Liberalization of Financial and Capital Markets - Singapore Is Almost There!

Beginning of article

I. Introduction

This paper provides an overview of financial and capital markets and

institutions in Singapore. A major financial center in Asia, Singapore

has well developed institutions, instruments, and policies and a very

open economy with few restrictions on the movement of goods and

capital. This openness is also evident in the financial sector; thus, there

are few remaining "liberalization issues" concerning capital markets.(1)

In Part II the economic and political systems in Singapore are briefly

discussed, followed by a description of the various financial institutions

in Singapore in Part III. Part IV discusses financial markets. Parts V and

VI discuss the nature of regulation and monetary and fiscal policies,

respectively. Part VII provides examples of the influence of international

institutions on the development and regulation of financial

markets in Singapore.

II. Singapore: Politics and Economics

The Republic of Singapore is a parliamentary democracy with

universal suffrage and compulsory voting. However, for all practical purposes,

Singapore is a one-party state. The current party in power, People's

Action Party or PAP, has been at the helm since 1959, with no

opposition in Parliament from 1969-1980.(2)

Linda Low has described the PAP government's philosophy as being

relentless in any political struggle to maintain power -- to the point of

sacrificing liberal democratic principles, if required.(3) The

government's top-down style of leadership emphasizes meritocracy, elitism,

and government by example, with a genuine desire to improve the

well-being of the people.(4) Low has identified the following elements of

the PAP government's political philosophy:

* a balanced budget;

* an open, competitive system;

* a lack of unnecessary interference with the conduct of

business;

* a policy that the government will do everything necessary

to support growth, the provision of an infrastructure, and

efficient public administration, and

* the policy rationale that good government is crucial since

the country has no natural resources.(5)

In accordance with its political and economic philosophy,

Singapore's government has a noticeable presence in the economy through

government-linked companies. This involvement allows the

government to control strategically important industries, to assume a

leadership role in sectors that it deems important yet where the private sector

has not taken any initiatives, and to direct the economy based on its

assessment of future economic developments. At the same time, the

government interferes only minimally with government-linked

companies, as they are run on corporate principles and established to make

money.

The government has also created an economic environment that

allows the free market to function and encourages foreign investment.

While there are some restrictions on foreign ownership in such sectors

as local banking, airlines, shipping, public utilities and the defense

industry, for the most part, Singapore has a free market economy with

most industries open to foreign investors. However, relevant

government departments or statutory boards must approve all foreign

investments. This process serves to direct investment to the appropriate

sectors rather than to limit foreign capital. The government further

provides tax incentives to attract local and foreign investment without

differentiating between the two sources of capital. Singapore imposes

no capital gains tax. The country's two main sources of revenue are

income taxes (personal and corporate) and the recently-introduced

three percent goods and services tax.

Singapore is an economic success and a developed country. Per

capita gross national product (GNP) stood at US$22,500 in 1994.(6)

From 1985-1994, the average annual growth of per capita GNP was

6.1%.(7) Gross domestic product (GDP) grew 8.3% per annum from

1985-1994.(8) The central government's surplus, as a percentage of GNP,

was 13.7% in 1994.(9) The nominal interest rate on deposits was 3%,(10)

while the lending rate was 5.9 %.(11) Inflation, measured as the change in

the GDP deflator, averaged 3.9% per annum from 1985-1995.(12)

Despite nominal exchange rate appreciation, terms of trade have

improved; the terms of trade index for Singapore stood at ninety-one in

1994 while it was 100 in 1987.(13) This economic report card, which

includes high non-inflationary growth and low unemployment, is

probably sufficient to win a general election in any country in the

world.

III. Financial Institutions

This Part discusses both banks and non-bank financial

intermediaries. While most financial institutions in Singapore, such as banks

and insurance companies, are no different from those in other countries,

there are a few that are particular to Singapore. These include the

Central Provident Fund (CPF) and the Post Office Savings Bank

(POSB), both of which play an important role in resource mobilization

and the conduct of macroeconomic policy.

A. Central Provident Fund (CPF)

The government originally intended the CPF, established in 1955, to

provide old age security to retired persons. Over the years, the CPF has

evolved into a comprehensive social security scheme. Singapore's

citizens may use contributions for home mortgage payments, health

care expenses not met by the employer, higher education for children,

and investment in approved securities. In addition, the CPF provides a

variety of insurance schemes such as home and dependents' protection

insurance.(14)

Most workers for hire must be members of the CPF. While

membership is voluntary for self-employed individuals, they must contribute to

the Medisave component of the CPF.(15) Active contributors represent

about seventy percent of all employed persons in Singapore. Inactive

members include the self-employed or retired persons. In 1994, the

CPF had about 2.5 million members, half of whom were active

contributors.(16)

The CPF is an individualized, as opposed to a pooled, scheme.

