"If the two sides do not resume a dialogue, then there is a real risk of heightened tension and instability which will affect not only China and Taiwan but also Hong Kong and the whole region," Mr Lee said.

The stand-off between Beijing and Taipei was complicated last May by the inauguration of the more pro-independence candidate Chen Shui-bian as Taiwan president.

Mr Lee was speaking at a lunch organised by the Hong Kong branch of the Singapore Chamber of Commerce.

Other uncertainties affecting Asia's economies included the magnitude of the expected slowdown in the United States.

"Our view is . . . that there will be a soft landing which means the [US] will grow 2 to 3 per cent this year and we may grow 5 to 7 per cent in Singapore," said Mr Lee.

Within Asia, political uncertainties in Malaysia, Indonesia and the Philippines also clouded investors' attitudes to the region.

"These are real political issues resulting in negative sentiment among analysts and investors about Southeast Asia. The sentiment affects Singapore [as] we are in the region," he said.

Singapore was addressing these problems by strengthening its economic links with countries outside Southeast Asia by negotiating free trade agreements with countries such as the US and Japan.

Singapore was also widening its hinterland to cover the whole of Asia rather than just the southeast of the continent, according to Mr Lee, though the Lion City would continue to strengthen links with members of the Association of Southeast Asian Nations.

"The idea is not just to benefit the countries directly co-operating but also to demonstrate that Asian countries are not down and out and there are things we can do to help ourselves," Mr Lee said.

Singapore would continue to liberalise its economy following the opening up of the telecommunication and financial sectors.

"The most difficult and important thing which we have done has been to liberalise the banking sector," he said.

Singaporean banks needed to expand and set up strategic alliances or merge with overseas partners to enter other markets.

However such liberalisation had limits as the government wanted to avoid all banks in Singapore being foreign-owned as they might flee if market conditions weakened.

"We believe strong local banks are a fundamental pillar of a financial system," Mr Lee said.

He also said the Singapore Government - which has stakes in many businesses - needed to examine what sectors of the economy it should pull out of.