Interest Rates and the Manufacturing Sector in Singapore

Interest Rates and the Manufacturing Sector in Singapore
Sam Choon Yin (2003)



            From the borrower’s point of view, the interest rates define the costs of borrowing funds. From the lender’s perspective, the interest rates define the compensation paid to the lender for the use of his or her funds. The interests received represent the ‘reward’ to the lender for sacrificing the present consumption and incurring interest rate risks like the risk of loans default. In this essay, I will discuss the link between the interest rates and the performance of the manufacturing sector in Singapore. How responsive is the demand for loans in the sector to changes in the interest rates? This is a pertinent question since basic economic theory tells us that higher investments lead to the attainment of higher equilibrium national income inflated by the multiplier effect. Purchases of investment goods provide business opportunities to the firms. Higher output translates to higher national output or gross domestic product (GDP). A second round of effect takes place when higher output leads to higher consumption, which in turn translates to increment in the GDP. This is followed by the third, fourth and further rounds of effect on the GDP. Depending on the magnitude of the multiplier, the equilibrium level of GDP rises by more than the increment in the autonomous investment.

It may be useful to understand the distinction between a manufacturing firm and a firm from the service sector. Interestingly, the distinction is not a very clear cut one. Usually, a manufacturing firm is deemed to be one that produces tangible goods while the services firm provides intangible services to the customers. This is not entirely true. A typical manufacturing firm touches on both tangible and intangible areas. After-sales service provided by computer manufacturers is an example of the intangible ‘item’ that the manufacturers have to take into consideration. This applies to the services firm as well. Just look at the McDonalds. The hamburgers the firm provides are tangible items. The classification and distinction between the manufacturing firms and services firms is a matter of convenience. How the classification is done depends on the proportion of the value added that is generated from its production side and the services side. Should the firm generate a larger proportion of the value added from the production then it is logical to classify the firm as a manufacturing firm. On the other hand, should the services provided account for the larger proportion of the value added, it is convenient to classify the firm as one that belongs to the services sector.

The essay is organized in the following manner. The next section (Section 2) provides an overview of the manufacturing sector in Singapore followed by a discussion on how the interest rates are determined (in Section 3), both from the theoretical perspective and in Singapore. Section 4 examines the factors affecting the real interest rates and the responsiveness of changes in the interest rates on the demand for loans in the manufacturing sector in Singapore. Section 5 contains the conclusion.


Manufacturing Sector in Singapore

            Singapore is a small city-state with a population of 4.131 million of which 3.319 million are Singapore citizens and permanent residents (as at 2001). In 2001, the recorded GDP was S$138,682.6 million, indicating a GDP per capita of S$33,571 for Singapore. With a land area of 682.3 square kilometers, Singapore has a high population density of more than 6,000 persons per square kilometer. Since gaining self-governed status from the British in 1959 and full independence in 1965 (after separating from Malaysia), Singapore has transformed from a third-world city to a first-world country. This is a great achievement given the fact that the city-state has no natural resources with the exception of its strategic location and strong labor force. Many have attributed Singapore’s success to the strong political leadership led by the former Prime Minister Lee Kuan Yew (who is currently the senior minister in the cabinet). The government plays a crucial role in eliminating corruption, building the necessary infrastructure and institutions in support of economic development, and taking the lead in business ventures through the government-linked companies.

For a brief period during the years when Singapore was part of Malaysia, Singapore adopted the import substitution strategy. This was a logical move given a larger domestic market of around 10 million in the ‘merged’ Malaysia. After the separation, the government realized that the strategy would do no good to the economy and hence decided to open up its economy to the outside world and adopt the export promotion strategy. Multinational companies were attracted to come to Singapore to take advantage of the low costs of production. Tax incentives were provided and infrastructures were constructed and improved to push the economy forward. Thanks to the growing trade around the world at that time, the MNCs were looking for places outside their home countries to produce their goods for ease of selling to other countries and to lower their costs of production. Locating strategically between the west (United States and Europe) and the east (Japan), Singapore was deemed as an attractive place in building their plants.

It may be useful at this juncture to highlight the different forms of business organizations in Singapore. The business organizations in Singapore can be categorized into three groups; the government-linked companies (GLCs), the multinational companies (MNCs) and the local private sector organizations. Following the separation from Malaysia in 1963, the Singapore government had pursued the two-legged policy which focused on the GLCs and the MNCs to spearhead the government’s industrialization initiative. The local private sector enterprises took third placing in the initiative although financial support was still available to assist the small local enterprises (an example was the Small Industries Finance Scheme launched in 1976). Changes took place over the years with more focus given to the local enterprises particularly the small and medium sized enterprises (SMEs). The recession in 1985 heightened the change. During the 1985 economic recession, the government began to take more notice of the local enterprises and recognize the potential contributions of the SMEs to the local economy. The Economic Committee (headed by the then Minister for Trade and Industry Lee Hsien Loong) was set up to study, among other things, measures to assist the SMEs. The recommendations were recorded in the SME Plan in 1989.

