Singapore
2007 Article IV Consultation: Staff Report; Staff Supplement; and Public Information Notice on the Executive Board Discussion

Singapore’s recent economic performance has been impressive, underpinned by prudent macroeconomic management. Economic activity remains strong despite a softening in external demand. On the demand side, domestic demand strengthened driven by private consumption and investment while net exports were broadly unchanged during the first half of 2007. It has been noted that the exchange-rate-based monetary policy framework has served Singapore’s small, open economy well. As inflation expectations are well anchored, they agreed that the present monetary policy stance of targeting a gradual nominal effective exchange rate appreciation remains appropriate.

Abstract

Singapore’s recent economic performance has been impressive, underpinned by prudent macroeconomic management. Economic activity remains strong despite a softening in external demand. On the demand side, domestic demand strengthened driven by private consumption and investment while net exports were broadly unchanged during the first half of 2007. It has been noted that the exchange-rate-based monetary policy framework has served Singapore’s small, open economy well. As inflation expectations are well anchored, they agreed that the present monetary policy stance of targeting a gradual nominal effective exchange rate appreciation remains appropriate.

I. Recent Developments and Outlook

1. Singapore’s economy has become increasingly resilient to changing global conditions, supported by pragmatic macroeconomic management and ongoing structural reform. Since the last Article IV consultation, economic performance has been impressive.

  • Real GDP growth reached 7.9 percent in 2006, underpinned by solid external demand and a pick up in domestic demand. (Figure 1 and Table 1). On the supply side, growth was driven by high value-added sectors (pharmaceuticals, transport engineering and the financial sector) and a recovery in construction supported by credit growth (Table 2). In the first quarter of 2007, growth moderated reflecting softening external demand but remained robust at about 6 percent (y/y) mainly driven by private investment.

  • Inflation has been subdued, reflecting benign domestic cost pressures. Wage growth has been modest despite the strong employment gains, although certain sectors, such as financial services, have experienced more rapid wage growth.

  • Financial and property markets have been in general orderly, and risks appear contained despite the global turbulence experienced in March 2007 (Figure 2 and Table 3). While high-end private residential property prices have recently risen sharply, price increases in the other segments of the property market have been modest.

  • The current account surplus widened further in 2006, reflecting strong export growth (Figures 3 and Table 4). Concurrently, net capital inflows surged to an estimated $18 billion in 2006 (minus $9 billion in 2005).1 Inflows largely reflect: (i) favorable growth prospects for Singapore and the ongoing appreciation of the Singapore dollar, which have increased the attractiveness of Singapore assets; (ii) increasing use of the Singapore dollar as a proxy for the strengthening major regional currencies; and (iii) greater foreign investor participation in the high-end property market.

  • The monetary policy stance has been kept on a tightening bias since April 2004, targeting a modest and gradual appreciation of the NEER. The Singapore dollar has appreciated by about 5 percent in nominal effective terms (2 percent in real effective terms) since the beginning of 2006, and has hovered near the upper bound of the policy band.

  • Fiscal performance in FY 2006 (ending March 2007) was better than envisaged in the budget (Table 5). This was largely due to higher receipts from government property sales and tax revenue gains associated with strong growth, as well as slower-than-planned development spending and net lending. The fiscal impulse was positive, mostly reflecting large one-off income transfers.

Figure 1.
Figure 1.

Singapore: Real Sector Developments

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

Source: CEIC Data Co. Ltd.
Table 1.

Singapore: Selected Economic and Financial Indicators, 2000–08

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Sources: Data provided by the Singapore authorities; and Fund staff estimates and projections.

Fiscal year beginning April 1.

In months of following year’s imports of goods and services.

IMF Information Notice System monthly index (2000 full-year average = 100).

Latest observations as of April 2007.

Table 2.

Singapore: Monetary Survey, 2000–07

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Source: IMF, International Financial Statistics.

Claims on public sector minus deposits.

Including other non-bank financial institutions.

Figure 2.
Figure 2.

