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Singapore's Balance of Payments 1965 to 2003: An Analysis MAS Staff Paper No. 33 August 2004 SINGAPORE’S BALANCE OF PAYMENTS, 1965 TO 2003: AN ANALYSIS* BY JEAN TAY SAKTIANDI SUPAAT SHIVANI THARMARATNAM EDWARD ROBINSON ECONOMIC POLICY DEPARTMENT MONETARY AUTHORITY OF SINGAPORE AUGUST 2004 * THE VIEWS IN THIS PAPER ARE SOLELY THOSE OF THE AUTHORS AND SHOULD NOT BE ATTRIBUTED TO THE MONETARY AUTHORITY OF SINGAPORE. THE AUTHORS ARE GRATEFUL TO DR KHOR HOE EE, PROFESSOR BARRY EICHENGREEN, TAN MIN-CHING AND NG YI PING FOR USEFUL DISCUSSIONS AND COMMENTS DURING THE PREPARATION OF THIS PAPER. THIS PAPER HAS ALSO BENEFITED FROM INPUTS FROM OUR COLLEAGUES IN THE MONETARY MANAGEMENT DIVISION. THE MONETARY AUTHORITY OF SINGAPORE JEL CLASSIFICATION NUMBER: F21, F31, F32 KEYWORDS: CURRENT ACCOUNT BALANCE, CAPITAL SAVING-INVESTMENT GAP, BALANCE OF PAYMENTS FLOWS, MAS Staff Paper No. 33 August 2004 EXECUTIVE SUMMARY 1 This paper provides a historical overview of developments in Singapore’s balance of payments over the years. We first analyse the trends in the current account balance using the saving-investment (S-I) and international trade perspectives. Then, we study the composition of the financial account, focusing on the nature and volatility of such flows. Finally, we conclude by examining the trends in the overall balance of payments and drawing out its links to foreign reserve accumulation. The Evolution of Singapore’s Current Account Position 2 Singapore’s current account surplus has displayed a steady trend increase from a deficit position of about 14% of Gross National Income (GNI) in 1980, reaching a surplus of 31% of GNI in 2003. (Chart 1) Chart 1 Current Account (% of GNI) and REER 200 Phase 2 Phase 1 Phase 3 30 REERULC (LHS) 160 20 140 10 % of GNI Index (1976=100) 180 40 0 120 Current Account (RHS) -10 100 80 -20 1976 1982 1988 1994 2000 2003 3 Apart from some cyclical fluctuations coinciding with the business cycle, the trend increase has been virtually uninterrupted over the past three decades. However, the underlying factors contributing to the rise in the current account balance have changed during the period. Table 1 summarises the driving forces underpinning the developments in the current account balance. MONETARY AUTHORITY OF SINGAPORE i MAS Staff Paper No. 33 August 2004 Table 1 Factors Underlying Current Account Balance Phase 1: 1965-1987 Phase 2: 1988-97 Phase 3: 1998-2003 Persistent current account deficits (Avg: 9% of GNI) Persistent current account surpluses (Avg: 12% of GNI) Widening current account surpluses (Avg: 21% of GNI) Negative private S-I gap, reflecting strong growth in private investment Increasing public S-I gap, reflecting strong fiscal position Increasing private S-I gap, due to drop in private investment Large deficits in the goods balance Large surpluses in the services balance Large surpluses in the goods balance 4 The rising current account position has been associated with an improving official foreign reserves (OFR) position, which increased almost 12fold since 1980 to reach S$163 billion at end-2003. In addition, since the late 1980s, the rising current account surplus has also been accompanied by larger outflows from the financial account, reflecting the acquisition of foreign assets abroad by residents. This is consistent with Singapore’s status as a net exporter of capital. 5 The increased flows through the financial account balance have largely reflected net outflows from the portfolio and "other investment" accounts, which have typically offset the inflows due to foreign direct investment (FDI). Our analysis shows that net portfolio investment flows are persistent, reflecting long-term investment by private and government entities in bonds, equities and acquisition of companies abroad. In comparison, flows from the “other investment” account are highly reversible, reflecting the more volatile nature of flows through the banking system. We also verify that FDI flows are persistent and largely permanent in nature. 6 Chart 1 also shows the real effective exchange rate (REER), which is the international price complement to the current account. Singapore’s REER has generally been on a strengthening trend, accompanying the improvement in the current account position over the years. Nevertheless, it has exhibited cyclical swings, coinciding with the mid-1980s recession and the series of shocks in the most recent period from 1998 onwards. 7 The last phase in the development of the current account, covering the period 1998 to 2003, was marked by an increased frequency of cyclical shocks hitting the Singapore economy. As a result, the secular movements in the current account were accentuated by short-term influences. These included a sharp fall in investment, a rise in precautionary saving on the part MONETARY AUTHORITY OF SINGAPORE ii MAS Staff Paper No. 33 August 2004 of the private sector and a fall in the public sector S-I gap, reflecting the more expansionary stance of fiscal policy. From the trade perspective, the contraction in gross national expenditure had caused imports to decline, thus boosting the merchandise trade surplus. On balance, these factors have boosted the current account surplus position. 8 Going forward, as the economy returns to its potential growth path, we can generally expect the current account surplus to moderate in line with a pickup in investment spending. In the private sector, a pickup in nonconstruction investment spending and inventory stock accumulation alongside some moderation in the saving rate is likely to imply a narrowing of the private sector S-I gap. Moreover, while the public sector resource gap is likely to improve with strengthening revenues, the permanent reductions in direct income tax rates would imply that the magnitude of the surplus may not reach the levels experienced during the 1990s. Nevertheless, Singapore is unlikely to see a significant narrowing of the overall S-I gap until about 2012, when demographic factors start having a greater influence on government spending and private saving. MONETARY AUTHORITY OF SINGAPORE iii MAS Staff Paper No. 33 August 2004 TABLE OF CONTENTS EXECUTIVE SUMMARY i-iii TABLE OF CONTENTS iv 1. INTRODUCTION 1 2. SINGAPORE’S CURRENT ACCOUNT 2 2.1 UNDERSTANDING THE CURRENT ACCOUNT 2 2.2 STYLISED FACTS ON SINGAPORE’S CURRENT ACCOUNT 3 2.3 A PERSPECTIVE BASED ON INTERNATIONAL TRADE IN GOODS AND SERVICES Box Item A: Determinants of Singapore’s Saving Rate 3. 12 8 Box Item B: How Large is Large? An International Comparison of Singapore’s S-I Gap 11 Box Item C:The Role of the Income Balance in Switzerland: Lessons for Singapore? 17 SINGAPORE’S CAPITAL AND FINANCIAL ACCOUNT 19 3.1 UNDERSTANDING THE CAPITAL & FINANCIAL ACCOUNT 19 4. 3.2 STYLISED FACTS ON SINGAPORE’S CAPITAL & FINANCIAL ACCOUNT 19 3.3 PERSISTENCE OF CAPITAL FLOWS 28 Box Item D: Merger and Acquisition Activity in Singapore 24 SINGAPORE’S OVERALL BALANCE OF PAYMENTS 32 4.1 UNDERSTANDING THE BALANCE OF PAYMENTS 32 4.2 HISTORICAL TRENDS IN THE OVERALL BOP AND OFR ACCUMULATION 32 APPENDIX 1 ASSESSING THE RELATIVE IMPORTANCE OF PERMANENT AND TEMPORARY COMPONENTS OF CAPITAL FLOWS MONETARY AUTHORITY OF SINGAPORE 35 iv MAS Staff Paper No. 33 1. August 2004 INTRODUCTION 1 This paper provides an analysis of developments in Singapore’s balance of payments from 1965-2003. We first analyse the trends in the current account balance from the saving-investment and the trade perspectives by examining the different components of the current account. Then, we study the composition of the financial account, focusing particularly on the nature and volatility of the flows. Finally, we conclude by examining the trends in the overall balance of payments, and drawing out its links to foreign reserve accumulation. Revisiting the Balance of Payments 2 Before undertaking a detailed discussion of trends in Singapore's balance of payments, it is useful to first revisit the basic economic relationships underpinning a country's balance of payments transactions. 3 The balance of payments (BOP) is the statistical record of economic transactions between domestic residents (households, firms and governments) and foreigners. There are two sides to these external accounts – namely the current account balance (CAB) and the capital and financial account balance (KAB). In principle, the sum of these balances must be zero under a floating exchange rate regime; that is: CAB + KAB = 0 4 Under a managed exchange rate system, the overall balance of payments is measured by changes in the official foreign reserves (OFR), or the central bank's holdings of financial assets denominated in foreign currency. This implies the following relationship: CAB + KAB = BOP 5 From this identity, it is clear that if the current account balance is persistently in deficit, it will be matched by surpluses on the capital and financial account, and a drawdown in OFR. Conversely, as in the case of Singapore, persistent current account surpluses are accompanied by deficits in the capital and financial account, and an accumulation of foreign reserves. MONETARY AUTHORITY OF SINGAPORE 1 MAS Staff Paper No. 33 August 2004 2 SINGAPORE’S CURRENT ACCOUNT 2.1 UNDERSTANDING THE CURRENT ACCOUNT 6 There are at least two complementary ways of describing the current account balance. First, the current account balance can be defined as the difference between the credits and debits of goods, services, income, and transfers, or simply the difference between exports and imports. Transactions classified under goods relate to the movement of merchandise and generally involve a change in ownership. Services refer mostly to the transportation and insurance of merchandise shipments, transport fares paid by travellers, tourist services1, royalties and license fees, and communication charges. Income may be derived from labour (compensation of employees) and from financial assets or liabilities (such as interest and dividend income). 