The GLCs are basically state-owned enterprises with the autonomy to make decisions like private sector companies. Established under the Companies Act, the GLCs obtain no protection from the government. They are allowed to fail just like any other private companies. Many have grown into large conglomerates comprising several companies bounded by a common culture. These companies are groomed to become world-class companies.

The local private sector companies comprise two sub-categories as defined by the government; the small and medium enterprises (SMEs) and the medium and large enterprises (the Big Business organizations). Local SMEs are defined as enterprises having at least 30 percent local equity, fixed productive assets (defined as net book value of factory building, machinery and equipment) not exceeding S$15 million, and employment size not exceeding 200 workers for non-manufacturing companies. Local companies in the private sector with asset and employment size that exceed the figures defined above are regarded as big business organizations.

            The setting up of the Economic Development Board (EDB) in 1961 was very important in helping to attract the MNCs in investing in Singapore. Providing jobs appeared to be a top priority in the young nation then with the unemployment rate recorded at more than 10 percent when the People’s Action Party (PAP) took over. The setting up of the EDB was recommended by Albert Winsemius and I.F. Tang from the United Nations (the UN sent the officials to Singapore to advice the government on economic issues). An interesting book entitled ‘Heart Work’, written by Chan Chin Bok, the former Chairman of the EDB, and his associates, reveals the work done by the EDB officials (old and new) in attracting investors to invest in Singapore. Particularly interesting were the accounts provided by the former officers from the EDB as they revealed the difficulties of attracting investors to Singapore to invest during the 1960s and 1970s.

            What are the specific roles of the EDB? According to the Economic Development Act 2001 (amended) Section 6, the functions of the board are, first, to stimulate the growth, expansion and development of Singapore’s economy by promoting Singapore as an international total business center; second, to formulate investment promotion policies and plans, promotional incentives and marketing strategies to attach foreign and local investments in advanced technology industries and skill-intensive services which enjoy good export market prospects; third, to promote, facilitate and assist in the development of support industries and services which provide important parts, components and related services to the manufacturing sector; fourth, to encourage foreign and local industries to upgrade their skill and technological levels through investment in new technology, automation, training, research and product development activities; fifth, to support the development of local entrepreneurs and small and medium business enterprises and to assist local companies to expand and upgrade their operations; sixth, to provide training in new skills required by manufacturing, business and technical services sector; and seventh, to identify and encourage key companies to establish their international operational headquarters and undertake a wide range of regional service and business activities in Singapore. Led by the Chairman, the EBD is overseen by the board of directors, and controlled by the management team and its workforce appointed by the board itself. The current chairman of the board is Teo Ming Kian, supported by the co-Chairman Philip Yeo Liat Kok who concurrently holds the position of Chairman of Agency for Science, Technology and Research.

The EDB (together with other statutory boards like the JTC Corporation and SPRING) tactfully sell Singapore to the foreign investors and make sure that the investors’ needs are taken care off. It is done to such an extent that local enterprises in Singapore have accused the government of caring the foreigners much more than the local enterprises although this has changed to some extent since the 1985 recession. National Semiconductor, Setron Electronics, Fairchild Semiconductor Texas Instruments, General Electric and Matsushita were some of the early MNCs attracted to Singapore back in the 1960s. Basically labor intensive in nature, these companies helped Singapore to solve its unemployment problem from a high rate of around 14 percent in the early 1960s to less than 4 percent in 1973. In the 1970s, Singapore went through a restructuring strategy moving away from labor-intensive operations to capital-intensive methods of production. One of the targeted industries was the precision engineering industry. Companies like Philips, Rollei, Sunstrand Engineering and Seiko were attracted to operate in Singapore. The 1980s saw the movement to high value added industries in the electronics (like wafer fabrication industry), computing-related industries and chemical industry and the 1990s to life sciences industry. This essentially saw strong investments from world-class companies like Apple Computer, Seagate Technology, IBM, Hitachi, Glaxo, Petrochemical Corporation of Singapore (jointly with Japan), Du Pont and Hoechst Celanese.

            The manufacturing sector is an important sector in Singapore contributing about 25 percent to Singapore’s GDP (Table 1). The electronics industry accounts for the largest share of the total manufacturing sector. The industry accounts for about 40 percent of the total manufacturing followed by the chemicals industry (Table 2). The chemicals industry comprises the pharmaceutical industry, the specialty chemicals industry and the petrochemical industry. Specific locations in Singapore are allocated to house these chemicals industry; the pharmaceutical industry in Woodlands and the other two being housed mainly in the Jurong Island. It may be important to note that the chemicals cluster (with the petroleum industry) is being promoted by the Singapore government to complement the electronics industry as one of the main pillars of growth in the manufacturing sector. The objectives in promoting the chemicals cluster were, first, to tap on the potential growth in these areas (they are high value added industries) and second, to lessen Singapore’s dependence on the electronics industry. The initiative appeared to pay-off. The chemicals cluster grew, when the electronics industry fell, during the Asian economic and financial crises that hit the region in the mid 1997. This had helped in softening the negative impact of the crises on the Singapore economy.