Singapore: Financial and Asset Market Developments

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

Sources: CEIC Data Co. Ltd.; and Bloomberg.
Table 3.

Singapore: Indicators of Vulnerability, 2000–06

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Sources: Data provided by the Singapore authorities; and IMF, Information Notice System.

Ratings of the three major local banks.

In percent of global non-bank loans.

The underlying price indices are computed based on the Laspeyres method and are 4-quarter moving averages.

Figure 3.
Figure 3.

Singapore: External Developments

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

Source: Singapore, Department of Statistics.
Table 4.

Singapore: Balance of Payments, 2000–08 1/

(In billions of U.S. dollars)

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Sources: Monetary Authority of Singapore, Economic Survey of Singapore; and Fund staff estimates and projections.

Data for the current account balance, the capital and financial account balance, and net errors and omissions are converted to U.S. dollars from the official presentation in Singapore dollars using the period-average exchange rate.

Including net errors and omissions and excluding capital flows associated with changes in the MAS’ forward position.

Table 5.

Singapore: Summary of Government Operations, 2002/03–2007/08 1/

(In percent of GDP)

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Sources: Data provided by the Singapore authorities; and Fund staff estimates and projections.

Fiscal year runs from April 1 through March 31.

Includes investment income from government assets (interest rates and dividends), including interest earnings on development loans.

Sale of government property.

Includes land reclamation expenditure.

Includes transfers to the Endowment Funds: Edusave, Medical, Lifelong Learning, and ElderCare.

Overall balance excluding investment income, capital revenue, debt service, net lending, and fund transfers.

Primary balance adjusted for cyclical impact on revenues associated with deviation between actual and potential economic output.

Change in the structural primary balance.

Data for end of calendar year. The table reports gross debt and does not reflect large net asset position of the government. Gross debt is issued to the Central Provident Fund (CPF) and as part of the Singapore Government Securities (SGS) program.

uA01fig01

Private Residential Property Price

(Index by segments, 2004Q1=100)

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

uA01fig02

Nominal and Real Effective Exchange Rate

(2000=100)

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

uA01fig03

Fiscal Performance

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

2. The near-term economic outlook is generally favorable. Growth is projected to be about 6 percent for 2007–08. Domestic demand would remain strong, driven by buoyant investment, including large construction-related projects. On the supply side, the slowdown in the electronics sector in line with softening global demand would be partly offset by resilience in the services sector, particularly financial services. Risks to this outlook are broadly balanced, as downside risks related to a severe downturn in the U.S. housing market, a disorderly unwinding of global imbalances, and an avian flu pandemic may possibly be offset by stronger growth in the financial services and construction sectors as well as among Singapore’s regional trade partners.

3. Medium-term growth prospects depend on a further deepening of structural reform. In response to increasing competition from low-cost economies, Singapore has pursued structural changes by promoting higher value-added activities, lowering business costs, and increasing labor market flexibility. Predicated on a continuation of these reforms, staff expects that GDP would grow in line with potential at around 5½ percent over the medium term (Table 6).

Table 6.

Singapore: Medium-Term Scenario, 2004–12

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Sources: Data provided by the Singapore authorities; and Fund staff estimates and projections.

Contribution to GDP growth.

On a calendar year basis.

In months of next year’s imports of goods and services.

II. Report on Discussions—Common Ground and Exchanges of Views

4. Given the generally favorable economic conditions, this year’s consultation was streamlined. Policy discussions focused primarily on the medium-term challenges related to globalization but also covered several near-term macroeconomic policy issues

A. Medium-Term Policies—Meeting the Challenges of Globalization

5. Globalization has benefited Singapore but also posed challenges. The country has enjoyed export market expansion and growth as an international financial center. Nonetheless, globalization has led to increased competitive pressures from low-cost countries and stagnant wages among low-skilled workers. Structural policies should continue to focus on sustaining robust economic growth, addressing rising income inequality, and ensuring continued growth and stability of the financial sector.