7 Second, another perspective is based on the national income and production accounts. This approach shows how changes in a nation’s saving and investment are reflected in the trade and current account balance. The current account balance is identical to the economy's resource gap, as measured by the difference between national saving (S) and domestic investment (I). That is, CAB = S - I 8 As implied from this equation, a change in the current account position (such as an increase in the surplus or a decrease in the deficit) must be matched by an increase in national saving relative to investment. In addition, the current account is also equal to the sum of the resource gaps of the public and private sectors, such that a given current account balance may be consistent with various combinations of private and public sector deficits and surpluses. CAB = (S-I)public + (S-I)private 9 All these concepts are relevant measures of the current account balance. Each highlights a different aspect of an economic system in which interacting events in both domestic and global economies determine the 1 Travel services (receipts/payments) consist of the expenditure by tourists (including medical patients), foreign students and cross-border or seasonal workers. MONETARY AUTHORITY OF SINGAPORE 2 MAS Staff Paper No. 33 August 2004 current account balance. The next section examines the historical trends in Singapore’s current account balance using the saving-investment (S-I) perspective, as well as the different components that make up the current account balance (i.e. goods, services, and income). 2.2 STYLISED FACTS ON SINGAPORE'S CURRENT ACCOUNT 10 Singapore experienced persistent current account deficits from 1965 to 1984, averaging 10% of GNI, financed by large capital flows mainly in the form of foreign direct investment. The large deficits over the two decades were not a cause of concern for policymakers, as they represented the burgeoning investment needs of an industrialising economy and were financed through long-term equity inflows. Since 1988, however, the current account has recorded surpluses, which averaged 12% of GNI in the pre-crisis period of 1988-1997. 11 Since 1998, the size of the current account surpluses has risen to an average of 21% of GNI. In this section, we use Singapore’s saving and investment behaviour to trace the current account’s transition from deficits to large surpluses over the years. In particular, the development of Singapore’s current account can be divided into three distinct phases: from 1965 to 1987; then from 1988 to 1997; and finally 1998 to 2003. (Chart 2.1) Total investment corresponding to the three phases is shown in Table 2.1, with a further breakdown for the first phase. Chart 2.1 Current Account Balance 45 Phase 2 Phase 1 Phase 3 % of GNI 30 15 Current Account Balance (S - I Gap) 0 -15 -30 1965 MONETARY AUTHORITY OF SINGAPORE 1970 1975 1980 1985 1990 1995 2000 2003 3 MAS Staff Paper No. 33 August 2004 Table 2.1 Total Investment By Component (% of GNI) Phase 1 Phase 2 Phase 3 1965-69 1970-79 1980-87 1988-97 1998-2003 23.3 40.7 44.7 34.7 25.7 11.0 15.1 23.2 16.0 15.8 Machinery & Equipment 8.0 14.2 13.0 12.2 10.1 Transport Equipment 2.5 6.8 6.5 5.3 4.0 Change in Stocks 1.9 4.6 2.1 1.2 -4.2 Overall Investment By Investment Type Construction & Works Phase 1: 1965 to 1987 12 In the period 1965-1987, the persistent current account deficits (averaging around 9% of GNI) or the shortfall in saving over investment were associated with a rise in domestic investment rather than a fall in saving. (Chart 2.2) Singapore imported a large amount of capital goods at that time as it was going through a housing boom and an industrialisation process, shifting from entrepôt services to labour-intensive production in the 1960s and subsequently to more capital-intensive manufacturing such as petroleum refining in the 1970s. By the mid-1980s, Singapore had moved into higher value-added production such as electronics and related components. Chart 2.2 (a) Saving and Investment Rate (b) Saving-Investment Gap 60 50 45 Investment Rate 30 GNI (YOY % Growth) Per Cent % of GNI 40 30 20 Saving Rate 0 -15 10 0 1965 15 S - I Gap (% of GNI) 1974 1983 1992 2003 -30 1965 1974 1983 1992 2003 13 As a result, Singapore’s gross investment rate rose sharply, from about 20% of GNI in the mid-1960s to about 40% in the 1980s. Residential MONETARY AUTHORITY OF SINGAPORE 4 MAS Staff Paper No. 33 August 2004 construction investment constituted a significant portion of gross fixed capital formation (GFCF) in the 1960s, as housing projects took off to meet the needs of a growing population. Subsequently, private housing construction also benefited from the government’s decision in 1981 to permit the use of CPF saving towards the purchase of private residential property. Non-residential construction investment also picked up significantly in the 1970s with the expansion in manufacturing. Private sector investment in machinery and transport equipment more than doubled from 5.5% and 1.9% of GNI respectively in the 1960s, to around 12% and 6.0% in the 1970s to 1980s. At the same time, the gross national saving rate climbed up steadily, from 11% in 1965 to 42% of GNI in 1985. Nevertheless, it was not until 1988 that the increase in saving was sufficient to fully finance the capital formation needs of the economy. 14 Using the saving-investment perspective, we can also disaggregate the S-I gap into its public and private sector components.2 During the period 1965-85, the shortfall in saving over investment was attributable to the private sector, as the public sector’s saving-investment position was largely in surplus.3 (Chart 2.3) In this regard, the external imbalances (current account deficits) experienced in the earlier years of Singapore’s development reflected to a large extent the optimising outcome of consumption and investment decisions of the private sector. 2 In this paper, the public sector is defined to include the central government and the government’s holdings in government-linked companies, as well as selected major statutory boards. 3 Public sector saving is internally estimated by EPD, MAS. Provided the public sector is in balance or the fiscal deficit is not excessive, the current account deficits reflect the outcome of optimising consumption and investment decisions of the private sector. We are grateful to Chris Murphy, our macro-modelling consultant for assistance in this area. MONETARY AUTHORITY OF SINGAPORE 5 MAS Staff Paper No. 33 August 2004 Chart 2.3 Saving-Investment Gap and Its Components (a) Private Sector (b) Public Sector 20 25 30 10 25 0 S-I Gap (RHS) 20 -10 15 -20 Investment Rate (LHS) 10 5 1975 1981 1987 1993 -30 -40 1999 2003 25 Investment Rate (LHS) Saving Rate 20 (LHS) 20 15 15 10 10 5 5 % of GNI % of GNI 30 % of GNI Saving Rate (LHS) 35 30 % of GNI 40 0 S-I Gap (RHS) 0 1975 1981 1987 1993 -5 1999 2003 EPD, MAS internal estimates Phase 2: 1988 to 1997 15 With the completion of major infrastructure projects, the resource (S-I) gap turned decisively positive in 1988, when it registered a surplus of 7.5% of GNI. The S-I gap remained positive throughout Phase 2, with the current account surplus averaging around 12% of GNI from 1988 to 1997. Indeed, the S-I gap widened over this period, as the investment rate stabilised while the saving rate continued to climb. In terms of composition, the growing current account surpluses from 1988-97 were underpinned by public sector surpluses, especially from the late-1980s to the mid-1990s. (Chart 2.4) In comparison, the private sector continued to register a net deficit position for most years until 1997. Chart 2.4 Budget Deficits and Surpluses in Singapore 10 8 S$ Billion 6 4 2 0 -2 -4 1985 1990 1995 2000 2004E Fiscal Year MONETARY AUTHORITY OF SINGAPORE 6 MAS Staff Paper No. 33 August 2004 16 The sharp and sustained rise in Singapore’s saving resulted in a doubling of the national saving rate from around 20% in the early 1970s to around 40% in the mid-1980s. It rose further to over 50% by 1995, and peaked at a high of 53% in 1998, before moderating somewhat in recent years. This sharp increase was underpinned by several factors, including demographic factors such as the steady decline in the population dependency ratio, the trend increase in labour force participation, and high-income growth. Prudent fiscal policy also played an important role in the accumulation of public sector saving, while institutional factors, such as the CPF saving scheme, helped to bolster private saving. Box Item A examines some of the underlying factors underpinning the sharp increase in Singapore’s saving rate. In particular, we note that slightly over half of the increase in Singapore’s gross domestic saving can be attributed to demographic factors. MONETARY AUTHORITY OF SINGAPORE 7 MAS Staff Paper No. 33 August 2004 Box Item A Determinants of Singapore’s Saving Rate Our empirical study of the factors behind Singapore’s saving behaviour over 19702000 found that demographic and income effects were the main factors behind the increase in gross domestic saving (GDS) over the period. Our estimates suggest that