            The importance of the manufacturing sector in Singapore is here to stay. This is confirmed in the recent report from the Economic Review Committee, chaired by the Deputy Prime Minister Lee Hsien Loong who is also the Minister for Finance. The report was published in February 2003. Despite recognizing the possibility of the smaller share accounted by the manufacturing sector in the near future (a scenario that is witnessed in other countries with the same level of per capita income), the committee felt that ‘there is a future for manufacturing in Singapore’. The report notes, ‘Singapore has significant competitive strength to sustain manufacturing as an integral part of our economy contributing 20 percent or more to GDP over the next decade. This is important because Singapore is a city-state, unlike economies such as Hong Kong, which has the Pearl River Delta as a production base and can afford to have its manufacturing base moved offshore’ (Report of the Economic Review Committee, 2003: 138-139). On the last point, it may be useful to note that Singapore has tried to encourage the more land and labor intensive operations in Singapore to move their operations to the Riau islands in Indonesia and Johor, a southern state in Peninsular Malaysia, which together with Singapore, forms the Growth Triangle in Southeast Asia. This strategy is welcomed at least from the Singapore’s perspective for it enables Singapore to attract multinational headquarters in setting up their operations in Singapore to complement their production bases in Johor and Riau islands.


Table 1

GDP in Singapore: By industry

(in million of Singapore dollars)





Total (GDP)




Goods producing industries
















        other goods industries








Services producing industries




        wholesale and retail trade




        hotel and restaurants




         transport and communications




         financial services




         business services




         other services industries








Owner-occupied dwellings




Add taxes




Less imputed bank service charge




Source: Yearbook of Statistics: Singapore (2002)


            As a result of the land shortage in Singapore, the government is rather selective in terms of the kind of manufacturing firms that are encouraged to operate in Singapore. Industrial land productivity is one of the criteria used in determining the attractiveness of the companies interested to invest here. More specifically, Singapore is interested in those companies that are high value added, productive and able to provide well-paying jobs to the people. In addition to the chemicals cluster and life sciences, the report of the Economic Review Committee has identified other potential manufacturing industries that are attractive to Singapore. These include industrial information technology, nanotechnology, photonics and MEM clusters.


Table 2

Manufacturing Sector in Singapore



(S$ million)

Share (%)


(S$ million)

Share (%)

Food, Beverage and Tobacco





Textiles and textiles manufactures





Wearing apparel except footwear





Leather, leather products and footwear





Wood and wood products





Paper and paper products





Printing and Reproduction of recorded media





Refined petroleum products





Chemicals and chemical products





Rubber and plastic products





Non-metallic mineral products





Basic metals





Fabricated metal products except machinery and apparatus





Machinery and equipment





Electrical machinery and apparatus





Electronic products and components





Medical, precision and optical instruments





Transport equipment





Other manufacturing industries





Recycling of metal/non-metal





Total manufacturing





Source: Yearbook of Statistics: Singapore (2002)


Determination of the interest rates

            How is the interest rate determined? This section tries to provide an answer to this question. It is important to recognize that, in a perfect world with no inflation and absence of risks in borrowing and lending, there is only one cost of borrowing and lending, the real rate of interests. But in reality, the actual interests that the savers receive and the borrowers pay is very likely to differ from the real interest rates because of the presence of risks and expected inflation. I will discuss this matter in greater details later but at this point, it is useful to see how the real interest rates are determined. The real rate of interests can be determined using a simply demand and supply analysis.[i]

            The money market comprises the demand for loanable funds and supply of loanable funds. The vertical axis shows the real interest rate while the horizontal axis is the real quantity of money. The term real is observed here to take into consideration the impact of the general price level on the demand for loanable funds so that any movements along the demand curve is essentially attributed to changes in the real interest rates. All other factors affecting the demand for loanable funds will result in the shift in the demand curve either to the right or left.

            The demand for loanable funds can be seen as investment demand. Some individuals have the desire to invest in some investment plans but lacking in the capital to do so. The demand function therefore shows the amount of loans demanded at different levels of the real interest rate. The demand for loanable funds curve, as Economics students would know, is downward sloping implying that as the interest rate rises, the quantity demanded for loanable funds falls, while a reduction in the level of interest rate would increase the quantity demanded for the loanable funds.