Sustaining Robust Economic Growth

6. The authorities recognize the challenges to sustaining robust growth. They plan to build on the past notable reform progress by continuing their efforts to: (i) promote high value added sectors; (ii) encourage research and development; (iii) strengthen human capital; (iv) enhance labor market flexibility; and (v) lower business costs.

7. While noting Singapore’s past success in fostering competitiveness, staff expressed concern about the extensive use of tax incentives. The FY 2007 budget includes a lowering of the CIT rate from 20 percent to 18 percent in January 2008 and further expansion of tax exemptions. Given their potential to distort economic decisions and the low level of effective taxation by international standards, staff recommended that tax incentives be streamlined to improve tax efficiency. The authorities noted that they had to respond to the highly competitive international tax environment but assured that a careful cost-benefit analysis is undertaken before granting tax incentives.

uA01fig04

Cross-Country Comparison of Effective CIT Rates

(in percent)

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

8. A level playing field is key to further promoting private sector growth. Public sector ownership in government-linked companies (GLCs) across a broad range of economic activities may stifle competition and private entrepreneurship. Therefore, staff recommended that the divestment of nonstrategic GLCs be accelerated in line with the recommendations of the government-sponsored Economic Review Committee. The authorities stressed that GLCs are run on a commercial basis and their strategic importance is constantly being evaluated.2 Moreover, the Competition Commission, which enforces and administers the Competition Act of 2004, is now fully operational.

Addressing Rising Income Inequality

9. The authorities shared staff’s concern about weak wage growth for low-skilled workers, which has contributed to growing income inequality as evidenced by the rising Gini coefficient. To address this concern, the authorities have introduced the Workfare Income Supplement (WIS) scheme in the FY 2007 budget.3 While recognizing the WIS as an important step to strengthen the social safety net, staff suggested that the authorities consider introducing an unemployment insurance scheme, which would not only provide individual income protection but also work as an automatic stabilizer for the broader economy. To minimize work disincentives, benefits could be subject to participation in active-labor-market programs, have limited duration, and cover mostly basic needs. The authorities reiterated their long-standing view that work is the best form of welfare. However, they did not rule out the possibility of broadening the social safety net in the future, noting that the WIS will be reviewed in 3 years.

uA01fig05

Singapore: Gini-Coefficient

Employed Households

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

10. Given Singapore’s aging population, staff welcomed the Central Provident Fund (CPF) reform measures taken in recent years to enhance financial security in retirement. For low-income households, the CPF is the main source of retirement income. However, income replacement rates are relatively low,4 partly reflecting modest returns on CPF savings. In this regard, staff welcomed the recent steps to reduce charges on new investments under the CPF Investment Scheme (CPFIS) and continuing efforts to promote investor education to increase the use of the CPFIS. Staff recommended that the authorities explore options allowing more (but simple) risk-return options for CPF savings.

Safeguarding Financial Sector Growth and Stability

11. The financial system is sound, and no short-term risks are evident (Figure 4 and Table 7). The health of the system has been supported by the improving financial position of banks, corporates, and households. Banks are well-capitalized, and profitability and asset quality have continued to improve. Bank exposures to the property and equity markets have risen but risks are manageable. Corporate profitability has also increased, and households’ liability-to-asset ratio has dropped further.

Figure 4.
Figure 4.

Singapore: Financial Sector Developments

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

Sources: CEIC Data Co. Ltd.; and the Monetary Authority of Singapore.
Table 7.

Singapore: Financial Soundness Indicators: Local Banking Sector, 2000–06

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Source: Monetary Authority of Singapore.

12. Most of the 2004 FSSA recommendations have now been implemented and adoption of Basel II is on track for early 2008 (Table 8). Recent measures include further lowering the minimum Tier-1 capital requirement for banks; amendments to the MAS Act, which clarified the MAS’ functions and objectives; and amendments to the Banking Act, including regulations related to large exposure limits. Staff stressed that reporting lags on corporate and household balance sheets and income statements should be reduced.

Table 8.

