Public Information Notice No. 03/05

Public Information Notice: IMF Concludes 2002 Article IV Consultation with Singapore

January 6, 2003

On December 9, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Singapore.¹

Background

Singapore faces the twin challenges of managing the recovery from its worst cyclical downturn and addressing competitive pressures to restructure and develop new industries. Following a strong, but short-lived economic rebound in 2000, the Singapore economy plunged into its most severe recession in 2001 due to simultaneous downturns in global demand and in the high-tech sector. Real GDP declined by 2 percent in 2001 after surging by 10 percent the year before. Although output growth recovered in early 2002, the rebound was narrowly based in the capital-intensive chemical cluster, where output is volatile and knock-on effects are limited. Consequently, the unemployment rate rose to 4.5 percent (a 14-year high) in the first quarter of 2002, before easing to 4.1 percent in the subsequent quarter. Consumer prices rose by 1 percent in 2001, but the significant slack in the region has contributed to mild deflation since November 2001, as price declines have hovered around ½ percent (year-on-year) through August 2002. Singapore's external position remains strong, and official reserves stood at US$80.7 billion (the equivalent of 8¼ months of imports) in August 2002.

While the authorities have traditionally eschewed counter-cyclical policies in favor of a medium-term focus, they pragmatically reacted to the large downturn in 2001 with sizable fiscal stimulus packages, an expansionary budget for FY2002/03, and monetary easing. In July and October 2001, two off-budget fiscal stimulus packages were passed with measures totaling 8½ percent of GDP, and the FY2002/03 budget included personal and corporate income tax rate cuts that provided additional stimulus. Monetary conditions have continued to ease since July 2001 when monetary policy shifted to a neutral stance.

The near-term outlook is for a moderate recovery in GDP growth, driven mainly by a pick-up in exports. The staff projects real GDP to grow by 2.8 percent in 2002 and by 4.1 percent in 2003. The initial boost from a positive inventory swing will require robust export growth, spurred by a pick-up in U.S. semiconductor demand, to sustain the recovery. Downside macroeconomic and event risks, however, continue to dominate the near-term outlook. The most prominent risks stem from uncertainties about the strength and sustainability of the global recovery, volatility in equity prices, potential conflict in Iraq, and terrorist attacks in South East Asia. Furthermore, if the global recovery were to falter, incipient deflationary pressures could intensify. However, Singapore's strong balance of payments position limits its external vulnerability.

At the same time, growing competition from low-cost regional producers created restructuring pressures to diversify from electronics manufacturing to knowledge-based activities in which Singapore retains comparative advantage. China's entry into the WTO could also have an impact on Singapore's role as a regional financial and trade hub. The new strategy proposed by the government-created Economic Review Committee (ERC) is aimed at improving competitiveness, encouraging private initiative, strengthening the service economy, and promoting internationalization. Government policies are aimed at helping to adapt domestic industries to the changing external environment, and at attracting and retaining workers with requisite skills. Specific initiatives include tax reform, changes to the Central Provident Fund, and encouraging domestic industry, especially Government-Linked Corporations (GLC), to increase efficiency and broaden their international focus.

Executive Board Assessment

Directors noted that in 2001 Singapore experienced its worst economic recession since its independence, after many years of stellar economic growth, mainly as a result of the global economic slowdown and a sharp drop in the demand for electronic exports. They commended the authorities' skillful negotiation of the recession with appropriate countercyclical policies that have paved the way for a modest economic recovery in 2002. Directors also welcomed the authorities' timely new medium-term development strategy, with wide-ranging restructuring and liberalization measures to promote new high-value-added activities, develop the services sector, and further enhance labor market flexibility.

Directors observed that, notwithstanding the moderate export-led recovery that has taken hold in 2002, economic prospects are clouded by downside risks. These risks relate to growing uncertainties about the strength of the global recovery—especially about the incipient rebound in the electronics sector-potential conflict in Iraq, and terrorist attacks in South East Asia. Therefore, Directors agreed that policies for the near term should maintain their easing bias. They expressed confidence that, over the medium term, the authorities will implement the recommendations of the Economic Review Committee to return the economy to a high-growth trajectory and to strengthen its resilience to external shocks. In this context, they noted that confidence in the financial system is high and the external position remains strong, and that economic restructuring is accelerating in the financial sector and spreading to the manufacturing and services sectors as Singapore responds to competitive challenges from abroad.

Directors noted that the well-timed fiscal stimulus packages announced in July and October 2001 had provided important support for domestic demand as the external environment deteriorated during 2001. Directors indicated that the government's reputation for prudent fiscal policies and its substantial net asset position should provide ample room for further fiscal action should the recovery be weaker than expected.

