Household debt: Singapore’s ‘Achilles heel’?

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Pedestrians walk down a street in downtown financial district in Singapore.

Singapore stepped up efforts to contain a rapid increase in household debt by tightening rules around unsecured credit late Wednesday – a move viewed by economists as a preemptive strike ahead of a rise in borrowing costs in the country.

"The central bank is being pre-emptive. Taken together with the previous measures announced, including the Total Debt Servicing Ratio (TDSR) framework for property loans, they will likely be effective," Michael Wan, economist at Credit Suisse told CNBC on Thursday, referring to a measure which caps monthly mortgage payments to 60 percent of a borrower's monthly income.

Among the new rules on unsecured credit, the Monetary Authority of Singapore, the country's central bank, requires banks to review a borrower's total debt and credit limit before granting a new credit card.

(Read more: How dangerous is Singapore's soaring household debt?)

In addition, financial institutions will not be allowed to grant further unsecured credit to individuals who have outstanding debt of more than 60 days with the institution.

While expectations are for short-term interest rates to begin rising in 2015, a hawkish Federal Reserve chairman could mean that an increase in borrowing costs comes sooner, said economists. When interest rates rise, households will have to pay a higher monthly mortgage payment as a portion of their income.

The benchmark Singapore interbank overnight rate (SIBOR), used to price housing loans, tracks rates in the U.S.

High household debt levels are being referred to by some as the "Achilles heel" of Singapore's otherwise seemingly healthy economy, with a large current account surplus, huge stock of foreign exchange reserves and strong fiscal balance sheet.

(Read more: Are financial risks in Singapore rising?)

"Rapid acceleration in household debt and bank lending are vulnerabilities for Singapore's economy, which could be destabilizing in the event of potential capital outflows and higher interest rates," Joey Chew, economist at Barclays wrote in a report titled "Openness and household debt – the Achilles' heel" on Wednesday.

The country has among the highest level of household borrowing relative to gross domestic product (GDP) in Asia at 75 percent, rising from around 63 percent in 2010, according to the bank, as record low interest rates in the recent years encouraged borrowing.

"While household debt has risen 41 percent over this period, household income has increased by only 25 percent and wages by even less, just 15 percent," she said.

Chew added that the nation's extensive trade, investment and financial links with the region, also pose a threat to the stability of its economy.

(Read more: Singapore may suffer from its neighbors' currency perils)

"Regardless of fundamentals, Singapore will never be completely immune to a contagion event. One of the economy's main strengths, its extreme openness, is also its Achilles heel," she said.

"Any shock originating from an ASEAN-4 economy (Indonesia, Malaysia, Philippines, and Thailand) would quickly affect Singapore," she added.

Singapore's exports to the four countries, for example, make up almost 30 percent of total exports.

—By CNBC's Ansuya Harjani; Follow her on Twitter @Ansuya_H