Benefits are limited to the extent of individual contributions plus

interest.(17) Both employers and employees make contributions.(18) The

contribution rate is twenty percent of wages for members in the 55 to

60 age group, 15% for those between 60 and 65, and 10% for those

above 65 years old. For members who are 55 years old or younger,

employees and their employers contribute equally at a forty percent

CPF contribution rate. Monthly contributions are capped at S$1,200

from both employers and the employees. No contributions are payable

on salaries in excess of S$6,000 a month.

The interest rate on CPF savings is market-related, based on a simple

average of the twelve-month fixed deposit rates and month-end savings

rates of the top four domestic commercial banks. One study has

calculated that the non-tax adjusted real rate of interest was

approximately two percent per annum from 1961-1984.(19) The CPF invests its

surplus funds in long-term government securities. Most of these have

ten to fifteen year terms. Advance deposits with the Monetary Authority

of Singapore (MAS) for subsequent subscription of government

securities represent another significant investment for the fund. At the end of

March 1996, the total value of CPF members' accounts stood at S$68.8

billion, S$45 billion of which was invested in government securities.(20)

Thus, the CPF is probably the most important financial intermediary in

Singapore. The government guarantees the CPF's liquidity and, thus,

has a statutory obligation to make good any temporary shortages.(21)

However, the CPF has had positive cash flow since its inception. From

the viewpoint of its membership, the CPF investment is safe because

there is no exchange rate risk (as the CPF holds no foreign securities),

no market risk (as bonds issued to the CPF are not traded in secondary

markets), and no default risk (as a result of government guarantees).

B. Post Office Savings Bank (POSB)

Established in 1877, the POSB did not play a major role as a financial

institution until it was placed under an independent statutory board in

1972. The two statutory objectives of the POSB are to encourage thrift

and to mobilize resources for public development.(22) Today, it is one of

the largest financial institutions in Singapore, with 4.9 million savings

accounts and a deposit base of S$25 billion as of March 31, 1997.(23)

As a government-owned institution, the POSB is exempt from the

requirements of the Banking Act. Unlike commercial banks, the POSB

is not subject to reserve requirements and liquid asset ratios. In

addition, it need not seek approval from the MAS to open new

branches. However, in order to fulfill its obligation to finance

development projects, the POSB is required to hold a minimum of fifty percent

of its assets in government securities, or as loans to statutory boards or

government enterprises, or in deposits with domestic banks.(24) The

POSB is not allowed to accept time deposits or deposits from the

corporate sector. It is also prohibited from either trading in foreign

currencies or financing international trade. Since 1969, all interest on

POSB deposits has been exempt from personal income tax.(25) While

there is no deposit insurance in Singapore, all POSB deposits are

guaranteed by the government.

The POSB has been a market leader introducing new products and

services to customers. It was the first to install automated teller

machines, money order payment services, and an electronic funds transfer

point-of-sale scheme. It also introduced such new products in the

housing loan market as renovation loans and loans to purchase rental

properties.

C. Merchant Banks

Merchant banks are important participants in the capital market in

Singapore. They first entered the market in the early 1970s, attracted

by the buoyant stock market and the rapidly expanding Asian dollar

market. Their activities include offshore banking, underwriting,

mergers and acquisitions, portfolio investment management, management

consulting, and other fee-based business. As of March 1997, there were

eighty merchant banks in Singapore, with total assets at the end of 1996

valued at S$53.3 billion.(26) All merchant banks operate in Asian

Currency Units (ACUS). Their major sources of funds are interbank

borrowing, borrowing from non-bank customers, and equity capital.

Major uses of funds include lending both to banks and non-bank

customers. Although merchant banks are incorporated under the

Companies Act, the MAS regulates them through notices and

directives. Merchant banks cannot accept deposits from individuals or issue

certificates of deposit or any other securitized liability.(27)

D. Finance Companies

The majority of finance companies in Singapore entered the market

in the 1950s to undertake the small scale financing that commercial

banks were less keen to provide.(28) They play an important role in the

financial system by lending to individuals. Major sources of funds are

deposits from individuals and institutions. In addition to making loans,

finance companies place deposits with banks and other institutions.

However, their market clout appears to be in decline as a result of

competition from banks and other non-bank …