Singapore: FSSA Recommendations

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13. The authorities appropriately view safeguarding financial sector growth and stability as crucial to Singapore’s heightened role as a global financial center. The MAS is continuing its efforts to improve risk-management capabilities of local banks and to enhance cross-border supervision of local banks’ overseas operations through supervisory cooperation with other countries. While local banks’ direct exposures to the rapidly growing asset management industry appear limited, indirect exposures through international banks and counterparties have likely increased, underscoring the need to strengthen cross-border risk management in financial institutions and monitoring by the authorities.

B. Macroeconomic Policies

Fiscal Policy

14. Sustained prudent fiscal policy has been an important pillar for Singapore’s economy. With large fiscal reserves, Singapore has been able to weather a series of adverse shocks and is well-prepared to accommodate the fiscal costs associated with an aging population and to meet the challenges associated with globalization.

15. The FY 2007 budget includes a number of important measures such as a shift toward indirect taxation and new permanent transfers to low-income households. Notwithstanding a cut in corporate income taxes, new income transfers and measures offsetting a hike in the goods and services tax (GST),5 the budget is slightly contractionary by staff estimates, partly reflecting the large one-off expenditures in the previous budget. Staff encouraged further front-loading of the GST-offset measures if the impact of the GST hike on consumption is larger than envisioned. The authorities stressed that the offset package in the budget should more than compensate for the impact on consumption, especially for low-income families.

16. Over the medium term, the large net fiscal reserves provide scope for a greater fiscal expansion to address issues related to aging and rising income inequality.6 While welcoming plans to expand spending on health care, education, and infrastructure, to be financed partly by capital gains on fiscal reserves, staff noted that the social safety net could be further expanded without undermining long-term fiscal sustainability.

17. Further improvement in the transparency of public finances is desirable. Staff welcomed the authorities’ agreement to undertake a fiscal ROSC in 2008 and the continued publication of annual reviews of Temasek’s operations. Steps should be taken to compile and publish consolidated public sector accounts, including more information on the financial position of the Government of Singapore Investment Corporation (GIC).

Exchange Rate and Monetary Policy

18. Singapore’s monetary policy framework centered on the management of the exchange rate has served the economy well, keeping inflation low in support of impressive growth (Box 1). Nevertheless, the surge in capital inflows meant that the MAS had to step up foreign exchange intervention to keep the NEER within the policy band. At the same time, the MAS sterilized the net liquidity impact of its foreign exchange intervention mainly through foreign exchange swaps. As a result, gross official reserves rose to $140 billion by end-April 2007 ($117 billion at end-2005), and the MAS’ forward position stood at $66 billion ($21 billion). The authorities noted that the MAS’ large forward position does not pose risks to the financial system given the MAS’ strong balance sheet and risk management as well as the depth of the swap market.

19. With inflation expectations well anchored, the authorities and staff saw no compelling reason to adjust the monetary policy stance at this moment. However, staff suggested that if large capital inflows persist, the MAS should refrain from sterilization. This would help reduce capital inflows, easing the need for foreign exchange intervention. The authorities did not see the need for adjusting their liquidity management (sterilization), stressing that the MAS’ money market operations are aimed at ensuring adequate liquidity in the banking system to meet banks’ demand for reserve and settlement balances and that interest rates are not their monetary policy instrument. They noted that within the exchange rate centered framework, interest rates could adjust on market expectations of the future path of the Singapore dollar without any shift in the MAS’ liquidity management. On the recent property price increase, the authorities noted that it has been largely confined to the high-end segment and they are monitoring the situation closely. They added that rather than using monetary policy, there are targeted prudential and administrative measures, which could be used to effectively curb excessive property price increases if deemed necessary.

Singapore’s Monetary Policy Operations

Since 1981, monetary policy has centered on the management of the exchange rate, which is used as a nominal anchor.1 The primary objective of monetary policy is to maintain price stability in support of sustainable economic growth. To achieve this objective, the MAS intervenes in the foreign exchange market to maintain the Singapore dollar against an undisclosed trade-weighted basket of currencies of Singapore’s major trading partners and competitors broadly within an undisclosed (width and rate of crawl) policy band. The MAS reviews this policy band semiannually and adjusts it if necessary to ensure its consistency with economic fundamentals and market conditions.

