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p. 32 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the world II. Economic trends and prospects in developing Asia East Asia Southeast Asia Cambodia Indonesia Lao People's Democratic Republic Malaysia Myanmar Philippines Singapore Thailand Viet Nam South Asia Central Asia The Pacific III. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia : Southeast Asia

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Singapore

Growth was stronger than expected in 2004, reflecting a broad recovery in both domestic and external demand, as well as the SARS-induced low base of the previous year. This led the Government to move from an accommodative macroeconomic policy stance to a moderate tightening. A slower, more sustainable growth path is expected in the medium term.

Macroeconomic assessment of 2004

Driven by strong domestic and external demand, the economy experienced a robust recovery in 2004, with GDP growth climbing to 8.4% from 1.4% in 2003. However, growth momentum was more moderate in the third and fourth quarters (Figure 2.11), largely reflecting the diminishing effects of the post-SARS rebound.

With regard to domestic demand, private fixed investment picked up by 13.9%, in sharp contrast to a 4.2% contraction in 2003. The upturn in the global electronics cycle boosted business confidence in Singapore’s manufacturing subsector, resulting in higher spending on machinery and equipment. However, public investment continued to fall, by 10.6% in 2004, and lowered total fixed investment growth to 8.4%. Excess capacity in manufacturing was gradually worked down while inventory adjustments slowed, which greatly contributed to the output growth. Economic recovery also gathered momentum from a revival in private consumption, which rose by 8.6%, marking a post-SARS upturn and an improvement in labor market conditions. Overall, domestic demand accounted for 8.2 percentage points of the GDP expansion in 2004, with a contribution of 4.8 percentage points from total investment and 3.4 percentage points from consumption.

Export demand strengthened in 2004 on the back of the improved global economic environment and strengthened IT demand. Merchandise exports in US dollars swelled by 24.2%, led by electronics, petrochemicals, and pharmaceuticals. Booming regional demand, particularly from the PRC, also boosted exports. Exports of pharmaceuticals grew rapidly as a result of earlier investment in the country by EU pharmaceutical companies. Import growth escalated from 8.5% in 2003 to 27.1% in 2004, due to strong demand for intermediate inputs for electronic products and for machinery and equipment.

With the exception of construction, all manufacturing and services subsectors registered growth in 2004, indicating a broad-based economic recovery. Manufacturing value added rose by 13.9%, led by biomedical manufacturing and transport engineering, which grew by 25.7% and 24.0%, respectively. Biomedical manufacturing, the second-largest manufacturing subsector after electronics, posted strong gains of 20.8% in the first quarter and 52.8% in the second on a year-on-year basis, then contracted by 16.9% in the third and grew by 56.7% in the fourth. The volatility reflects Singapore’s reliance on a limited number of companies in this industry. Electronics recorded an upswing of 14.9%, underpinned by the rapid expansion of semiconductors and IT and of consumer electronic products.

With oversupply in the property market, construction declined by 6.5% in 2004, the sixth consecutive year of contraction. In contrast, services bounced back by 7.2%, largely reflecting the post-SARS rebound and rapid development of regional trade, especially for trade- and tourism-related services. Both wholesale and retail trading and the hotel and restaurant services subsectors posted double-digit growth in 2004. Transport and communications registered growth of 9.1%. Financial services grew modestly by 6.0%, with foreign-exchange trading, fund management, and insurance the major contributors.

The economy’s acceleration had the effect of raising government receipts, which largely offset a 2 percentage point cut in the corporate income tax rate and other tax exemptions introduced in 2004. Operating revenues, excluding investment, interest, and capital income, climbed by 6.9% in 2004. Government operating expenditures increased by 3.6%, mainly due to a rise in spending on security, education, and social welfare. Development spending rose by 6.7%, driven by increased spending on transport infrastructure as well as research and development. The primary operating deficit in 2004 shrunk to S$2.1 billion (1.1% of GDP) from S$2.5 billion (1.6%) in 2003.

In the financial markets, domestic monetary conditions tightened slightly after mid-2004, in tandem with US rate rises. The 3-month interbank rate nudged up from 0.75% to 0.81% by end-June and to 1.44% in September. The prime lending rate was kept at 5.3% though, reflecting ample liquidity in the banking system. Buoyed by the strength of the economy and renewed interest in many Asia-Pacific stock markets, the Straits Times Index gained 15% over the year.

Inflation edged up to a year-average 1.7% in 2004 from 0.5% in 2003. Prices of oil-related items, such as electricity and gasoline, jumped, while the costs of some services, such as education and health care, also contributed to higher consumer prices. Labor market conditions improved as the economy gathered momentum, with total employment expanding by an encouraging 66,200 jobs. Accordingly, the unemployment rate fell from 4.7% in 2003 to 4.0% in 2004.

Despite the surge in imports, the trade surplus rose to US$31.1 billion in 2004, and the current account surplus moved up to US$27.8 billion, equivalent to 26.1% of GDP. The net outflow on the capital and financial account declined to US$13.0 billion from US$20.1 billion a year earlier, mainly due to increased overseas borrowings by the nonbank sector. Both direct investment inflows and outflows rose significantly, spurred by the Government’s effort to attract FDI and by the greater merger and acquisition activity overseas by domestic companies. Gross international reserves rose to US$112.8 billion at end-2004.

