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Will Fed tapering erode Singapore’s appeal?

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Singapore's long-held status as a financial market safe haven could come under pressure from potential risk of higher rates amid the imminent tapering of U.S. monetary stimulus.

The country is a favorite among foreign investors looking for fairly low-risk stocks that pay high dividends. But the prospect of a tightening monetary environment could erode that appeal, analysts say.

"The world is tumbling headlong into a rising interest rate environment, and dividend yields that are artificially leveled up will not hold up when financing costs rise," Kenneth Ng, an analyst at CIMB, said in a report. "Losers from a potential spike in interest rates do not make for safe hiding holes."

(Read more: Is the worst over for the Singapore economy?)

For example, while Singapore's REITs currently offer high dividend yields, they face a hit from rising interest rates, he said. Rising rates will make any property acquisitions more expensive, as well as affecting interest costs.

Gains in Singapore's yield plays were supported by investors' ever-wider search for yield over the past couple years, spurred by rock bottom interest rates on traditional fixed income instruments such as U.S. Treasurys. But as U.S. rates rise, the riskier yield from stocks becomes less attractive than bonds.

(Read more: Is it that much better to be in stocks than in bonds?)

"When bond yields rise, the attractiveness of these yield stocks falls," said Herald Van Der Linde, head of equity strategy for Asia-Pacific at HSBC, noting that previously some of Singapore's dividend plays offered higher yields than bonds. "There can be a risk."

Additionally, if inflows into yield plays were financed by a "carry trade" of funds borrowed at lower rates, those trades become less profitable as the cost of borrowing rises, Daiwa noted in a report.

Caught in the EM storm

Singapore stocks have been caught in the downdraft that has swept across emerging markets in recent days, with the benchmark Straits Times index falling nearly 4 percent so far this week.

Part of the pullback centers on concerns over how a weaker rupiah and rupee could reduce the purchasing power from India and Indonesia, with sectors like as palm oil, tourism, wealth products and property most susceptible, Citigroup said in a note.

(Read more: Brutality scorecard: Which emerging stocks have it the worst?)

CIMB's Ng also noted that the city's telecom sector, a traditional safe haven, may not offer the usual shielding. For example, SingTel, Singapore's largest capitalization stock and a key index bellwether, gets 12 percent of its profit before tax from India and 22 percent from Indonesia, with those earnings likely to take a hit when translated back into Singapore dollars, CIMB's Ng noted .

To be sure, there are reasons to believe Singapore will remain more resilient than its neighbors.

"Singapore is the cheapest among Asean markets," said Jit Soon Lim, an equity strategist at Nomura. Singapore's STI is trading at 7.1 times earnings, compared with Indonesia's around 12.5 times and around 14.7 times for the Sensex, according to data from Reuters. "The market will probably hold up relatively well. It could move in sympathy, but to a lesser extent," Lim said.

(Read more: Emerging markets mauled by bearish investors)

According to Jason Hughes, head of sales trading at CMC Markets Singapore, while the market's correlation with neighboring Asian markets will likely continue in the short term, the positive outlook remains intact.

"The initial knee jerk reaction will be the same," said Hughes, adding that he expects the city-state's yield stocks will still be favored longer term.

"(Singapore) is in a strange sort of hybrid situation. It's a developed market, but it's surrounded by emerging markets," added Mark Matthews, head of research for Asia at Julius Baer.

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