Money market operations are aimed at ensuring adequate liquidity in the banking system, which has helped contain interest rate volatility. All banks in Singapore are required to keep zero-interest minimum cash balances (MCB) with the MAS at 3 percent of their liabilities base to meet daily reserve requirements and settlement balance requirements. Intraday fluctuations in the MCB may range from 2 to 4 percent, but the average MCB ratio cannot be less than 3 percent over the maintenance period of two weeks. Banks may choose to set aside additional cash balances with the MAS, usually depending on the level and volatility of interest rates. In the event of a liquidity shortage, banks can borrow from the MAS’ lending facilities. The MAS conducts money market operations exclusively with Singapore Government Securities (SGS) primary dealers through the use of three instruments: foreign exchange swaps (most used); direct borrowing/lending with banks; and SGS repos.

1 See Monetary Policy Operations in Singapore (MAS, April 2007) www.mas.gov.sg/publications/monographs/Monetarv Policy Operations in Singapore.html.

20. It was agreed that the large current account surplus can be explained mainly by structural and cyclical factors (Box 2). Assuming an unchanged real effective exchange rate, the current account surplus as a percent of GDP is projected to narrow somewhat over the medium term as the recovery in private investment continues and corporate savings decline partly due to more modest profit growth, but would still remain large. With regard to the exchange rate, the authorities expressed the view that based on their empirical analysis, its level appeared broadly in line with fundamentals. They added that this finding was consistent with the absence of high inflation, excessive wage pressures, and disorderly asset market conditions—usual signs of exchange rate undervaluation.

What is Driving the Current Account in Singapore?

Since 1980, Singapore’s current account balance shifted considerably, from large deficits to sizable surpluses, as the country developed rapidly.

During 1980–98, the shift to current account surpluses occurred in tandem with significant changes in the structural determinants of savings and investment. Throughout this period, savings remained high, supported by rising income levels, sizeable government savings (averaging 10 percent of GDP in 1990–98), and a gradual increase in the working-age dependency ratio, which helped sustain household savings. Meanwhile, investment fell as Singapore moved from manufacturing such as oil refining, which typically requires large capital outlays, to electronics. Moreover, the end of the infrastructure-led investment boom in the late 1980s also led to a gradual decline in construction-related investment to an average of 17 percent of GDP during 1990–98 (25 percent of GDP during 1980–85), further contributing to the increase in the current account surplus. During this period, the real effective exchange rate fluctuated, showing no clear correlation with the current account.

uA01bx02fig01

Savings, Investment, the Current Account, and the REER

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

During 1999–2002, the current account surplus declined substantially, as the fall in savings outpaced the decline in investment. The decline in savings reflected (i) lower corporate profitability and the restructuring of the corporate sector; (ii) lower government savings as a result of countercyclical fiscal policy; and (iii) an estimated decline in household savings as growth slowed. The fall in investment was mainly due to a continued drop in construction-related investment.

uA01bx02fig02

Fixed Capital Formation

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

uA01bx02fig03

Savings

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

Since 2003, the current account surplus has rebounded significantly. Corporate savings recovered as corporate profitability improved sharply on the back of strong productivity growth. Despite the recent investment recovery, the investment to GDP ratio remained sluggish, partly reflecting the decline in investment costs and the continued shift to knowledge-based industries and the services sector. These sectors tend to require less physical investment and significant human capital investment, which is not recorded in the national income statistics as investment. Concurrently, Singapore’s investment in the region continued to expand (where labor costs are relatively low), including through Temasek and the GIC.