slightly over half (54%) of the increase in Singapore’s GDS during the period 1970s through the 1990s can be attributed to demographic variables – in particular, the decline in the proportion of young and aged dependents relative to the earning population. This is shown by a decline of the dependency ratio, and the trend increase in the labour force participation rate over this period. Rapid income growth, in the generally high growth years of the late 1970s and the late 1980s, also contributed roughly 25-30% of the increase in the GDS ratio. Nevertheless, the importance of the demographic and income factors suggests that going forward, Singapore’s saving rate may plateau and decline somewhat, as the population ages and the economy settles into a slower pace of growth in the longer term. Similarly, a recent IMF (2003) study1/ which assessed the role of demographics in the evolution of the current account balance, found that population dynamics help explain the historical shift in Singapore’s current account from a deficit to surplus position. The study had calibrated an intertemporal optimising model which successfully replicated this broad shift in Singapore’s current account balance. The model predicts that demographic forces will tend to keep Singapore’s saving rate high till at least 2010, before the baby boomers start to dissave in retirement. (Chart A1) Chart A1 (i) IMF Simulated S-I Gap (ii) Old Age Dependency Ratio 25 0.6 20 Hong Kong Investment Rate (LHS) 0.5 20 10 0.4 0 Ratio 15 % of GDP % of GDP S-I Gap(RHS) Korea Japan 0.3 Malaysia 0.2 10 -10 5 -20 1910 1950 1990 2030 2070 2110 Thailand 0.1 Saving Rate (LHS) Singapore 0.0 1950 1970 1990 2010 2030 2100 Source: IMF Estimates 1/ “Population Ageing and Current Account Surplus”, Singapore: Selected Issues, IMF Country Report No. 04/103, pp. 39-45, available at http://www.imf.org/external/country/SGP/index.htm. MONETARY AUTHORITY OF SINGAPORE 8 MAS Staff Paper No. 33 August 2004 In comparison, about 6.5% of the increase in Singapore’s GDS ratio was attributable to an increase in government saving since 1977. (Another important empirical result concerns the crowding out effect of government saving on private saving. It was found that government saving induces only a partial offset to private saving, implying that the Ricardian Equivalence does not hold fully.2/) Finally, the study found that CPF scheme has also contributed to the rise in Singapore’s GDS ratio, although its importance appears to have declined from the late 1980s onwards. This was largely due to the further liberalisation of CPF funds for investment, and consequently the increasing extent to which households have come to regard their own voluntary or discretionary saving as substitutable with CPF saving. Finally, sound macro and exchange rate policies have helped to foster a stable macroeconomic environment with low inflation, which in turn has encouraged individuals to take a long-term perspective in their planning decisions. 2/ According to the Ricardian Equivalence hypothesis, changes in government saving rates induce offsetting changes in private saving, implying no change in the overall saving rates. Phase 3: 1998 to 2003 17 Singapore’s current account surplus has continued to rise steadily since 1998, averaging 21% of GNI over 1998-2003. However, unlike in the earlier period, when the rise in the S-I gap was underpinned by strong growth in the saving rate, the more recent widening of the S-I gap was attributable to a decline in investment. 18 In particular, we note that private sector net saving has played an increasingly important role, compared with net saving in the public sector. The rise in private sector S-I gap was due to a sharp decline in investment, as private investment as a ratio of GNI dropped from 30% in 1997 to an average of 14% in 2001-03. (Chart 2.5a) This mainly reflected the plunge in residential investment during the post-crisis period, with the construction sector plagued by oversupply and generally weak economic conditions. Nonresidential investment also fell, albeit at a slightly slower pace, with investment opportunities and returns reduced by three consecutive shocks to the Singapore economy (namely, the 1997 Asian financial crisis, the 2001 global electronics downturn and the 2003 SARS outbreak). (Chart 2.5b) MONETARY AUTHORITY OF SINGAPORE 9 MAS Staff Paper No. 33 August 2004 Chart 2.5 (a) Private and Public Sector Investment (b) Construction Investment 14 40 Private Investment 12 Private Residential 10 S$ Billion % of GNI 30 20 Public Investment 8 6 Public Residential 4 10 Private Non-residential 2 0 1960 1967 1974 1981 1988 1995 Public Non-residential 0 1960 2003 1967 1974 1981 1988 1995 2003 19 The increase in private sector net saving since 1997 has more than offset the fall in net saving of the public sector. In fact, the private sector S-I gap has actually exceeded that of the public sector since 2002. The smaller public sector S-I gap in recent years was primarily due to smaller fiscal surpluses as the government adopted a more expansionary fiscal stance in the face of the weak economic environment. (Chart 2.6) Chart 2.6 Saving-Investment Gap Total 30 Public Phase 1 Private Phase 2 Phase 3 % of GNI 20 10 0 -10 -20 -30 1975 1979 1983 1987 1991 1995 1999 2003 EPD, MAS internal estimates MONETARY AUTHORITY OF SINGAPORE 10 MAS Staff Paper No. 33 August 2004 Box Item B How Large is Large? An International Comparison of Singapore’s S-I Gap International comparisons are often used as a benchmark in examining the adequacy of national saving and investment levels. The comparisons indicate that Singapore’s S-I gap is relatively large when compared to the NIE-3, G7 and OECD averages.1/ (Chart B1) The NIE-3 average showed a narrowing S-I gap or smaller current account surpluses since 1988, while the fairly stable gap for the OECD indicated a current account that was close to balance. Chart B1 International Comparison of S-I Gap 40 30 Singapore % of GDP 20 10 OECD NIE-3 0 -10 -20 -30 1960 1966 1972 1978 1984 1990 1996 2003 Prior to the mid-1980s, Singapore, like the NIE-3 countries, ran current account deficits, as domestic investment surged reflecting the rapid industrialisation of the economy. From the 1990s, however, Singapore recorded persistent current account surpluses that were significantly larger than the NIE-3 and OECD averages. The main reason behind this appears to be the striking difference in the saving patterns, given that the investment rate in Singapore and the NIE-3 have shifted down closer to the OECD level. (Chart B2(i)) Indeed, Chart B2(ii) shows that although the NIE-3 countries had similar, strong saving patterns till the mid-1970s, the saving rate for the NIE-3 started to trend down by 1988, dragged down by a marked decline in private sector saving. In comparison, Singapore’s relatively high saving rate continued to increase further to a new high of 53% in 1998, far above the 30% for the NIE-3 and 24% for the OECD. As mentioned earlier, while Singapore’s 1/ These comparisons are best made on a gross basis, because methods of calculating depreciations can vary markedly across countries and can result in misleading inferences. Hence, this section uses gross domestic saving and investment rates as a basis of comparison. MONETARY AUTHORITY OF SINGAPORE 11 MAS Staff Paper No. 33 August 2004 private sector saving was initially boosted by demographic and income factors, public sector saving was underpinned by the government’s prudent fiscal policy stance, with budget surpluses averaging around 4.3% of GDP each year over the 1990s. In comparison, the NIE-3 countries ran a small budget deficit, which averaged 0.7% of GDP each year over the same period, while OECD countries recorded a slightly larger deficit averaging 3.2% of GDP. More recently, however, the main factor driving the sharp increase in Singapore’s current account surplus in 2002-03 was the collapse in investment rather than an increase in the saving rate. Chart B2 International Comparison of (i) Domestic Investment Rate (ii) Domestic Saving Rate 60 60 50 50 Singapore 40 % of GDP % of GDP 40 NIE-3 30 20 Singapore NIE-3 30 OECD 20 10 OECD 10 0 0 1960 2.3 1969 1978 1987 1996 2003 -10 1960 1969 1978 1987 1996 2003 A PERSPECTIVE BASED ON INTERNATIONAL TRADE IN GOODS AND SERVICES 20 We now turn to assess developments in Singapore’s current account balance by examining the components of the current account, namely, goods, services and income balances. 