            While they are persons who demand for loanable funds, there are also persons who like to save some of their excess funds. These individuals have funds that are greater than what they are willing to spend in the current state. The curve for the supply for loanable funds is upward sloping. The reason is that with higher real interest rate, the opportunity cost of spending the funds in the current state increases. This essentially prompts the individuals with the excess funds to save or invest them in some financial institutions to take advantage of the higher real rate of return.

            The equilibrium level of the interest rate (say r0) is determined by the intersection of the demand and supply curves. At this point, the quantity supplied of loanable funds is exactly the same as the quantity demanded for such funds, implying that there is neither excess demand nor supply for loanable funds. The money market is therefore stable at this point. Consider what will happen to the market if the interest rate is above r0. At any points above r0, the market has excess supply of the loanable funds relative to the demand. The excess supply of loanable funds held by the individuals compels the savers to lower the real interest rates to attract more people to borrow. As the real interest rates fall, the quantity demanded for loanable funds will correspondingly increase while the quantity supplied of loanable funds will fall as some savers will find it not worthwhile anymore to take part in the market. The process continues until the new equilibrium positions are reached. Now, what would happen to the market if the interest rate falls below the equilibrium position r0? In this case, the market faces a shortage of loanable funds problem with the quantity demanded for the funds exceeding that of the supply. Those who are unable to obtain the funds will bid up the real interest rate to attract more savers to provide them with the funds. The real interest rate therefore increases. As the interest rate increases, more savers are willing to save therefore providing more funds to the potential borrowers to take up the loans. The process will continue until the equilibrium level of interest rate at r0 is reached, the point where the demand for funds is exactly matched with the supply of the funds.

            The discussion so far focuses on the determination of the real interest rate. Quite often, the real interest rate is not the rate that the borrower actually pays or the rate that the lenders actually receive. This point is very well illustrated in Lawrence Gitman’s popular textbook on Managerial Finance (Gitman et al, 1998). What the borrower actually needs to consider as the actual cost of borrowing is the nominal rate of interest. There are two reasons why the nominal rate of interests is different from the real rate of interests. First, the lenders may charge a rate different from the real interest rate because of the inflationary expectations. Should the lenders expect the inflation rate to be positive, it will then make economic sense for the lenders to pass on the inflationary risk to the borrowers by charging a higher nominal interest rate to the borrowers. This is to compensate the lenders for taking the risk of forgoing current consumption and having to pay higher prices for the goods and services in the near future. Second, the nominal interest rate could be higher than the real rate of interest because of the risk that the lenders have to face in the event that they are not able to recover the loans from the borrowers. The magnitude of the difference is quite subjective here depending on the risk profile of the borrowers. Someone who has a greater likelihood of defaulting without any possibility of recovering the loans from him or her is likely to face a much higher nominal rate of interest as compared to one who is less risky. Letting r to be the nominal rate of interest, k is the real rate of interest, i is the expected inflation rate and f is the risk premium rate; the nominal rate of interest (r) can be determined using the following simple formula:


r = k + i  + f


            The above equation says that the nominal interest rates (or the actual rate of interest charged to the borrowers) is equivalent to the real rate of interest plus the expected inflation and the risk premium rate. Obviously, in the perfect environment with zero risks and zero inflation rate, the nominal rate is equivalent to the real rate of interests. Given the subjectivity of the risk profile of the borrowers, it is usually the norm to assume f to be zero at least from the macroeconomics perspective. This essentially reduces the above formula to the following:


r = k + i


            The above equation shows that the nominal interest rates can be computed by summing the real interest rates and the inflation rate. The real interest rates therefore can be obtained by taking the difference between the nominal interest rates and the inflation rate.

            Table 3 below shows the values for the above variables for Singapore. The nominal interest rates are computed using the average prime lending rates of the leading banks in Singapore. Since 1982, the nominal interest rates had been in single-digit indicating that the interest rates in Singapore were relatively low. The real interest rates are perhaps more useful to look into since theoretically, they are the rates that are determined in the market. The real interest rates are computed by the taking the difference between the nominal interest rates and the inflation rates. They are better indicators of the changes in the interest rates for the numbers had accounted for the inflationary effect. At this juncture, it may be important to note that before 1975, the banks in Singapore were allowed to operate in a cartel to determine the interest rates. The real interest rates were therefore not market-determined. This is no longer true. Since 1975, the government has liberalized the banking regulation in allowing the interest rates to be determined by the market. This explains the rigidity in the nominal interest rates during the economic slowdown in the early 1970s as a result of the oil crisis.

            After the deregulation, the interest rates are moving more in tandem to the prevailing economic environment. Consider the periods 1985-1986 and 1997-2001 where the Singapore economy experienced and economic slowdown. Both the real and nominal interest rates fell in response to the lower demand for funds. This is in contrast to the early 1970s where, despite the economic slowdown, the nominal interest rates did not go down as much as the increased in the inflation rates. This results in the negative real interest rates in Singapore during the period with the real interest rates recorded at –10.6 percent and –12.5 percent in 1973 and 1974 respectively. The observation was noted by economists Gavin Peebles and Peter Wilson in a popular book about the Singapore economy (Peebles and Wilson, 1996: 57).

