Trends in Capital Flows

A key feature of the Singapore economy is its extreme openness to trade and capital flows. The size of total imports and exports has been approximately three times that of GDP over the past three decades. In relation to capital flows, almost all forms of capital controls and foreign exchange restrictions have been dismantled since 1978. As a consequence of its small open nature, the Singapore economy has often been buffeted by shocks from the external environment such as the downturn in the global electronics industry in 1996-1997, the Asian crisis in 1997-1998, and the burst of the information technology bubble in 2001.

Notwithstanding the fluidity of the economic environment and free capital mobility, Singapore has persistently recorded current account surpluses and exported capital abroad (see Figure 1 [ PDF 28.4KB | 1 pages ]). With the lone exception of 2001, the overall balance of payments (BOP) has remained positive since 1990. In fact, the overall BOP surplus has been growing in recent years, reflecting the expansion in the current account surplus over the same period. Concomitantly, the excess of national savings over investment has allowed Singapore residents to acquire foreign assets abroad. This includes the Singapore government investing public sector budget surpluses abroad.

To differentiate amongst the various types of capital flows, Figure 2 [ PDF 29.5KB | 1 pages ] provides a breakdown of the financial account into foreign direct investment, portfolio investment, and other investment. We observe a general pattern over the past decade that net positive foreign direct investment (FDI) is consistently offset by net outflows in portfolio and other investment accounts.

It is evident from Figure 3 [ PDF 29.6KB | 1 pages ] that direct investment inflows have been on a general upward trend since the early 1990s. In comparison, with the exception of 2001, direct investment outflows have been hovering around S$10 billion.⁴ The strong inflows of FDI reflect Singapore's commitment to attract multinational corporations to aid its economic growth. In terms of sectoral distribution, the financial services, manufacturing, and commerce sectors are the major recipients of the FDI inflows, accounting for 38%, 33%, and 16% of the total FDI stock at end 2005, respectively. As is well recognized, such long-term inflows are a relatively stable form of finance and generally do not contribute to an increase in macroeconomic or financial risk. Rather, they have undoubtedly been beneficial for the development and growth of the Singapore economy.

In comparison, the portfolio investment account has consistently recorded net outflows. Figure 4 [ PDF 28.6KB | 1 pages ] provides a breakdown of portfolio inflows and outflows into the various financial instruments. Portfolio inflows have generally been on the rise in the post-crisis period, partly reflecting a return of foreign investors to the local stock market since 2003. However, this is more than offset by the large portfolio outflows, which capture both government and private sector investment in foreign equity and debt markets. Portfolio flows tend to be volatile as investors have the flexibility to shift from one financial instrument into another because these instruments are traded. Indeed, portfolio investment has a tendency to accentuate crises (Dobson and Hufbauer, 2001). In this regard, the low volume of portfolio inflows (relative to FDI inflows) helps to reduce Singapore's vulnerability to capital flow reversal.

The main components of the other investment account include loans, and currency and deposits (C&D). Figure 5 [ PDF 27.1KB | 1 pages ] depicts the trends in the key components of this category's inflows and outflows. The high volume of capital flows reflects a lively interaction between domestic banks and foreign financial institutions (and other non-residents). As in the portfolio investment account, we observe an increase in both inflows and outflows in the recent period, with the latter exceeding the former. Bank lending⁵ is, by conventional wisdom, considered to be the most liable to reversal than the other forms of capital flows including portfolio investment. In the case of portfolio flows, adjustments in the volume are mitigated by price adjustments of the relevant assets (Williamson, 2005). We observe from Figure 5 that bank lending has been considerably reduced in net terms after the crisis.

In total, gross capital inflows have not only recovered after the crisis but have exceeded the pre-crisis peak level (see Figure 6 [ PDF 28.1KB | 1 pages ]). The recent surge in capital inflows poses several interesting questions. In particular, how do the various types of capital inflows affect the domestic economy? What are the factors that serve to attract stable long-term capital flows while inhibiting volatile speculative inflows? What policies and measures has the government adopted to meet with the challenges posed by volatile capital flows? These issues will be examined in the following sections.

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