21 Singapore’s rapid growth in exports since the early 1980s resulted in a turnaround in the current account from a deficit to a surplus position since 1988. Although the goods balance recorded consistent deficits prior to 1994 (except in 1988), the services balance has all along been in surplus, while the income balance showed a surplus from 1984 till the late 1990s. MONETARY AUTHORITY OF SINGAPORE 12 MAS Staff Paper No. 33 August 2004 Trends in the Goods Balance 22 Since 1994, the rapid growth in Singapore’s exports led to a turnaround in the goods balance from a deficit to a surplus position. Along with the strong demand for Singapore’s manufactured goods, Singapore’s attraction as a major bunkering port and centre for repairs of ships and aircraft also led to the growth in goods procured in ports and repairs of goods.4 23 Reflecting these developments, the goods balance rose steadily from an average deficit of 2.3% of GNI in 1988-93, to a surplus of 5.9% in 1994-97, and 20% in 1998-2003. Concomitantly, its contribution to the overall current account surplus surged from 12% in 1994 to over 100% in 2003. The large goods balance has provided offset to the general deterioration in the services and income balances since 1994. (Chart 2.7) Chart 2.7 Goods/Services/Income Balances (a) S$ Billion (b) % of GNI 60 30 50 % of GNI S$ Billion 10 30 20 Services 10 0 -10 -20 0 -30 -10 Income -20 Goods Services Income -40 -50 1980 4 20 Goods 40 1986 1992 1998 2003 1980 1986 1992 1998 2003 In 1998, the implementation of BPM5 led to the re-classification of certain balance of payments items. This included the shift of repairs on goods, and goods procured in ports from the services to the goods account. The income balance was also shifted out of the services balance to form a separate category under the current account balance, to reflect the importance of cross-border income flows. The series were backdated to 1980, so that the current account data before and after 1998 are comparable. MONETARY AUTHORITY OF SINGAPORE 13 MAS Staff Paper No. 33 August 2004 Trends in the Services Balance 24 The strength of the services balance helped to underpin the overall current account surplus in the 1980s and early 1990s. More recently, the smaller services surpluses recorded in 2001-03 were largely due to the steady decline in the travel balance5 since 1993, which turned into a deficit position in the last three years. These trends have reflected both a decline in travel receipts, as competition from the region to attract tourists intensified, as well as an increase in residents’ travel expenditure abroad. (Chart 2.8a) Chart 2.8 (a) Travel Receipts and Payments (b) Breakdown of Services Balance 12 12 Travel Receipts Other Services 8 S$ Billion S$ Billion 10 8 6 4 0 Travel Payments 4 -4 2 Travel Government Services Transportation Insurance -8 1989 1993 1997 2001 2003 1989 1993 1997 2001 2003 25 The increased deficits in the transportation and insurance balances have also contributed to the decline in the services balance. While Singapore’s position as a transportation hub underscores the importance of transportation receipts, the substantial payments for port services and freight shipments have led to persistent deficits in the transportation services account. Similarly, the insurance balance has historically shown a deficit position, largely reflecting premium payments incurred for the import of goods. (Chart 2.8b) 26 With the exception of the “other services” segment, all the other major services balances were in a deficit position over the past three years. The “other services” balance covers a wide spectrum of activities including financial services, construction services, computer & information services, royalties, social services and other services. Financial services is a key segment, and accounted for a sizable 12% share of “other services” receipts 5 From 1995, the coverage of the services account was expanded, facilitated by a number of DOS surveys such as the Survey on International Trade in Services (TIS). MONETARY AUTHORITY OF SINGAPORE 14 MAS Staff Paper No. 33 August 2004 in 2002-03, reflecting the development and importance of Singapore as a financial and business services hub.6 Indeed, the increased surplus in the “other services” balance until 1997 was largely due to a rise in financial services’ net receipts. (Chart 2.9) Thereafter, the “other services” surplus dropped sharply, in part due to the significant increase in royalty payments for manufactured goods especially pharmaceuticals. More recently, its improvement in 2002-03 was underpinned by a recovery in financial services net receipts. Chart 2.9 Major Components of Other Services 10.0 Other Services 7.5 S$ Billion 5.0 2.5 Financial Services 0.0 -2.5 -5.0 Royalties -7.5 1995 1997 1999 2001 2003 Trends in the Income Balance 27 The income balance has held up over the years, indicating the importance of net investment income as a source of earnings. It registered a net positive inflow throughout the 1990s, as the income from foreign reserves and government investments abroad more than offset the repatriation of profits by foreign MNCs in Singapore. Indeed, the surplus in the income balance averaged around S$2.5 billion each year over the period 1990-99, with income receipts more than doubling since the early 1990s, from S$11.8 billion in 1990 to peak at S$27.6 billion in 2000. (Chart 2.10) 6 As a share of total services exports, financial services accounted for 5.1% in 2002-03. This was smaller than the shares for travel (14%) and transportation (39%). MONETARY AUTHORITY OF SINGAPORE 15 MAS Staff Paper No. 33 August 2004 Chart 2.10 Income Balance 6 30 S$ Billion 2 25 Income Receipts 20 (RHS) 15 0 10 Income Payments (RHS) -2 S$ Billion Income Balance (LHS) 4 5 -4 1980 1984 1988 1992 1996 2000 0 2003 28 The moderation in total income receipts since 2000, to S$24.7 billion in 2002 and S$23.4 billion in 2003, reflected the decline in receipts from both public and private investment income, as interest income fell in line with the soft global interest rate environment. At the same time, payments due to private investment income have remained relatively stable over the past few years, reflecting large foreign investment in Singapore. As a result, the income balance narrowed and turned in deficits of S$0.2 billion and S$2.0 billion in 2002 and 2003 respectively. 29 Nevertheless, as Singapore continues with its efforts to develop an “external wing” overseas, it is likely that the income balance would play an increasingly important role in sustaining the current account surplus. In the following box item, we look at the case of Switzerland, which has recorded consistent current account surpluses over the years underpinned by strong surpluses in the income account, and attempt to draw some comparisons with Singapore. (See Box Item C.) MONETARY AUTHORITY OF SINGAPORE 16 MAS Staff Paper No. 33 August 2004 Box Item C The Role of the Income Balance in Switzerland: Lessons for Singapore? Like Singapore, one small and open European economy that has consistently experienced a high current account surplus relative to its GDP is Switzerland. The country’s current account balance has recorded persistent surpluses averaging around 8% of GDP since 1990. On closer examination, however, we find that the composition of the large current account surpluses for these two economies is considerably different in structure. While Singapore’s surpluses can be attributed primarily to the large surpluses generated by its goods and services balance, Switzerland’s current account surpluses have generally been dominated by the income account. The Switzerland Case Until the early 1980s, Switzerland’s current account balance, like Singapore’s, was largely determined by fluctuations in the goods and services account. In the past two decades, however, growing surpluses from the income account balance have come to exert increasing influence over the current account balance. (Table C1) In fact, from the mid-1990s up till 2002, the surplus from the income balance accounted for around two-thirds of Switzerland’s current account balance. The remainder was mostly due to the services account surplus, while the goods account actually recorded small surpluses or even deficits in recent years. Table C1 Switzerland’s Current Account (% of GDP) Current Account Balance Trade Balance Services Balance Income Balance Current Transfers, net 1980-89 3.6 -3.3 3.3 4.5 -0.9 1990-99 7.4 0.0 4.0 4.7 -1.3 2000-02 11.3 1.3 4.9 6.5 -1.5 The surpluses from the income account have been sizeable, averaging around US$13 billion a year since 1990. These were entirely due to the contribution of net investment income, as net labour income has been recording deficits for most years. About a fifth of the Swiss workforce is foreign based, and this trend is set to continue as Switzerland becomes more and more closely integrated with the rest of Europe and the mobility of labour increases. In comparison, Switzerland’s net investment income rose practically without interruption over the period 1950 to 2000, to peak at US$26.5 billion in 2000. The reason for this steady increase was the growth in Switzerland’s net international investment position, as well as the uptrend in interest rates till the end of the 1980s. More recently, however, the marked reduction in interest rates has put strong MONETARY AUTHORITY OF SINGAPORE 17 MAS Staff Paper No. 33 August 2004 downward pressure on the investment income surplus in 2001 and 2002. Both investment income from abroad as well as payments abroad plummeted as a result of lower interest rates and receding direct investment income. With income on Swiss investment abroad falling at a much faster rate compared to the decline in payments relating to foreign investment in Switzerland, the income account surplus narrowed in 2001 and 2002. Lessons for Singapore? Compared with Switzerland, contributions from the income account to Singapore’s current account surplus remain relatively limited. Going forward, however, the importance of the income balance should not be underestimated as a key source of inflows, as illustrated by the case of Switzerland. First, we note that the strong inflows from Switzerland’s income account have been underpinned by the accumulation of a large net international investment position over the years. Indeed, Switzerland’s net foreign assets have risen six-fold over the past two decades, from US$69.7 billion in 1983 to US$432 billion in 2002 (or 161% of GDP). In comparison, Singapore’s net international investment position stood at a much more modest position. More notably, Switzerland’s external wing