Singapore and the Asian Economic Crisis: An Assessment of Policy Responses

Abstract

Singapore seems to have weathered the financial storm of East Asia better than most in the region. Yet it was not spared from contagion. Economic growth slowed from 7.8 per cent in 1997 to 1.5 per cent in 1998. The declining regional demand for Singapore's exports due to contraction in the crisis economies and loss of competitiveness in the face of competitive devaluations posed new challenges for Singapore which had to adopt policies to combat the crisis. This article examines the effects of proposed policies using a computable general equilibrium model. We find that the wage reduction and devaluation policies are more promising than domestic demand stimulation. I. Introduction Singapore seems to have weathered the financial storm of East Asia better than most in the region. Yet it was not spared from contagion. Economic growth slowed from 7.8 per cent in 1997 to 1.5 per cent in 1998. The crisis impacted different sectors unevenly. Sectors such as commerce, transport, tourism, and financial services, which have large regional exposures, were badly hit. The declining regional demand for exports and the challenge of maintaining international competitiveness despite competitive devaluations mean that Singapore had to adopt effective policy responses. This paper uses a computable general equilibrium (CGE) model to simulate the effects of policies adopted by Singapore. Section II is a brief discussion of the Asian crisis and its implications for Singapore. Section III reviews Singapore's policy responses to the crisis. Section IV presents the results. Section V concludes. II. The Asian Crisis and Its Implications for Singapore The Asian crisis began as an exchange rate crisis in Thailand and spread quickly to the Philippines and Indonesia, and then to Malaysia. This led to financial crises which, in turn, produced severe downturns in real economic activity in these, and other, countries. While a full discussion of the causes, propagation channels, and effects are beyond our scope,1 some points need to be made to show how, and to what extent, Singapore was caught up in the crisis. We focus on Thailand, the first domino. An overvalued exchange rate pegged to the US$,2 declining exports,3 and a growing current account deficit made Thailand vulnerable to a speculative exchange rate attack. The falling yen and an effective depreciation of about 10 per cent of the yuan4 contributed to reduced export competitiveness. The resulting devaluation triggered a financial crisis. Substantial capital inflows, about 6 per cent of GDP, had fuelled price bubbles in real estate and the stock market. Although these bubbles peaked at the end of 1993, by the end of 1997 share prices fell to about 29 per cent of their 1995 levels while the property company share index fell to 10 per cent of its 1995 level (Edison, Luangaram and Miller 1998, p. 4). In addition, relatively high domestic interest rates and the pegged exchange rate led to increases in foreign short-term borrowing5 that was largely unhedged. As the exchange rate fell, financial institutions suffered large capital losses as the value of their foreign denominated debt increased. These losses were magnified since most bank lending was backed by collateral, particularly real estate. Financial system solvency, already impaired, was further damaged as the value of the banks' collateral collapsed6 and non-performing loans increased. New domestic credit dried up, as did foreign credit with capital outflows of about 2 per cent of GDP. Otherwise viable firms were unable to finance working capital and new investment, leading to widespread bankruptcies and sharp declines in aggregate demand and real output.7 Financial system weaknesses (including implicit government guarantees against risk, inadequate monitoring, and supervision) prevented the devaluation from stimulating the economy as exporting firms were unable to take advantage of their increased price competitiveness (Montes and Popov 1999). …