            From Table 3, one can see that the interest rates had stabilized in the post 1975 period although they appeared to be declining since the 1980s. The real interest rates were much higher in the earlier years. One possible reason was that higher real interest rates were offered in the earlier years to encourage more savers to put their money with the financial institutions. As years passed by, the institutions’ assets had grown and the challenge to the institutions in the contemporary period was to attract borrowers to take up the loans from them. Also, with the improvements in the technology and communications, international financial markets have expanded and international borrowings have become possible. This essentially raises the supply of loanable funds and therefore lowers the real interest rates. A recent book by Raghuram Rajan and Luigi Zingales ‘Saving Capitalism from the Capitalists’ proves this point (Rajan and Zingales, 2003). With Singapore continuous liberalization policies and its openness to international trade, it is not impossible for the investors to acquire funds abroad instead of relying solely on the funds supplied by the domestic institutions.


                                                 Table 3

Nominal interest rate, real interest rate and the inflation rates in Singapore


Inflation rate

Nominal Interest rate

Real interest rate


Inflation rate

Nominal Interest rate

Real interest rate









































































































































Source: Yearbook of Statistic (Singapore), various years (data prior to 1968 was incomplete)


Notes: The inflation rates are computed using the consumer price index. The nominal rate of interests is the average prime lending rates of the leading banks in Singapore. The real rate of interests is computed by taking the difference between the nominal rate of interests and the inflation rates (k = r – i).


            The factors affecting the real interest rates are discussed in greater details in the next section.


How responsive is the demand for and supply of loans to changes in the interest rate?

            The preceding section explains how the real interest rates are determined. It is possible for the rates to change either upwards or downwards in response to changes in the demand for and supply of the loanable funds. In a wonderful book on introductory Economics, Singapore economists Hoon Hian Teck (currently with the Singapore Management University) together with Koh Ai Tee, Anthony Chin and Euston Quah from the National University of Singapore, highlighted the pertinent factors affecting the real rate of interests. The factors are categorized in two categories; factors causing a shift in the supply of loanable funds and factors explaining the shift in the demand for the funds. The former factors include:


a.         A change in the preference for present consumption – in the event where there is a reduction in the preference for present consumption, the supply of loanable funds will increase leading to a shift in the supply curve of loanable funds to the right. This will result in the fall in the equilibrium real interest rates.


b.         A change in the desire to leave bequest for the children – savings may increase when an earlier generation has a stronger desire to leave bequest for the next generation. When this happens, the current level of savings will increase causing an increase in the size of the loanable funds. Like the earlier case, the supply curve of loanable funds will shift to the right and the equilibrium real interest rates fall.


c.         A change in the expectation for future income – if the individuals expect the level of income to fall in the future, the level of savings in the current period is likely to increase. This is to make sure that there are sufficient funds in the future to tide over the expected ‘crisis’ at least to maintain the same standard of living. Therefore an expected fall in the future income is likely to shift the supply curve of loanable funds to the right resulting in a reduction in the equilibrium real interest rates.


d.         A change in the government budget -  funds available in the market are limited. The funds are not meant only for the private sector but the public sector as well. In other words, the individuals in the private sector have to compete with the public sector for the limited funds. In the case where the government budget deficit has reduced, there is a lesser need for the public sector to compete for the funds. In this case, the supply of loanable funds will increase with more funds available for the individuals to acquire. A shift in the supply curve of the funds to the right will result in a reduction in the equilibrium real interest rates.


The authors also discuss those factors that could result in the shift in the demand curve for loanable funds. These factors are:


a.         A change in the expected future marginal revenue product (MRP) of capital – the MRP of capital measures the change in the total revenue when an additional dollar is spent in acquiring the capital. An increase in the MRP of capital stimulates more investments since an additional dollar spent on capital provides more than a dollar increment in the revenue. On the other hand, should the individual expects a reduction in the future MRP of capital, it does not pay for him or her to place an additional dollar on capital since that additional dollar is expected to yield a smaller change in the revenue as compared to the previous dollar spent. In this case, the demand for loanable funds is likely to fall resulting in lower equilibrium real interest rates.


b.         A change in the tax policy – in the event when there is an increase in the corporate tax, the demand for loanable funds is likely to fall, ceteris paribus. The reason is simple. With higher corporate tax, there is a lower incentive for the individuals to invest their funds in the investment goods since a higher proportion of a dollar profit earned goes to the government. The demand curve for loanable funds will shift to the left and the equilibrium real interest rates falls. A similar effect may be realized if the government decides to withdraw or reduce investment tax credits that the individuals were able to enjoy previously. Should this happens, the individuals would be less able to subtract the investment costs from the expenditures to minimize the tax liabilities. In other words, the individuals would have to end up paying a higher tax to the government. Again, this will shift the demand curve for the loanable funds to the left resulting in the decline in the equilibrium real interest rates.