Directors welcomed the structural measures taken in the FY2002/03 Budget to broaden the revenue base by further shifting toward indirect taxes, and to boost supply-side incentives by lowering marginal income tax rates. Given the global trend toward lower direct taxes, however, and taking into account the weaknesses in the economy, some Directors suggested accelerating the pace of income tax cuts. Also, while Directors noted the decision of the authorities to phase in the Goods and Services Tax increase, some considered that a delay in raising the tax might be appropriate.

Directors considered that the easing of monetary policy to a neutral stance in July 2001 and subsequent adjustments that provided additional support as external conditions weakened were appropriate. They believed that the current ample domestic liquidity and the low interest rate environment provide sufficient support for domestic activity. Nevertheless, given that inflationary pressures are expected to continue to be low, most Directors stressed that monetary policy should stand ready to ease further if significant downside risks and incipient deflation materialize.

Directors noted that the exchange rate-centered monetary policy framework has served Singapore well since 1981, noting that the external position remains very strong. Directors strongly endorsed recent initiatives taken to convey the authorities' policy intentions to the public, and most looked forward to further action to enhance transparency. It was noted that increasing disclosure about key macroeconomic fundamentals would help anchor expectations for monetary policy and reduce the attention paid by the private sector to increasingly volatile market-driven developments in the foreign exchange market. Increased transparency could provide the authorities with greater operational flexibility and allow the exchange rate to be a more effective shock absorber.

Directors welcomed the continued improvements being made to Singapore's already well-developed legal and regulatory framework for its financial system. Directors encouraged the authorities to continue to adapt their risk-based supervisory approach by linking bank capital requirements to individual risk profiles, and thereby enable domestic banks to compete more effectively in the domestic and international markets. They noted recent efforts by the Monetary Authority of Singapore to strengthen its capacity to gauge group-wide risk-taking within complex financial institutions on a consolidated basis and to monitor aggregate market risks and vulnerabilities. In this connection, Directors welcomed the authorities' participation in the Financial Sector Assessment Program.

Looking ahead, Directors observed that Singapore's financial markets face challenges from global financial industry consolidation and technological trends funneling activities to global centers. At the same time, modernization and liberalization among Singapore's neighbors could erode Singapore's traditional role as a regional financial hub. Directors believed that Singapore could bolster its attractiveness as a financial center by removing regulations that create unwarranted perceptions of binding restrictions on financial activity, and that discourage global investors and issuers from using Singapore as a center for their operations. In this regard, most Directors pointed to the remaining two restrictions related to the non-internationalization of the Singapore dollar as candidates for early reconsideration, though a few others felt that these restrictions provide some safeguard against currency speculation.

While there has been a welcome increase in the transparency of the monetary policy framework, Directors observed that more progress should be made on fiscal transparency. In particular, they encouraged the publication of a medium-term budgetary framework, and recommended the preparation of a fiscal ROSC to complement Singapore's self-assessment of the Fiscal Transparency Code. Directors also encouraged the authorities to adopt the new methodology outlined in the revised IMF manual on government finance statistics, including the compilation and dissemination of data on the net worth of the public sector. Directors expressed satisfaction with Singapore's efforts to combat money laundering and the financing of terrorism, and looked forward to the ratification of the UN Convention on the Suppression of the Financing of Terrorism by the end of this year.

Directors supported the authorities' approach to dealing with the high unemployment rate stemming from ongoing restructuring, which is to focus on retraining and improvements in the efficiency of job search. A number of Directors also recommended that consideration be given to consolidating and strengthening the social safety net, so long as such changes do not have adverse effects on work incentives.

Directors commended the authorities for implementing a wide range of other structural reforms affecting the pension system, housing policy, and the operations of Government Linked Corporations (GLCs). They supported the steps taken to reduce the bias in the Central Provident Fund (CPF) toward housing investment, and to encourage its diversification into alternative financial investments. Noting Singapore has one of the highest rates of home ownership in the world, Directors considered appropriate the privatization of some functions of the Housing Development Board, now that it has successfully met its mandate to provide Singapore residents with adequate housing. While acknowledging that GLCs have been managed strictly on commercial principles, several Directors encouraged the authorities to advance their plans for divesting these enterprises to bolster the credibility of the government's restructuring policies and to send positive signals about the government's intentions to boost entrepreneurship. However, a few Directors considered that the authorities were prudent and responsible in their approach to divesting the GLCs.