is significantly more well-developed than Singapore’s. Since the mid-1980s, Switzerland’s direct investment overseas have outstripped foreign investment into the country, with net outflows from the direct investment account averaging US$9.3 billion each year over the period 1988-2002. In comparison, while direct investment abroad by Singaporean investors has risen sharply since the late 1990s, it remains considerably lower than direct investment into Singapore. This has led to net inflows to the direct investment account almost every year (with the exception of 2001, which saw a high level of M&A activity). As a result, it is not entirely surprising that the level of net income receipts into Singapore is still only a fraction of income inflows to Switzerland, despite some trend increase over the past decade. In addition, the weak global investment and soft global interest rate conditions over the recent few years have put further downward pressure on income receipts, even as income payments have remained fairly stable. Given that Singapore’s stellar economic performance over the past three decades has been primarily driven by large-scale investment by MNCs and foreigners, the high level of direct investment flows into Singapore is hardly unexpected. Nevertheless, this also implies that the large and growing factor payment to abroad, due to the repatriation of profits and other factors, has probably offset to a large extent, the increase in receipts from overseas investments. In particular, we note that the rise in income receipts since 1999 has generally been offset by higher income payments over the same period, resulting in a smaller surplus or even deficit in the income account in recent years. MONETARY AUTHORITY OF SINGAPORE 18 MAS Staff Paper No. 33 3 SINGAPORE’S CAPITAL AND FINANCIAL ACCOUNT 3.1 UNDERSTANDING THE CAPITAL AND FINANCIAL ACCOUNT August 2004 30 While transactions involving goods and services appear in the current account of the balance of payments, international sales or purchases of financial assets appear in the financial account, a subdivision of the capital and financial account. The capital and financial account shows how an economy’s balance of payments transactions are financed. If an economy’s saving exceeds its investment, the surplus must be reflected in net financial outflow or net financial investment in the rest of the world. If, on the other hand, an economy’s saving is less than its investment, the economy will be a net importer of goods and services from the rest of the world. These net imports must be financed by a net financial inflow from the rest of the world. In other words, a deficit on current account transactions would be financed by a capital and financial account surplus, while a current account surplus would be matched by net outflows from the capital and financial account and changes in OFR. 31 In the case of Singapore, which has recorded persistent current account surpluses since the mid-1980s, net capital and financial outflows reflect the acquisition of foreign assets abroad by residents. There has also been an accompanying build-up in OFR. In line with Singapore's position as a net exporter of capital, the overall capital and financial account has largely been in deficit since the early 1990s. 3.2 STYLISED FACTS ON SINGAPORE’S CAPITAL AND FINANCIAL ACCOUNT 32 The overall capital and financial account balance (KAB) in Singapore comprises the capital account balance and the financial account balance. The former consists of capital transfers (which include migrants' transfers, debt forgiveness, etc.) and the acquisition and disposal of nonproduced and non-financial assets (e.g. patents and copyrights). The capital account balance has consistently recorded a small negative balance, and its contribution to the overall KAB has been relatively small in Singapore (averaging 0.2% of GDP since 1993). The KAB has therefore been MONETARY AUTHORITY OF SINGAPORE 19 MAS Staff Paper No. 33 August 2004 dominated by flows from the financial account. Comprising the financial account are the direct investment account, portfolio investment account, as well as "other investment" account, which represents financial flows intermediated through the banking system (e.g. trade credit, loans and advances, currency and deposits). 33 As noted earlier, the excess of national saving over investment in Singapore has allowed more resources to be deployed overseas to acquire foreign assets. The government has been investing public sector surpluses abroad, and has also encouraged private entities to develop an “external wing” overseas, i.e. long-term investment abroad which will over time generate a steady source of foreign income for the country. This strategy has been reflected in a shift of Singapore’s financial account position from a surplus to a deficit since 1993. (Chart 3.1) The net export of capital has been dominated by huge outflows of portfolio investment, particularly net purchases by residents (including the government) of overseas equities and to a smaller extent, debt securities. Nevertheless, net FDI has remained positive despite the surge in outward direct investment by Singapore-based companies since 1993, as Singapore continued to attract large inflows of FDI to finance a substantial part of domestic investment (especially in manufacturing). Such a unique arrangement, in which the bulk of domestic saving is invested abroad while a substantial proportion of domestic investment is financed by FDI, has served the Singapore economy well over the years. Chart 3.1 Current Account and Capital and Financial Account 40 60 40 Overall Balance of Payments Current Account Balance 20 % of GNI S$ Billion 20 0 Capital & Financial Account Balance -20 Overall Balance of Payments Current Account Balance Capital & Financial Account Balance 30 10 0 -10 -20 -40 -30 -60 -40 1980 1984 1988 1992 1996 2000 2003 1980 1984 1988 1992 1996 2000 2003 34 Net outflows from the capital and financial account have increased since the Asian crisis, and at a more rapid rate than the expansion in the current account balance during that period. The capital and financial account deficit has risen from around 7% of GNI over the pre-crisis period of 1993-97, MONETARY AUTHORITY OF SINGAPORE 20 MAS Staff Paper No. 33 August 2004 to an average of 15% over the period 1998-2002, in line with the increase in the current account surplus. More recently, the capital and financial account deficit has surged to 28% of GNI in 2003, largely reflecting a sharp increase in outflows from the “other investment” account. In particular, net outflows from the "other sectors" and official category within the “other investment” account amounted to S$35 billion in 2003, compared with S$9.1 billion in the previous year. Nature and Composition of Singapore’s Financial Flows 35 The flows in the financial account are divided into three main categories – direct investment, portfolio investment and other investment. Direct investment is usually distinguished from portfolio equity investment by the size of the stake taken in a foreign company. A stake greater than 10 per cent is deemed to indicate some degree of control and constitutes direct investment. Anything lower than that is deemed to be a portfolio allocation decision. Prior to 1993, the financial account was dominated by net inflows from the direct investment account. Since then, however, net outflows from the portfolio and "other investment" accounts have tended to be the more important components. (Chart 3.2) Chart 3.2 Components of the Financial Account Balance 30 20 20 Direct Investment 10 0 0 % of GNI S$ Billion Financial 10 Account Balance Portfolio Investment -10 -20 -10 -20 Other Investment -30 Financial Account Balance Direct Investment Portfolio Investment Other Investment -30 -40 -50 -40 1980 1986 1992 1998 2003 1980 1986 1992 1998 2003 Direct Investment 36 Direct investment is defined as a category of international investment in which a resident entity in one economy (the direct investor) acquires a lasting interest in an enterprise resident in another economy (the direct investment enterprise). Direct investment implies a long-term relationship between the direct investor and the direct investment enterprise MONETARY AUTHORITY OF SINGAPORE 21 MAS Staff Paper No. 33 August 2004 and a significant degree of influence by the direct investor on the management of the direct investment enterprise. The IMF’s Balance of Payments Manual (5th edition) recommends a minimum equity stake deemed necessary for an effective voice as 10%. 