            The illustration above concentrates on the downward change in the equilibrium real interest rates. The converse occurs if the opposite events take place. Obviously, the impact of the change in the real interest rate on the manufacturing sector would depend on the factors causing the change. Looking at the supply factors, an increase in the supply of funds in general represents good news to one managing a firm because of the resulted lower real rate of interest. However, should the cause of the change be stronger preference to savings in the present state or stronger preference to save for the next generation, then the individuals manning the firms may not consider the events to be a positive one. This is because the events, while leading to more funds being made available, signal a potential fall in the present and near future consumption, which essentially means that the demand for the goods and services that the individuals supply are expected to fall. This essentially downgrades the desire to invest. However, this problem may not be a serious one in Singapore particularly to those firms that sell to the international markets, which is a common thing amongst the firms operating in Singapore. To these firms, the world is essentially the firms’ potential customers. What happens domestically may only have a minor effect on them. In general therefore, a surplus of funds provides a positive signal to the enterprises because of the expected decline in the real interest rates leaving the firms with more discretionary income. This is particularly pertinent to the enterprises in the manufacturing because of the high expenditures outlays.

            On the demand side, it is interesting to note that a reduction in the real interest rates does not provide a good signal to the manufacturing sector. As noted earlier, a fall in the real interest rates could be attributed to lower expected future MRP of capital and higher tax liabilities. Both events are non favorable to the firms. However, it is important to recognize that the quantity demanded for loanable funds will still increase despite the problems due to the excess supply of the funds and therefore lower real interest rates. Those who remain in the manufacturing sector will benefit. Those decided to remain should also be those that are relatively more efficient since, despite the deficiencies in the business environment, these firms were still able to operate in such environment and having the interest to invest further into their businesses. There is essentially a trade-off in conjunction to the fall in the real interest rates from the demand side and the net effect on the manufacturing enterprises is uncertain depending on the magnitude of the positive effects vis--vis the negative effects.

            Even with the reduction in the real interest rates, there is no guarantee that the manufacturing enterprises would take up a large amount of the loans. This is an issue pertaining to the interest rates elasticity of demand for loans, which measures the responsiveness of the demand for loans to changes in the real interest rates, ceteris paribus. While the earlier part of this section examines those factors that would shift the demand and supply curves for loanable funds, it is my intention at this point to examine the steepness of the demand curve.[ii] Clearly, the former excludes the endogenous factor, the real interest rate, as one of the factors. The latter case includes the factor. There are several reasons to suggest that the demand for loans is interest rate sensitive in Singapore, which implies that a fall in the interest rates provides a strong incentive for the enterprises in taking up the loans and invest them.

            First, there are substitutes for loans from the financial institutions. In the earlier days, many local Chinese businessmen in Singapore started their businesses using their own savings or borrowed money from their relatives. There were two reasons; high interest rates and low initial capital outlay. As noted earlier, the real interest rates in Singapore were relatively high in the earlier years of independence. Coupled with the high-risk premium attached to the loans, it was not feasible for the local businessmen to take up the loans from the financial institutions. Also, many of them were venturing into trading and services activities which did not require a high capital outlay. Coming from China to earn a living, many were expected to return back to their homeland after gaining sufficient monetary earnings. Political and economic uncertainties in Singapore prevailing in the 1960s (like the separation from Malaysia, confrontation with the Indonesia and the withdrawal of British troops) further encouraged these temporary migrants to return home. Therefore, it did not make sense for them to venture into the manufacturing business which required a higher capital outlay and a longer gestation period before any returns, if any, were obtained. Absence of these local businessmen in venturing into the manufacturing sector prompted the PAP government to take the lead. It set up many government-linked companies and encouraged multinational companies to come into Singapore to boost the growth of the manufacturing sector.

            However, that was the past. While own savings or borrowings from family members and relatives are still possible, loans from the financial institutions have become more attractive now because the interest rates were generally low. The financial institutions are interested in lending the money for this provides an attractive source of revenue to the institutions. Competition from the venture capitalists[iii], financial schemes from the government[iv], and international lenders have also prompted the financial institutions in providing attractive packages to the would-be borrowers therefore further encouraging them to take up the loans. Given these various choices of obtaining funds, the manufacturing enterprises are more responsive to the changes in the real interest rates quoted in the financial institutions.