21 . That said, over the long term, the current account surplus is likely to narrow further in relation to GDP as the economy’s high national savings rate declines with population aging. Aging is projected to accelerate beyond 2015, with the ratio of those age 65 and older to the number of individuals between 15 and 65 years of age (the old-age dependency ratio) rising sharply, especially compared with other countries with large financial centers. The need for maintaining large fiscal reserves to guard against adversity would also decline over time as structural reforms further strengthen Singapore’s resilience to shocks. As part of the adjustment process, Singapore’s real effective exchange rate would be expected to appreciate gradually. Nevertheless, the extent of undervaluation from a long-term perspective is difficult to pinpoint, with the estimates of the long-term equilibrium exchange rate for Singapore varying widely depending upon model specifications and assumptions.7 More information, particularly on corporate and household savings, could help deepen the analysis of the appropriate value of the Singapore dollar.

uA01fig06

Old-Age Dependency Ratios

Citation: IMF Staff Country Reports 2008, 100; 10.5089/9781451834260.002.A001

Source: United Nations.

III. Staff Appraisal

22. Singapore’s recent economic performance has been impressive, underpinned by prudent macroeconomic management. The near-term outlook is generally favorable, and risks are broadly balanced.

23. In order for Singapore to continue to reap the benefits of globalization over the medium term, the authorities should further advance structural reform. Proactive steps and policies already in train aimed at sustaining robust growth are welcome. However, due consideration should be given to streamlining tax incentives. Moreover, a faster pace of divestment of nonstrategic GLCs would assure investors of a level playing field and promote private sector growth.

24. While welcoming recent efforts to support low-income workers, further expansion of the social safety net would be desirable. Unemployment insurance could be introduced while preserving work incentives. Staff also welcomes efforts to enhance financial security in retirement and suggests that the authorities explore options allowing more (but simple) risk-return options for CPF savings.

25. Heightened focus on preserving financial sector stability is appropriate as the financial sector further integrates into the global system. While local banks’ direct exposures to the rapidly growing asset management industry appear limited, indirect exposures through international banks and counterparties have likely increased, underscoring the need to strengthen cross-border risk management in financial institutions and monitoring by the authorities.

26. The large net fiscal reserves provide scope for fiscal expansion. In the near term, the authorities could further front-load some of the GST-offset measures in the event that the GST hike has a larger-than-envisioned negative impact on consumption. Over the medium term, emerging issues related to low-income families and aging should be addressed.

27. Further steps to improve the transparency of public finances are desirable. While the authorities’ agreement to undertake a fiscal ROSC in 2008 is welcome, consolidated public sector accounts should be compiled and published, including more information on the GIC’s financial position.

28. The monetary policy framework centered on the management of the exchange rate has served the economy well. As inflation expectations are well anchored, there is no need to change the present monetary policy stance of a modest tightening bias. Nevertheless, if large capital inflows persist, the MAS should refrain from sterilization. This would discourage such inflows, easing the need for foreign exchange intervention.

29. The large current account surplus can be explained mainly by structural and cyclical factors. However, over the long term, the current account surplus is expected to narrow, as a rapidly rising old-age dependency ratio leads to a decline in national savings. As part of the adjustment process, the real effective exchange rate would be expected to appreciate gradually.

30. It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

1

This excludes capital outflows associated with the MAS’ foreign exchange swaps. The MAS has been using such swaps to sterilize the net liquidity impact of its foreign exchange intervention (see Box 1). The swaps result in an increase in banks’ foreign assets, which are recorded as other capital outflows in the balance of payments.

2

Forty firms have been divested since end-2005.

3

This scheme provides income supplement for employed low wage workers over age 35.

4

Estimated replacement rates based on the CPF Minimum Sum range from 20-40 percent.

5

’ The announced GST hike by 2 percentage points to 7 percent will take effect in July 2007.

6

The net fiscal reserves are estimated by staff to exceed 150 percent of GDP.

7

As a related matter, estimates based on the CGER methodology yield an undervaluation from a medium-term perspective in the range of 15-20 percent. Other estimates prepared by the mission team did not yield conclusive evidence that the Singapore dollar is significantly undervalued.

Singapore: 2007 Article IV Consultation: Staff Report; Staff Supplement; and Public Information Notice on the Executive Board Discussion
Author: International Monetary Fund