37 Direct investment inflows have generally increased over the years, rising by over 60% from an average of S$13.2 billion a year in the 1990s to S$21.7 billion a year since 2000. Indeed, FDI inflows to Singapore have consistently been in excess of S$10 billion each year since 1994. (Chart 3.3) Since 1997, Europe has overtaken Asia as the largest source of FDI in Singapore, accounting for nearly 40% of the total stock of FDI as at end-2001. In terms of country breakdown, the US remains Singapore's largest foreign direct investor, accounting for around 17% of the total stock of FDI in Singapore, followed by Netherlands and Japan at 16% and 13% respectively. The bulk of the foreign investment has been in the financial services (37%) and manufacturing sectors (36%), which made up over 70% of total investment. Chart 3.3 Gross Inflows and Outflows for Foreign Direct Investment 30 40 Inflows 30 Outflows 20 20 10 % of GNI S$ Billion Inflows 10 0 -10 0 -10 Outflows -20 -20 -30 -40 1972 1978 1984 1990 1996 2003 -30 1972 1977 1982 1987 1992 1997 2003 38 Nevertheless, the stable inflows from FDI have increasingly been offset by significant outflows due to a rise in investment abroad, reflecting efforts to develop Singapore’s “external wing”, as well as an increase in merger and acquisition (M&A) activity in recent years. (See Box Item D for further details on M&A activity and its impact on direct investment outflows.) Gross outflows from the direct investment account have doubled from an average of S$7.0 billion per year over the 1990s to S$14.0 billion per year since 2000. These outflows have been somewhat more volatile than gross direct investment inflows, and range from as low as S$5.0 billion in 1998 immediately following the Asian crisis, to as high as S$30.6 billion in 2001, MONETARY AUTHORITY OF SINGAPORE 22 MAS Staff Paper No. 33 August 2004 before moderating to around S$9.6 billion last year. In terms of the location and activity of overseas operations, nearly half of Singapore's direct investment abroad was concentrated in Asia, with China being the largest host country, accounting for 13% of total direct investment abroad as at end2001, followed by Malaysia (7.9%) and Hong Kong (7.1%). US also accounted for a significant proportion of overseas investment, at 5.0%. 39 Reflecting these developments, the size of net inflows from direct investment has risen steadily since the Asian crisis to peak at S$20.5 billion in 2000, underpinned by a surge in gross direct investment inflows that year to a high of S$29.7 billion. Subsequently however, with the pickup in local investment abroad, net inflows moderated sharply, and even turned negative in 2001, due to the high level of M&A activity during the year. MONETARY AUTHORITY OF SINGAPORE 23 MAS Staff Paper No. 33 August 2004 Box Item D Merger and Acquisition Activity in Singapore Merger and acquisition (M&A) activity in Singapore picked up strongly since the late 1990s, with the number of such deals rising steadily from 137 in 1998, to a high of 679 in 2003. Similarly, the total value of M&A activity has increased sharply from US$5 billion in 1998 and US$22.4 billion in 2000, to peak at US$44.6 billion in 2001, before falling off in 2002. In terms of composition, M&A activity in Singapore has been dominated by domestic merger and acquisition activity, as well as overseas acquisitions by local companies. In comparison, foreign acquisition of local companies appears to have been somewhat less significant, especially in recent years. Chart D1 Completed and Pending M&A Deals 50 Local Acquisition Abroad 700 Foreign Acquisition in S'pore 600 Domestic Merger Activiity Volume of M&A Activity (US$ Billion) Number of deals 800 500 400 300 200 100 0 Local Acquisition Abroad Foreign Acquisition in S'pore 40 Domestic Merger Activiity 30 20 10 0 1997 1998 1999 2000 2001 2002 2003 1997 1998 1999 2000 2001 2002 2003 Source: Bloomberg While the number of deals has been fairly large over the years, most of the M&A volume can be traced to a small number of big deals. In particular, Singtel’s acquisition of Optus in 2001 represented the largest acquisition abroad by a local company thus far, amounting to US$9.7 billion. Another high volume deal was DBS’ acquisition of Dao Heng bank in 2001, which amounted to around US$5.3 billion. Domestic M&A activity also picked up strongly in 2001, with mergers of several local banks taking centrestage as a result of the consolidation in the domestic banking sector. The largest foreign acquisition of a Singapore company was made in 2000 when Solectron Corp acquired Natsteel Electronics for around US$2 billion. Impact on BOP Flows In general, M&A activity is captured in the financial account under direct investment inflows (if it is a foreign acquisition in Singapore) or outflows (if it is an acquisition abroad by a local company). For instance, the large acquisitions abroad by Singtel and DBS were reflected in the jump in gross direct investment outflows to S$24.1 MONETARY AUTHORITY OF SINGAPORE 24 MAS Staff Paper No. 33 August 2004 billion in Q3 2001, from an average of S$1.6 billion over the previous two quarters. As a result, total investment abroad by local investors amounted to S$30.6 billion in 2001, which more than offset the S$26.9 billion direct investment inflow into Singapore, leading to a net outflow from the direct investment account for the first time in over thirty years. These large acquisitions abroad led in turn to high demand for US$ by Singtel and DBS, and contributed to significant downward pressure on the Singapore dollar in 2001. In comparison, foreign acquisitions of local companies, such as the Solectron deal in 2000, would have had the opposite effect. In this case, the high demand for S$ resulted in MAS’ intervention to dampen the strong appreciation of the domestic currency, and keep the trade-weighted index within its policy band. Portfolio Investment 40 The portfolio investment component of the financial account covers transactions in equities, other securities, and financial derivatives – except when these transactions relate to the direct investment or reserve assets components of the financial account. The essential characteristic of these instruments is that they are traded. That is, they offer investors the flexibility to shift – regardless of the underlying maturity of the instrument invested – capital from one instrument to another. 41 In Singapore, the portfolio investment account has consistently recorded large net outflows over the years, especially since the Asian crisis. (Chart 3.4) Indeed, this appears to be the main channel by which the sizeable public sector surpluses, as well as net saving from the private sector, are recycled abroad. The portfolio investment account is divided into the official and “other sectors” categories. Official outflows reflect the government's investment abroad, while the latter is largely due to resident investors purchasing equities and debt instruments overseas. Prior to 2000, the official outflows comprised the bulk of the overall net portfolio outflows. Since then, however, the size of private sector outflows has risen significantly and contributed a larger proportion of the net portfolio outflows. MONETARY AUTHORITY OF SINGAPORE 25 MAS Staff Paper No. 33 August 2004 Chart 3.4 Gross Inflows and Outflows for Portfolio Investment 10 10 Inflows 5 0 % of GNI S$ Billion 0 -5 -10 -5 -10 -15 Outflows -15 -20 -25 1972 Outflows 5 Inflows 1978 1984 1990 1996 2003 -20 1972 1977 1982 1987 1992 1997 2003 42 The size of net official outflows has been fairly large and stable, averaging around S$11.8 billion over the period 1993-99. This mainly reflected the government's overseas investments in foreign equity and debt, as the sizeable public sector budget surpluses over this period were channelled abroad. In comparison, the size of net outflows from the private sector was significantly smaller, averaging S$4.3 billion each year between 1993-99. 43 Nevertheless, in recent years, the composition of portfolio investment outflows has shifted, with outflows from the private sector exceeding official outflows. (Chart 3.5) Since 2000, the size of these private sector outflows has risen sharply to average S$11.8 billion per year, while that of official outflows has dipped to S$8.0 billion during the same period. Not only has the increase in private sector outflows reflected increased investment by local investors in foreign debt and equity markets, it has also reflected the pullback of foreign investors from the local stock market, particularly in the last two years. Chart 3.5 Outflows of Portfolio Investment 5 Private Public 0 S$ Billion -5 -10 -15 -20 -25 1993 MONETARY AUTHORITY OF SINGAPORE 1995 1997 1999 2001 2003 26 MAS Staff Paper No. 33 August 2004 Other Investment 44 The “other investment” account is a residual category that includes all financial transactions not considered direct investment, portfolio investment, or reserve assets. In Singapore, the "other investment" category comprises mainly loans, currency and deposits, and inter-company debts. These largely reflect the flows between the banking sector as well as other non-bank sectors and their foreign counterparts (including the Asian Dollar Market), and are driven by their financing requirements and investment decisions. Given the nature of such flows, they can be fairly volatile and easily reversible, with their direction varying from quarter to quarter. The absolute size of such flows has increased significantly, especially since the Asian crisis. On the whole, the “other investment” balance has tended to record net outflows (with the exception of 1990, 1993, 1996 and 1997 due to the large interbank inflows). (Chart 3.6a) Chart 3.6 Other Investment Balance (a) Gross Inflows and Outflows (b) Components 80 30 60 Net Official Flows Net Other Sector Flows Net Bank Flows 20 Inflows 10 % of GNI S$ Billion 40 20 0 0 -10 -20 Outflows -40 Net Outflows -60 -20 -30 1980 1986 1992 1998 2003 1980 1986 1992 1998 2003 45 Flows from this category can be divided into three sectors, namely the banking, official, and other sectors. (Chart 3.6b) The banking sector records the foreign assets and liabilities of commercial banks, including interbank assets and liabilities with Asian Currency Units (ACUs) and foreign commercial banks. 