Second, I hypothesize that the interest rate elasticity of demand for loanable funds is likely to be on a high side because the business culture of doing business based on trust and quanxi is fast disappearing in Singapore. Let me explain what I mean. In the past, it was possible for businessmen to borrow money from the financial institutions and request for favorable treatments because of the established relationship between the bank and the company. During periods of hardship, the businessman could visit the bank and asked for some sort of favorable treatment from the bank to help him or her to tide over the crisis. This could be to the extent of extending the loan repayment periods. Trust (xinyong) was vital in the conduct of business transactions. In an interesting study, Tong Chee Kiong from the National University of Singapore, found that, through his interviews with Chinese businessmen in Singapore, verbal contracts and the reputation of a person were vital. One of the interviewers was quoted in saying:


‘During my father’s time, there was very little need for signing of contracts. Only with the government was there signing. Amongst the business associated, just a man’s word was good enough. When my father said that he would do something, he would never go back on his word. It is dishonorable and shameful. If word goes round, his reputation would be ruined and no one will want to do business with him. If a man says ‘one’ it must be ‘one and not ‘two’. An agreement is an agreement’ (Tong, 1991: 182).


This essentially indicates the flexibility in doing business at that time as far as borrowings is concerned. Even with the higher interest rates, they would be quite unlikely in detering the local businessmen from acquiring the funds since it was possible for the ‘contracts’ to alter to suit the business conditions prevailing during that period of time. Of course, one reason was the fact that trust and quanxi were vital and formed part of the business culture in Chinese-dominated societies like Singapore. The other reason was due to the fact that at that time, the number of financial institutions offering loans to the enterprises was relatively larger. Competition was keen and corporate governance was relaxed and so were the lending requirements.

This is no longer true. The financial institutions have been consolidated with the weaker ones being acquired by the larger ones. Corporate governance has become stronger with the board of members playing a more constructive and demanding role in representing the shareholders and in making sure that the executive managements are doing things that are in tandem with the objective of maximizing the shareholders’ values. Strong institutions were established in Singapore to encourage more business dealings to be carried out through the proper legal channels rather than through quanxi. A large part of the business dealings in Singapore are based on the rule of law and arms-length relationship as stipulated in the legal institution. Business disputes were settled through the legal means rather than within the businesses themselves or through the affiliated associations. Chan Kwok Bun and Ng Beoy Kui observed that the strong legal system and more transparent corporate governance were important contributing factors leading to the fast disappearance of the quanxi and trust business cultures as well as nepotism and cronyism problems in Singapore (Chan and Ng, 2000 and 2001).

What the above implies, is that with stronger corporate governance practices and more demanding shareholders in overseeing the performance of the financial institutions, it has become more difficult for the borrowers to gain personal advantages to suit their needs by establishing good contacts with the financial institutions. At the present state, it is likely for the financial institutions to sought legal means and enforce their rights to recover the loans in the event that the borrowers defaulted. This essentially tells us that businessmen are likely to take notice of the prevailing real interest rates in gauging the attractiveness of obtaining the funds from the financial institutions. A higher interest rates would force the businessmen to think twice about obtaining the loans because of the higher possibility of being sued or losing the collaterals should they defaulted on the loans. Of course, the converse is true, that is, a lower interest rate enhances the incentive for the businessmen in taking up the loans. In the economic jargon, one can say that the over time, the demand for loanable funds have become more interest rates elastic such that a percentage change in the real interest rate will bring about more than a percentage change in the quantity demanded for loanable funds. A fall in the real interest rates for example would likely to increase the quantity demanded for the funds by more than a percentage point.



            This essay is a humble attempt to illuminate the link between the interest rates and the manufacturing sector in Singapore. Not much has been written in this subject. This is surprising given the importance of the manufacturing sector in Singapore, and the close link between interest rates and investments, at least from the theoretical point of view.

This essay begins with an introduction of the manufacturing sector in Singapore. It noted that the sector would remain important in Singapore as exemplified in the recently released Report of the Economic Committee published in February 2003 by the Ministry of Trade and Industry in Singapore. The emphasis is on attracting high value added and knowledge based manufacturing enterprises in providing high paying jobs to the people and high value added contributions to the economy. The recent signing of the agreement of cooperation between the EDB of Singapore and the French Chamber of Commerce signaled Singapore’s position in her interest in promoting more foreign investments in Singapore. As reported, the agreement is expected to bring in at least 10 French technology and knowledge-drive enterprises in Singapore with S$1 million in value addition and the creation of at least 50 well-paying jobs over the next two years in areas like software development, pharmaceuticals and nanotechnologies (The Straits Times, 30 May 2003).

