Asian Financial Crisis and Singapore

Singapore’s experience with the Asian crisis and its quick recovery following the

policy responses makes it a worthwhile and an interesting case study. In terms of both current

and capital accounts, Singapore has a very open economy, yet the impact of the crisis was

less severe in comparison to much less open economies in the region which have experienced

dramatic economic. In Singapore, the crisis impacted different sectors unevenly. Sectors such

as commerce, transport, tourism, and financial services, which have a large regional

exposure, were badly hit.

Interestingly, the policy responses to the crisis were not to reject globalization and

liberalization and adopt capital control measures but to make much stronger domestic

financial system and to improve Singapore’s international competitiveness.1 Since the crisis,

many alternative explanations have emerged as the causes for the substantial economic

downturn in the region. Among these some political economy arguments and weakening of

macroeconomic fundamentals caused by the adoption of policies that are inconsistent with a

peg exchanged rate regime have occupied an important part of the debate.

The Asian crisis began as an exchange rate crisis in Thailand and spread almost

immediately to Malaysia, Indonesia, and the Philippines. This led to financial crises which, in

turn, produced severe downturns in real economic activity in these, and other, countries.

While a full discussion of the causes, circulation channels, and effects are beyond our scope,

some points need to be made to show how, and to what extent, Singapore was caught up in

the crisis. We focus on Thailand, the first domino. An overvalued exchange rate pegged to

the US$, declining exports, and a growing current account deficit made it vulnerable to a

speculative exchange rate attack. The falling yen and an effective depreciation of about 10

per cent of the yuan contributed to the reducing export competitiveness.2

The resulting devaluation triggered a financial crisis. Substantial capital inflows,

about 6 per cent of GDP, had fuelled price bubbles in real estate and the stock market.

Although these bubbles peaked at the end of 1993, by the end of 1997 share prices fell to

about 29 per cent of their 1995 levels while the property company share index fell to 10 per

1 Garry Rodan, “Singapore: Globalization, the State, and Politics,” in The Political Economy of South-East Asia: Markets, Power and Contestation, (Melbourne: Oxford University Press, 2006), pp. 137-139 2 Ibid, pp. 169

cent of its 1995 level.3 In addition, relatively high domestic interest rates and the pegged

exchange rate led to increases in foreign short-term borrowing5 that was largely unhedged.

As the exchange rate fell, financial institutions suffered large capital losses as the value of

their foreign denominated debt increased.

There were (at least) three channels through which the initial exchange rate crises

spread in Singapore. First, they spread to economies with similar macroeconomic, including

financial, fundamentals. Second, they spread because of financial panic and speculative

attacks which reduced international capital flows. Third, they spread through, and to,

economies with strong trade linkages. The first two channels are interactive. Singapore's

strong macroeconomic fundamentals and healthy financial system explain why it was the

least affected ASEAN states. Singapore's better exchange rate performance was also

underpinned by these factors. From July 1997 to October 1998 the Singapore dollar fell by

about 16 per cent against the US$, but appreciated by about 20 per cent against the Ringgit,

Baht, and Peso and 60 per cent against Rupiah.4

The trade channel operates through both price and income effects. Export-competing

countries are at a price disadvantage in their export markets when a competitor devalues.

Falling real income also reduces demand for imports from trading partners. ASEAN trade can

be divided by two stylized facts: (1) ASEAN exports, largely labor-intensive manufactured

goods, are very similar and, thus, compete with each other and (2) intra-ASEAN trade, while

not high in some measures, is quite significant.5

Singapore’s GNP grew by 7.8 per cent in 1997 but growth declined sharply to 1.5 per

cent in 1998.6 As revealed by the results in the previous section, this is a manifestation of the

trade linkages operating through two effects: an income effect via falls in aggregate demand

in other ASEAN states and a price effect (reduction in export competitiveness) via the

appreciation of the Singapore dollar vis-à-vis her Asian competitors. Another important cause

of the reduction in competitiveness was the increase in Singapore’s unit labor costs relative to

other newly industrializing economies which by the end of 1997 had increased by 70 per cent

from a cyclical low in 1993.