46 Other sectors include individuals, non-bank financial institutions (e.g. merchant banks, finance companies) and other companies. Transactions of non-bank residents with ACUs are also included here. The other sectors have generally recorded net outflows in recent years, mainly due to the consistently large outflows of residents' deposits to ACUs and other MONETARY AUTHORITY OF SINGAPORE 27 MAS Staff Paper No. 33 August 2004 foreign institutions that are recorded on the asset side. This has typically more than offset the gross inflows due to loans from ACUs and other foreign creditors, which are recorded on the liability side. 47 Prior to the crisis, the size of net flows from the “other investment” category could range from an inflow of S$4.0 billion to an outflow of as high as S$7.8 billion, bringing the overall average to S$0.2 billion for 1990-97. Since the crisis, however, the size of net outflows has averaged S$16.2 billion a year, surging to over S$20 billion each year in 1998-99 before moderating somewhat in the subsequent years. Most recently, net outflows from “other investment’ hit a new high of S$35.0 billion in 2003, reflecting increased placement of funds abroad by non-financial institutions and individuals. This was due to both a higher outflow of funds from residents to ACUs, as well as increased external lending abroad by companies. 3.3 PERSISTENCE OF CAPITAL FLOWS 48 In this section, we briefly examine the different components of the financial account to determine whether they are “hot” (volatile and easily reversible) or “cold” (persistent and permanent) flows. As a first step, we present in Table 3.1 the summary statistics of the quarterly financial account flows. Table 3.1 Summary Statistics on Components of Capital and Financial Account Balance, 1990Q1-2003Q4 Mean (S$ million) Standard Deviation (S$ million) Coefficient of Variation (%) Average Share in Capital and Financial Account (%) -3,407.6 5518.6 162 100 -50.6 29.2 58 2 Foreign Direct Investment 1,656.2 3578.7 216 -49 Portfolio Investment -3,255.6 2232.8 69 95 Other Investment -1,757.6 6383.1 363 52 Capital and Financial Account (net) Capital Account MONETARY AUTHORITY OF SINGAPORE 28 MAS Staff Paper No. 33 August 2004 49 From the computed coefficient of variation7, the capital account and portfolio investment flows appear to be less volatile than foreign direct investment and “other investment” flows. While the relatively high degree of volatility for “other investment” flows is not surprising, that for direct investment flows might initially appear somewhat unexpected. Nevertheless, a closer characterisation of capital flows into “hot” or “cold” would require an examination of the persistence and reversibility characteristics of the flows (Claessens, Dooley and Warner (1995)). 50 We calculate the autocorrelations for each type of capital and financial account transaction. A “cold” capital flow is represented by a series of large and positive autocorrelations. Alternatively, a “hot” money flow is one that is subject to quick reversibility, and therefore, its autocorrelations would show alternating signs. 51 Chart 3.7 displays the quarterly autocorrelations for each type of capital flows calculated over the sample period 1990Q1 to 2003Q4. Portfolio investment flows show signs of persistence as highlighted by the positive autocorrelations for a number of quarterly lags. This provides evidence that a substantial amount of these flows are actually long-term investment by private and government entities in bonds, equities and acquisition of companies abroad. 52 In comparison, the alternating signs of the “other investment” autocorrelations point towards the quick reversal of fund flows in and out of the banking system. This result is also unsurprising, given that such flows are especially volatile and “hot”, as funds move in and out of the banking system relatively quickly and are highly responsive to exchange rate and interest rate movements. 53 Finally, the autocorrelations of net FDI flows show that they are transitory in nature. This seems to contradict the usual perception that direct investment consists of mostly "cold" or more persistent flows, since they should reflect strategic, long-term interests of investors. However, in Singapore, the volume of outward direct investment can be substantial, and the timing of the outward flows may tend to offset the relatively stable inward flows such that, on a net basis, the overall series appears to lack persistence. 7 The coefficient of variation is a measure of relative dispersion and is given by: coefficient of variation = standard deviation/mean. It is generally expressed as a percentage. The use of the coefficient of variation lies partly in the fact that the mean and standard deviation tend to change together in many experiments. MONETARY AUTHORITY OF SINGAPORE 29 MAS Staff Paper No. 33 August 2004 Chart 3.7 Autocorrelations of Net Capital Flows, 1990Q1 – 2003Q4* 1.5 0.4 0.5 0.0 Net Portfolio Investment Account -0.5 0.2 0.1 0.0 -0.1 Net Other Investment Account -0.2 -1.0 Autocorrelation Autocorrelation 1.0 Autocorrelation 0.5 0.3 -0.3 -1.5 -0.4 1 6 11 16 21 26 31 Lag 36 0.4 0.3 0.2 0.1 0.0 -0.1 Net Direct Investment Account -0.2 -0.3 -0.4 -0.5 -0.6 1 6 11 16 21 26 Lag 31 36 1 6 11 16 21 26 Lag * Dotted red lines represent two times the estimated standard errors 54 It is important to gauge the degree of permanence of capital inflows into Singapore, since their reversibility can potentially generate high adjustment costs arising from resource allocation, sunk costs or other market imperfections. Therefore, we focus on assessing the permanence or persistence of gross inflows (as opposed to net flows) over the period 19902003. In particular, we compare the persistence of capital flows across three broad categories, namely, portfolio inflows, foreign direct investment inflows, and “other investment” flows which capture both bank and corporate/individual flows. 55 We examine the persistence of capital flows using the unobserved components model suggested by Harvey (1981, 1989).8 This model allows the inflows to be broken down into its permanent and temporary components using maximum likelihood estimation. The relative contribution of each component is given by the estimated variance parameters. If a large and statistically significant proportion of the variation in flows is attributed to the permanent component, we would expect a large part of the capital flows to remain in the country for an indeterminate period of time. In comparison, if a large portion of the variation is explained by movements in the temporary components, this indicates a higher degree of potential reversibility. 56 Our results in Chart 3.8 show that the permanent component is largely responsible for most of the variation in direct investment inflows. This is consistent with the view that FDI inflows are more persistent and largely permanent in nature. It also lends credence to the earlier observation that the 8 These methods were applied by Sarno and Taylor (1999), to gauge the relative importance of the permanent and temporary components of capital flows to Latin American and Asian developing countries over the period 1988-97. MONETARY AUTHORITY OF SINGAPORE 30 31 36 MAS Staff Paper No. 33 August 2004 unexpectedly low persistence in net direct investment flows is mainly due to the size and volatility of outflows. Chart 3.8 Relative Contribution of the Persistent and Temporary Components to the Total Variation in Inflows 100 Estimated SD of error term : Per Cent of Total Permanent Component 80 Temporary Component 60 40 20 0 Portfolio Investment Direct Investment Other Investment 57 Similarly, changes in portfolio inflows are also dominated by the permanent component. The high degree of persistence for portfolio inflows provides evidence that a substantial amount of these flows are actually longterm investment by foreign entities in domestic bonds and equities and acquisition of companies. In comparison, we find that “other investment” inflows appear to contain a relatively large temporary component, which indicate that such flows are highly volatile and easily reversible. MONETARY AUTHORITY OF SINGAPORE 31 MAS Staff Paper No. 33 August 2004 4 SINGAPORE’S OVERALL BALANCE OF PAYMENTS 4.1 UNDERSTANDING THE BALANCE OF PAYMENTS 58 As mentioned earlier, under a floating exchange rate system, a net surplus on current account transactions would be exactly matched by a net deficit on international capital and financial transactions. (That is, CAB + KAB = 0.) In theory, any imbalances between the current and capital and financial account flows would be adjusted automatically through movements in the exchange rate. 59 Under a managed exchange rate system, any mismatch between both sides of the external accounts (i.e. current and capital/financial transactions) is known as the overall balance of payments (BOP). (That is, CAB + KAB = BOP.) This overall balance of payments is measured by changes in the value of official reserve assets, or MAS’ holdings of foreign currency assets. Foreign exchange intervention operations and swap operations by the MAS facilitate the conversion into Singapore’s official foreign reserves (OFR). Chart 4.1 Official Foreign Reserves 25 180 150 Overall BOP (LHS) 15 10 120 90 Change in Stock of OFR (LHS) 5 0 60 30 Stock of OFR (RHS) -5 1965 4.2 S$ Billion S$ Billion 20 0 1971 1977 1983 1989 1995 2003 HISTORICAL TRENDS IN THE OVERALL BOP AND OFR ACCUMULATION 60 With current account surpluses exceeding capital and financial account deficits, Singapore’s overall BOP has been positive for almost every year since 1966 (with the exception of 2001), thus allowing for a build-up of MONETARY AUTHORITY OF SINGAPORE 32 MAS Staff Paper No. 33 August 2004 foreign reserves. Nevertheless, we observe that the overall BOP surplus has shrunk in the post-crisis period, reflecting larger capital outflows from the capital and financial account in recent years, which have offset a greater part of the inflows from the current account. (Chart 4.2) Chart 4.2 Overall Balance of Payments (a) S$ Billion (b) % of GNI 60 40 40 Overall Balance of Payments Current Account Balance 20 % of GNI S$ Billion 20 0 Capital & Financial Account Balance -20 Overall Balance of Payments Current Account Balance Capital & Financial Account Balance 30 10 0 -10 -20 -40 -30 -60 -40 1980 1984 1988 1992 1996 2000 2003 1980 1984 1988 1992 1996 2000 2003 61 In line with the rise in the current account surplus over the years, the size of the overall BOP surplus has increased from an average of 6.6% of GNI in the 1980s to around 10% of GNI between 1990-97. Since then, however, it has fallen to around 3.3% of GNI in the post-crisis period of 19982002. More recently, the overall BOP has risen to 7.5% (or S$11.8 billion) in 2003, largely reflecting the surge in the current account surplus due to the strong export-led recovery. 