (ERC) in 2003. The ERC recommended measures to enhance competitiveness, promote private entrepreneurship, and facilitate economic diversification. Significant progress has been made in implementing these recommendations, such as increasing wage and labor market flexibility, reducing business costs and taxes, and promoting the outward expansion of Singapore firms and Singapore as a business hub.

Looking ahead, economic activity is expected to moderate to more sustainable levels in the near term. Taking into account the softening in global demand, particularly the cresting of the global electronic cycle, output growth could slow to about 4 percent in 2005. The outlook is subject to some uncertainty, especially on the external front. Despite the expected moderation in activity, however, there is likely to be little slack in the economy, reflecting the recent rapid growth. The tightening in the labor market and high energy prices could raise inflationary pressures. Over the medium term, IMF staff expects growth to average around 4-5 percent.

Executive Board Assessment

Executive Directors welcomed the Singapore economy's strong turnaround since mid-2003, which has owed much to a favorable external environment, supportive macroeconomic policies, and continued structural reforms to diversify the economy and improve its competitiveness. Directors considered that Singapore's sustained fiscal surpluses, lack of external debt, comfortable net asset position, healthy reserves, and large current account surpluses provided a strong buffer against exogenous shocks. At the same time, they welcomed the authorities' determination to resist complacency, and to continue to identify new sources of growth in an increasingly challenging regional and global environment.

Directors observed that growth had begun to slow and was likely to return to more sustainable levels as world demand softened. Given the little slack remaining in the economy following the recent rebound, the moderation in activity could be helpful in restraining inflationary pressures coming from tightened labor market conditions and higher energy prices.

Directors saw the current tightening stance of monetary policy as paving the way for an orderly withdrawal of the stimulus provided in recent years. However, if the downside risks to growth—especially from external factors—were to materialize, threatening a sharper deceleration than expected, Directors considered that monetary policy might need to become more supportive.

Directors welcomed ongoing efforts to increase the transparency of the monetary policy framework, which had been effective in keeping inflation low and stable. A few Directors considered that releasing more detailed information about the government's inflation target and exchange rate policies would be helpful.

Directors agreed that the real exchange rate for the Singapore dollar appeared broadly appropriate notwithstanding the large current account surpluses. It was observed that active foreign investment by the government and the government-linked companies may have kept the real exchange rate from appreciating. However, Directors considered that, as domestic investment recovered from its recent low levels, the current account surpluses were likely to narrow in the period ahead. Keeping exchange rate policy biased toward appreciation, together with greater flexibility, would also help in this regard.

Directors commended the authorities' use of fiscal policy in recent years to support the economy, while adhering to the objective of a balanced operational budget over the medium term. The prudent medium-term fiscal framework had resulted in a significant reserves accumulation that had strengthened investor confidence. Some Directors suggested that the strong fiscal position created scope for additional targeted social spending, particularly on the elderly and the unemployed, and personal income tax reductions. Many Directors also supported the authorities' focus on retraining and job-matching schemes to address the structural changes in the labor market and help reduce unemployment further.

Directors welcomed the recent public review of operations of Temasek, the government's investment holding company, as a milestone in enhancing fiscal transparency. Following this example, they encouraged the authorities to consider publishing general information on the Government of Singapore Investment Corporation (GIC), and to develop and disseminate consolidated public sector accounts. Directors also encouraged the authorities to undertake a fiscal Report on the Observance of Standards and Codes (ROSC) in the near future.

Directors supported the authorities' implementation of structural reforms to enhance competitiveness and sustain growth in the medium term. Significant progress had been made in increasing labor market and wage flexibility and reducing business taxes and costs. Also encouraging were the quality upgrading and diversification taking place in the manufacturing sector, and the emergence of Singapore as a hub for regional asset management, health, and education services. Directors welcomed the government's adoption of the recommendations of the Economic Review Committee, aimed at furthering research and development and investment in human capital. Many Directors observed that a faster pace of divestment of those government-linked companies not of strategic importance to the country would promote entrepreneurship and the growth of the private sector. Others, however, agreed with the authorities' careful approach.

Directors viewed the financial system as robust, benefiting from an efficient legal system and good accounting standards. They welcomed the authorities' increasing attention to the regulatory challenges arising from banks' overseas expansion. They commended the progress made in implementing the recommendations of the Financial System Stability Assessment (FSSA), and looked forward to the timely operationalization of the remaining recommendations.

Directors noted that a key challenge of Singapore's aging population was to ensure that the retired are adequately provided for. Thus, they welcomed the recent measures to refocus the Central Provident Fund (CPF) as a core retirement scheme. They recommended that, to make participation in the CPF's investment scheme more attractive, the scheme's transaction costs be reduced, by pooling funds under a smaller number of asset managers with simpler portfolio choices.

Directors welcomed the authorities' continued efforts to improve data quality, which they agreed was broadly satisfactory for surveillance purposes. They encouraged the authorities to begin a comprehensive review of the statistical base by participating in a data ROSC in the near future.