3 http://www.mof.gov.sg/aboutus_initiatives/nurturing.html>, accessed 7 May 2011. 4 Op. Cit, pp. 57-585 Lee Hsien Loong, “The Asian Financial Crisis: Challenges to Business Management”, http://stars.nhb.gov.sg/stars/public 6 Ibid, Lee Hsien Loong

Since external demand accounts for about two-thirds of total demand, these effects

The government has adopted the policy package recommended in the report of the

Committee on Singapore’s Competitiveness (CSC). It contains both short and medium term

recommendations. Our focus is the short-term responses. Its main feature is a 15 per cent

reduction in total wage costs (through a 10 percentage point reduction in the rate of

employers’ contributions to the Central Provident Fund and reductions in the variable

components of wages). Other business costs such as foreign worker levies, land and factory

rentals, charges for government-supplied services and vehicle-related costs also have been

cut. The Committee estimated that this package would reduce business costs by about S$10

billion per year or about 7 per cent of GDP.7

In addition to the CSC recommendations, the Budget Statement of 1999 announced

further measures to boost domestic expenditure to arrest the economic slowdown. It proposed

a 6 per cent increase in government expenditure. Various corporate and personal income tax

rebates were also adopted. These measures should help cushion the effect of wage cuts on

domestic demand. Another significant part of the package was an extension of the Local

Enterprise Finance Scheme to bolster working capital flows to local businesses.

We argue that Singapore is well known for its Budget surpluses and excess private

savings, both of which result in an annual current surplus of 15 percent or so of GDP.

Singapore has no sovereign external debt. Its internal debt is merely the reflection of

reshuffling of funds between Statutory Boards via the Treasury. For Singapore, interest rate

differentials have historically meant lower domestic rates because the twin surpluses

mentioned earlier, together with substantial capital inflows, especially of FDI, have meant

currency appreciation. Hence Singapore corporations and financial institutions had not been

substantially exposed to short-term foreign debts, as were the afflicted Asian countries. The

contagion Singapore suffered came via trade and financial links as well as the behaviour of

international investors. Fifty percent of Singapore's trade is with Asian countries including

Japan. Singapore banks had substantial exposure to the region as well. Singaporeans had

invested in stocks and property in the region. Moreover, the behaviour of international

portfolio investors provided three channels of contagion.

7 Lee Kuan Yew, From Third World to First: The Singapore Story, 1965-2000 (Singapore: Times Editions, 2000), pp.389-390.

The first channel is because of asymmetric information, fund managers follow

investment trends of other investors to protect themselves from blame in the event of losses.

The reward system for fund managers apparently make them especially prone to this.

Alternatively, they may regard emerging markets as an asset class, regardless of differing

fundamentals: this obviously at the disadvantage of Singapore. A second channel is portfolio

allocation: any shock to one emerging market's returns will contribute to changes in

allocation to all other emerging markets. A third channel is portfolio interdependence: losses

in one market will cause fund managers to sell out in other markets to meet contingent

investor redemptions. It should be noted that small shifts in industrial countries' portfolios

result in inflows and outflows that are large in relation to emerging markets whose bourses

are small in capitalization and most of whose stocks are usually thinly traded. Investors from

the region too undoubtedly contributed to the asset deflation. Heavy losses incurred in one

country led them to sell out in markets that were still relatively unscathed. Hence stocks in

Singapore suffered a sell-off when markets plunged in Thailand and Indonesia.

Banks in Singapore had substantial exposure to the region: consequently their bad

debts increased as currencies and assets deflated in the region. Singapore is also Southeast

Asia's entrepot. Moreover, nearly 55% of the commodity exports go to East and Southeast

Asia. The region is also a major market for Singapore's exports of services, especially in the

areas of tourism and finance. It is easy to see why Singapore suffered when the financially

crippled Asian countries drastically reduced their imports.

Despite the Crisis, the Monetary Authority of Singapore has pushed ahead to

liberalize the financial market, to make it more competitive. The Stock Exchange and Banks

will face more foreign competition and higher standards of disclosure. The latter is a very

important move as much of Asian savings are invested outside the region while foreign funds

are solicited for domestic investment and financing. The Crisis has shown the vulnerability

that such a practice can produce. Singapore is clearly committed to globalization with a

vengeance, despite the risks. It is clearly banking on good governance to keep currency and

banking crises at bay. The resilience of its economy during the Asian Crisis shows that the

confidence is not misplaced. The strategies outlined above should assure Singapore of a good

future.