Macroeconomic policy developments

As the more self-sustained recovery gradually reduced the need for policy stimulus, the authorities switched from an accommodative macroeconomic policy to a moderate tightening. The Monetary Authority of Singapore in April 2004 shifted its stance from zero appreciation of the trade-weighted nominal effective exchange rate to a modest and gradual appreciation, aimed at reducing the risk of imported inflation. The Singapore dollar appreciated by 4.1% against the US currency over the year, supported by stronger capital inflows to the region associated with an improved regional economic outlook. However, the local currency weakened against the euro, sterling, and regional currencies such as the Korean won and New Taiwan dollar, resulting in a slight appreciation of the trade-weighted nominal effective exchange rate over the year.

The budget for FY2004 (beginning 1 April) continued to tweak tax policy in an effort to improve competitiveness and attract FDI, and included a reduction in the corporate income tax rate to 20% from 22%, tax exemptions for newly incorporated companies, and tax exemptions for foreign-sourced income and Singapore-sourced investment income. Overall, the fiscal stance was more prudent in terms of its narrower budget deficit than in FY2003. The budget for FY2005 projects a small surplus of S$210 million, or 0.1% of GDP.

Aiming to attract internationally mobile talent, the Government will reduce the upper end of the personal income tax rate to 20% from 22% in two steps, starting in the 2006 assessment year. Also, the budget for FY2005 includes some fine-tuning of tax measures to support financial services, logistics, and tourism, such as a waiver of stamp duty on transfers of Singapore properties into real estate investment trusts for a 5-year period, removal of stamp duties for Islamic real estate transactions, and a concessional corporate tax rate of 10% for events companies that have tourism events approved in the next 5 years.

In contrast, the case of PRC-controlled China Aviation Oil (Singapore) Corp. (CAO Singapore) raised questions about Singapore’s regulatory system. In November, CAO Singapore reported US$550 million in losses from trading oil derivatives. The Singapore Exchange took swift steps to protect the market’s credibility by suspending trading in CAO Singapore shares. The Monetary Authority said it will work with the exchange to review corporate governance and market conduct rules once all investigations into the affair are finished.

Another government strategy is to strengthen external economic linkages through bilateral and multilateral trade arrangements. The Government signed a free trade agreement with Korea in 2004, which is expected to take effect this year. Under this agreement, almost 75% of domestic exports to Korea, which amount to over S$3 billion, will benefit from the immediate elimination of tariffs. Furthermore, Singapore is pursuing bilateral free trade agreements with other countries, including the PRC and India. Given its strategic location and prominence as a regional hub for business and financial activities, it aims to play a role as a bridge between these two growth engines in Asia.

Outlook for 2005-2007 and medium-term trends

After the peak in the first half of 2004, a slowdown appears to be under way. During 2005, the moderation of global growth and downswing in the electronics cycle will slow the momentum. The economy is expected to decelerate to a more sustainable track and GDP is forecast to expand by 4.1% in 2005. A slight pickup is expected in 2006 and 2007, to 4.5% and 4.4%, respectively, on the resumption of an upturn in the global electronics cycle.

The recovery in domestic demand will provide a partial buffer against the weakening of external demand. After the peaking of structural and business cycle-related unemployment in 2003, consumer confidence has improved in line with the gradual decline in unemployment and rising real wages. Private consumption, which strengthened by 8.6% in 2004, is forecast to rise by 4.6% in 2005 and by 4.5% in 2006-2007. The growth of fixed asset investment is expected to slow to 4.5% in 2005, as decelerating exports damp the business outlook. However, inventory building is likely to continue contributing to the growth of total investment.

The upward trend in exports will moderate in line with weaker demand in the world electronics market. Still, robust growth in Asia, outside of Japan, will keep regional import demand healthy, which will stimulate Singapore’s economy. The PRC, which accounted for 9.0% of Singapore’s domestic exports in 2004, will become a more important trade partner, even as PRC growth slows. Overall, merchandise exports measured in US dollars are forecast to advance by 8.0% in 2005. Imports will likely rise at a slower pace than exports, owing to the softening domestic investment demand and reduced demand in electronic intermediate goods. The current account surplus is forecast to stay at around 26.0% of GDP in 2005, mainly because income payments to overseas investors will increase.

From a sector perspective, electronics is expected to register modest growth in 2005, while biomedical manufacturing will continue moving ahead since more pharmaceutical companies plan to expand capacity. The momentum in services is likely to ease, reflecting the effects of moderating domestic consumption spending, though some subsectors, such as tourism and financial services, are expected to continue their trajectory through 2005, underpinned by robust regional economic growth and some strengthening in capital market activities.

The Monetary Authority is likely to keep to its tightened policy stance by allowing a modest appreciation of the Singapore dollar, in the context of the general weakness of the US dollar and the rise in imported inflation. Wages are expected to edge up following the improvement in the labor market. Due to lingering structural unemployment, however, the unemployment rate may stay at around 4%. The monetary policy stance, combined with slower growth in domestic and external demand, will contain the rise in the CPI to around 1.4% in 2005.

Downside risks to this outlook include any severe and protracted downleg in the global electronics cycle, a sharp correction of the US external imbalance, and much higher oil prices. Although the oil refining sector may benefit from rising oil prices in the short term, the negative impact of higher oil prices on the world economy would ultimately hurt Singapore.

Structural changes under way could improve the economic outlook. In manufacturing, efforts to diversify the pharmaceutical manufacturing base and develop the entire supply chain of pharmaceutical-related activities could pay off in terms of higher medium-term economic growth and reduced exposure to swings in global electronics demand. In services, further liberalization in banking, the cultivation of fund management, and efforts to deepen and broaden the capital markets will enhance Singapore’s position as a regional financial hub and cushion the economy from some of the effects of manufacturing volatility.

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