62 In line with these developments, we also observe a rapid accumulation of OFR from 1990-97, averaging S$10.1 billion per year. Over this period, the strong growth of the Singapore economy, and widening of the current account surplus resulted in upward pressures on the domestic currency. Institutional factors like the sizeable fiscal surpluses and contributions to the CPF which implied a withdrawal of liquidity from the banking system, also put additional upward pressure on the S$. This led the central bank to intervene (by “leaning against the wind”) to dampen the S$ appreciation, which contributed to the build-up of OFR. 63 Subsequently, however, the rate of OFR accumulation slowed to around S$4.6 billion per year in the post-Asian crisis period of 1998-2002, as the overall BOP surpluses declined mainly due to increased outflows from the capital account. During this period, the frequency of shocks hitting the MONETARY AUTHORITY OF SINGAPORE 33 MAS Staff Paper No. 33 August 2004 Singapore economy increased and the domestic currency experienced more episodes of speculative pressure. As a result, the MAS had to intervene to stem the downward pressure on the S$ exchange rate.9 These developments moderated the rate of OFR accumulation over this period. 64 In 2003, the BOP surplus surged to S$11.8 billion, reflecting a sharp rise in the current account surplus, which was underpinned by a turnaround in the external environment and strong export recovery. The improved domestic economic outlook in the second half of 2003, coupled with the general weakness in the US$, exerted strong upward pressure on the S$. In the later part of the year, MAS intervened to keep the trade-weighted exchange rate stable within its lower, re-centered band, so as to support the incipient economic recovery amidst benign inflationary pressures.10 Singapore’s OFR increased by about S$20 billion for the year as a whole.11 9 The small BOP deficit in 2001 reflected a sharp rise in outflows from the financial account, which more than offset the increase in the current account surplus. The larger financial account deficit was mainly due to a surge in outward direct investment that year, as M&A activity picked up strongly. This M&A activity in turn led to strong demand for US$ in the foreign exchange market. 10 Please see MAS Monetary Policy Statement, 12 April 2004. 11 The difference between the OFR and overall BOP figure is primarily due to valuation gains and losses. MONETARY AUTHORITY OF SINGAPORE 34 MAS Staff Paper No. 33 August 2004 APPENDIX 1 ASSESSING THE RELATIVE IMPORTANCE OF PERMANENT AND TEMPORARY COMPONENTS OF CAPITAL FLOWS This appendix briefly describes the methodology used to examine the permanence of various categories of capital flows to Singapore over the period 1990-2003. Capital flows are classified into three broad categories: portfolio flows; foreign direct investment, whereby a firm largely owned by foreign residents acquires or expands a factory or subsidiary firm located in Singapore; and “other investment” flows which capture both bank and corporate/individual flows. We analyse the time series properties of these various categories of flows and in particular, their degree of persistence using maximum likelihood Kalman filtering techniques. It allows the time series to be broken down into unobserved permanent and temporary components. Sarno and Taylor (1999)12 used this approach to gauge the relative importance of permanent and temporary components of capital flows to Latin American and Asian developing countries. The unobserved components model may be written as: fit = uit + vit + eit i= 1,..., N; t=1,..., T (1) where f may be any of the financial and capital account component, u is a trend component, e is the irregular component which is approximately normally independently distributed with zero mean and constant variance, and v represents a first order autoregressive, AR(1) component. Intuitively, equation (1) expresses the capital flow as the sum of a permanent component (u), a purely temporary, zero persistence component (e) and a more slowly decaying temporary component (v). Thus the model separates out the persistent and temporary components of the data in a general comprehensive fashion. The estimation of the unobserved components model is done in a state space form. The estimated variance parameters are then assessed to indicate the relative contribution of each component in the 12 L. Sarno, M.P. Taylor, (1999), Hot money, accounting labels and the permanence of capital flows to developing countries: an empirical investigation, Journal of Development Economics, Vol. 59, pp 337-364. MONETARY AUTHORITY OF SINGAPORE 35 MAS Staff Paper No. 33 August 2004 state vector to explaining the total variation in the time series under consideration. These estimated variances provide information on the size of the nonstationary and the stationary components in the series and help quantify the degree of persistence of the series in question. If a large and statistically significant proportion of the variation in flows is attributed to the stochastic trend level (u), for example, then we expect that a large part of the capital flows will remain in the country for an indeterminate period of time. In comparison, if a large portion of the variation in the time series is explained by movements in the temporary components (e) or (v), then the capital flows under consideration may be regarded as characterised by low persistence, indicating a higher degree of potential reversibility. Results Table 1 classifies the various model specifications estimated for the different categories of capital flows to Singapore. The most appropriate model for each component is made on the basis of the goodness of fit criteria. Table 2 shows the results of estimating the most appropriate structural time series model in state space form by the Kalman filter maximum likelihood method. In the second and third columns of Table 2, details of the unobserved components included in the estimated structural time series model are reported. The fourth column shows the estimated standard deviations (SD) of the disturbances of the stochastic components. The last column contains the estimated AR(1) coefficient (the damping factor ρ), which provides evidence on the degree of persistence of the stationary AR(1) component of the model. MONETARY AUTHORITY OF SINGAPORE 36 MAS Staff Paper No. 33 August 2004 Table 1 Structural Time Series Models Adopted in Modelling Capital Flows Model 1: Stochastic level (no slope) + AR(1) ft = µt + νt µt = µt-1 + ηt νt = ρννt-1 +ξt ρν<1 Model 2: Stochastic level (no slope) + irregular component ft = µt + εt µt = µt-1 + ηt Model 3: Stochastic level (no slope) + AR(1) + irregular component ft = µt + νt + εt µt = µt-1 + ηt νt = ρννt-1 +ξt ρν<1 Model 4: Stochastic level (fixed slope) + AR(1) + irregular component ft = µt + νt + εt µt = µt-1 + β + ηt νt = ρννt-1 +ξt ρν<1 Model 5: Stochastic level (fixed slope) + irregular component ft = µt + εt µt = µt-1 + β + ηt Model 6: Stochastic level (fixed slope) + AR(1) ft = µt + νt µt = µt-1 + β + ηt νt = ρννt-1 +ξt ρν<1 MONETARY AUTHORITY OF SINGAPORE 37 MAS Staff Paper No. 33 August 2004 Table 2 Results of Unobserved Components Model Estimation using Gross Inflows Investment Inflow Category Model Portfolio 2 Direct 2 Other 3 Components Stochastic level, Irregular Stochastic level, Irregular Stochastic level, AR(1), Irregular Estimated SD of error term Level: 0.098 Irregular: 0.061 Level: 0.202 Irregular: 0.123 Level: 0.323 AR(1): 3.100 Irregular: 3.105 Estimated AR parameter, ρν 0.370 The results (Column 4) show that for portfolio and direct investment inflows, the permanent component has a higher variance compared to the variance of the irregular component. This is clearly consistent with our prior reasoning that FDI inflows are largely permanent in nature. The high degree of persistence for portfolio inflows provide evidence that a substantial amount of these flows could actually be long-term investment by foreign private and government entities in bonds, equities and acquisition of companies. This suggests that both these types of flows are relatively more sensitive to the long-term structural forces relating to Singapore’s performance. In comparison, “other investment” flows, which comprise of inter-bank, corporate and household flows, are more volatile and appear to contain a relatively large temporary component. MONETARY AUTHORITY OF SINGAPORE 38