The essay then focuses on the interest rates. It makes the distinction between real and nominal interest rates and explains how these rates are determined. The section noted that in the absence of expected inflation and risks, the two rates should be equal, and the essay shows how the real interest rates are determined using a simple demand and supply diagram. However, in the event where there is expected inflation and that there are risks involved in the supply and demand for loanable funds (which is common in reality), the two rates will differ. While the real interest rates are usually non-observable, the common practice is to estimate it using the difference between the nominal interest rates and the inflation rates. The formula is applied in the case of Singapore. It is noted that the real interest rates were relatively higher and erratic in the earlier years (particularly before 1975, the year which saw the Singapore government changing the banking regulation in allowing the interest rates to be determined by the market). The post 1975 periods saw greater stability in the real interest rates.

It is the interest of this essay then to follow up with the earlier sections to discuss how changes in the interest rates can influence the behavior and performance of the manufacturing enterprises. After highlighting the factors affecting the real interest rates (factors that shift the demand curve for loanable funds and the supply curve of the funds), the essay pointed out that the resultant changes in the real interest rates might not always bring about positive effects to the manufacturing sector. It is important to recognize this point. In general though, a fall in the interest rates (say due to an increase in the supply of funds) represents good news to the investors since the costs of borrowing have declined. While knowing the direction of change in the interest rates (and its reasons) are important, it is also important to see how responsive is the change in the interest rates to the demand for loanable funds from the manufacturing sector perspective. Applying the case of Singapore, the essay provides reasons to suggest that the interest rate elasticity of demand for the loanable funds in Singapore is expected to be high. Two reasons were given. The first reason is related to the availability of substitutes for the domestic funds and the second one relates to the changing business culture in Singapore. I have to admit that the views presented in this essay are not strong since they have little support from the empirical evidence. Nevertheless, should these views be accepted, a reduction in the real interest rates would be deemed crucial in raising the quantity demanded for loanable funds although the caveats highlighted in this essay must be noted. Lower real interest rates would in turn increase the level of investments and therefore the equilibrium national income of Singapore through a multiplier effect.

It may be useful to reiterate the point that this essay represents a humble attempt in discussing the issues pertaining to the interest rates and the manufacturing sector. There are lots more to be done. It is indeed an area of research that is currently lacking and worth taking.



1.         Chan, Chin Bok (2002) Heart Work, Singapore Economic Development Board and EDB Society (Singapore).

2.         Chan, Kwok Bun and Ng, Beoy Kui (2000) ‘Myths and Misperceptions of Ethnic Chinese Capitalism’, in Chan Kwok Bun (editor) Chinese Business Networks: State, Economy and Culture, Prentice-Hall (Singapore).

3.         Chan, Kwok Bun and Ng, Beoy Kui (2001) ‘Singapore’, in Edmund Terence Gomez and Michael Hsiao (editors) Chinese Business in Southeast Asia: Contesting Cultural Explanations, Researching Entrepreneurship, Curzon Press (Great Britain).

4.         Gitman, Lawrence et al (1998) Principles of Managerial Finance, Second Edition, Addison Wesley Longman (Australia).

5.         Hoon, Hian Teck; Koh, Ai Tee; Anthony Chin and Euston Quah (1998) Economics Theory and Applications, McGraw-Hill Book Co (Singapore).

6.         Peebles, Gavin and Wilson, Peter (1996) The Singapore Economy, Edward Elgar (United Kingdom).

7.         Rajan, Raghuram and Zingales, Luigi (2003) Saving Capitalism from the Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity, Crown Business (New York).

8.         Report of the Economic Review Committee (2003) New Challenges, Fresh Goals: Towards a Dynamic Global City, Ministry of Trade and Industry (Singapore).

9.         Sam, Choon Yin (2000) ‘How Companies Benefit from Higher Land Productivity’, in Productivity Digest. Singapore Productivity and Standards Board (Singapore). February issue.

10.       Tan, Chwee Huat (1989) Financial Markets and Institutions in Singapore, Sixth edition, Singapore University Press (Singapore).

11.       Tong, Chee Kiong (1991) ‘Centripetal Authority, Differentiated Networks: The Social Organization of Chinese Firms in Singapore’, in Gary Hamilton (editor) Business Networks and Economic Development in East and Southeast Asia, center of Asian Studies: University of Hong Kong (Hong Kong).




[i] The original paper contains a graph showing the money market. It has been removed for this online version.


[ii] The discussion of the steepness of the supply is excluded. The objectives of this essay are first, to examine the direction of change in the real interest rates, and second to see how the manufacturing enterprises will response to the change. The steepness of the supply curve affects the magnitude of these changes, not the direction of change. It also has no implications on the second objective.


[iii] An example is the EDB venture capital fund set up in 1985. The S$100 million fund was set up to assist local companies in acquiring new technology and to support local entrepreneurship and innovations (see Tan, 1989: 320-321). A practical account on how the EDB venture capital fund works is contained in Chan (2002:235-236).


[iv] Various financial assistance schemes are available in Singapore both in the past and the present. See for example Tan, 1989: 315-323; Sam, 2000; and Chan, 2002: 58,59,221 and 229.