Public Information Notice No. 06/45

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Singapore

May 5, 2006

On March 17, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Singapore.¹

Background

Singapore's economy has recovered rapidly since mid-2003, having weathered a series of adverse shocks since the Asian crisis. This turnaround owes much to a favorable external environment, supportive macroeconomic policies, and continued structural reforms. Although growth moderated in 2005, the strength of economic activity has surprised on the upside. Much of the stronger activity reflects higher-than-expected external demand for pharmaceuticals and oil exploration equipment. Growth is estimated to have reached 6.4 percent in 2005 and is projected to slow to around 5½ percent in 2006 as external demand growth moderates, with the risks to the outlook being broadly balanced. Inflation remains low, but upward pressures are rising. Unemployment has fallen, although it remains high among the low-skilled workers.

The Monetary Authority of Singapore (MAS) has kept monetary policy on a tightening stance since April 2004. In the October 2005 semi-annual monetary policy review, MAS reaffirmed its policy stance of keeping the trade-weighted exchange rate on a "modest and gradual appreciation path." The trade-weighted exchange rate index (as calculated by the IMF) has appreciated by around 4½ percent (as of January 2006) since April 2004.

With stronger-than-expected economic activity, the fiscal outturn for FY 2005/06 is likely to be better than budgeted. The recently proposed FY 2006/2007 budget entails a somewhat expansionary stance, reflecting increased outlays on social spending. The increase in social spending expands the government's strategy to help low-income families and low-skilled workers through targeted assistance. In addition, the budget proposed a number of measures aimed at upgrading and further restructuring the economy, including additional spending on R&D.

Increased regional competition in recent years has forced the corporate sector to restructure and has moved structural reforms to the foreground. Thus, the authorities have implemented a great majority of the recommendations made by the government-sponsored Economic Review Committee, which were presented in 2003 and focused on improving competitiveness, encouraging private sector entrepreneurship, strengthening the service economy, and enhancing labor market flexibility. They are also planning further measures to strengthen the manufacturing sector by promoting integrated supply chain systems, improve education and skills training, and increase R&D investment.

Singapore's role as a regional financial center has continued to grow. Domestic banks have expanded in the region, broadened their product lines, and sought out new markets, such as Islamic banking. Banks remain profitable and well-capitalized, and the financial system is generally healthy. With banks expanding abroad, MAS has focused on increased cooperation with regional regulators, including through greater information sharing. To protect depositors, a deposit insurance scheme was introduced last year. Foreign listings on the Singapore stock exchange and bond markets have also grown and new derivative products, including those linked to other countries' equity markets, are being introduced.

Executive Board Assessment

Executive Directors welcomed the strong recovery of Singapore's economy since mid-2003 and commended the authorities for the supportive strong macroeconomic policies and continued structural reforms, which, together with favorable external conditions, underpinned the recovery. In addition, job creation has also increased, resulting in a significant decline in the unemployment rate.

Looking ahead, Directors considered that the Singapore economy remains strong, and near-term prospects are favorable. They observed that sustaining robust economic growth over the medium term will require Singapore to meet the rising challenges from low-cost regional economies. They welcomed the authorities' awareness of, and commitment to meeting, these challenges, and supported the ongoing efforts to restructure the economy and enhance competitiveness.

With the declining slack in the economy, Directors considered the current tightening stance of monetary policy to be appropriate. Upside risks to the inflation outlook arise from the continued strong growth momentum, increased pass-through of higher oil prices to consumers, and the tightening of the labor market. Directors considered, therefore, that if inflationary pressures turn out to be stronger than anticipated, the authorities should stand ready to tighten monetary policy further. Directors considered that the current monetary policy framework, based on the management of a trade-weighted exchange rate index, has been successful in keeping inflation low and stable. Looking ahead, many Directors considered such a framework to be adequate to accommodate any further increase in regional exchange rate flexibility. A number of Directors, however, saw room for greater exchange rate flexibility within the existing framework, particularly if greater flexibility in regional regimes leads to heightened market uncertainty.

Directors noted that the authorities have focused exchange rate policy primarily on maintaining low inflation, and have relied on structural and fiscal policy to strengthen competitiveness. Thus, domestic prices are free to adjust to correct for any real exchange rate misalignment, and there have been no such price adjustments or clear signs of any pent-up pressures. At the same time, some Directors noted that the active outward investment by the government and government-linked companies may well have alleviated upward pressures on the exchange rate. In this regard, a few Directors noted that the authorities' strategy of diversifying investment overseas is well suited for a small open economy like Singapore. Most Directors agreed with the view that, on balance, the real exchange rate does not appear to be misaligned despite the large current account surpluses.

Directors commended the authorities' conduct of counter-cyclical fiscal policy in recent years, undertaken within a prudent medium-term framework. They strongly endorsed the authorities' job retraining programs for the long-term unemployed and targeted expenditure support to low-income households, and suggested that the strong fiscal position allows for an expansion of such programs going forward. Directors welcomed the steps taken in this direction in the FY 2006/07 budget. They also supported the strategic focus of the budget on measures for enhancing Singapore's growth prospects, including through investment in education, research and development, and various services sectors. They also noted that the expansionary stance of the budget could help increase domestic demand and contribute to a lowering of the current account surplus.

Directors welcomed the authorities' decision to undertake a fiscal Report on the Observance of Standards and Codes (ROSC), noting the importance of further enhancing fiscal transparency. They supported the continued publication of the annual review of Temasek's operations. A number of Directors called for the publication of more financial information on the activities of the Government of Singapore Investment Corporation and the compilation and publication of consolidated public sector accounts.

Directors applauded the authorities for keeping structural reforms high on the agenda, with the objective of upgrading and restructuring traditional industries, promoting the private sector, and enhancing competitiveness. They noted the progress made in implementing the recommendations of the government-sponsored Economic Review Committee, which aim at lowering income tax rates, enhancing labor market flexibility, and reducing the government's role in the economy. Directors also welcomed the planned new measures to help expand the manufacturing sector and looked forward to the early implementation of the newly legislated competition law. They urged the authorities to consider further divestment of nonstrategic government-linked companies in order to encourage private sector entrepreneurship.

Directors noted the expansion of banks in the region and the growth of Singapore as a regional financial center. Although the financial system is generally healthy, Directors cautioned that the continued expansion by banks in the region and the increased growth and sophistication of the capital markets will require close ongoing surveillance. In this context, Directors welcomed the authorities' strengthened cooperation with regional regulators and the introduction last year of a deposit insurance scheme.

With the aging of Singapore's population, Directors observed that a key challenge will be to provide adequately for the needs of the retired. They welcomed the authorities' intention to explore ways for improving the investment choices and risk-return options for mandatory savings under the Central Provident Fund.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.