The leaders of Singapore, Malaya, Sabah, and Sarawak signed the Malaysia Agreement on July 9, 1963, under which the Federation of Malaysia was scheduled to come into being on August 31. Tengku Abdul Rahman changed the date to September 16, however, to allow the UN time to complete its survey. On August 31, Lee declared Singapore to be independent with the PAP government to act as trustees for fifteen days until the formation of Malaysia on September 16. On September 3, Lee dissolved the Legislative Assembly and called for a new election on September 21, to obtain a new mandate for the PAP government. In a bitterly contested campaign, the Barisan Sosialis denounced the merger as a "sell-out" and pledged increased support for Chinese education and culture. About half of Barisan's Central Executive Committee, including Lim Chin Siong, were in jail, however, following mass arrests the previous February by the Internal Security Council of political, labor, and student leaders who had supported a rebellion in Brunei. The mass arrests, although undertaken by the British and Malayans, benefited the PAP because there was less opposition. The party campaigned on its economic and social achievements and the achievement of merger. Lee visited every corner of the island in search of votes, and the PAP won thirty-seven of the fifty-one seats while the Barisan Sosialis won only thirteen.

On September 14, the UN mission had reported that the majority of the peoples of Sabah and Sarawak were in favor of joining Malaysia. Sukarno immediately broke off diplomatic and trade relations between Indonesia and Malaysia, and Indonesia intensified its Confrontation operations. Singapore was particularly hard hit by the loss of its Indonesian barter trade. Indonesian commandos conducted armed raids into Sabah and Sarawak, and Singaporean fishing boats were seized by Indonesian gunboats. Indonesian terrorists bombed the Ambassador Hotel on September 24, beginning a year of terrorism and propaganda aimed at creating communal unrest in Singapore. The propaganda campaign was effective among Singapore Malays who had hoped that merger with Malaysia would bring them the same preferences in employment and obtaining business licenses that were given Malays in the Federation. When the PAP government refused to grant any economic advantages other than financial aid for education, extremist UMNO leaders from Kuala Lumpur and the Malay press whipped up antigovernment sentiment and racial and religious tension. On July 21, 1964, fighting between Malay and Chinese youths during a Muslim procession celebrating the Prophet Muhammad's birthday erupted into racial riots, in which twenty-three people were killed and hundreds injured. In September Indonesian agents provoked communal violence in which 12 people were killed and 100 were injured. In Singapore, which normally prided itself on the peace and harmony among its various ethnic groups, shock and disbelief followed in the wake of the violence. Both Lee Kuan Yew and Tengku Abdul Rahman toured the island in an effort to restore calm, and they agreed to avoid wrangling over sensitive issues for two years.

The first year of merger was also disappointing for Singapore in the financial arena. No progress was made toward establishing a common market, which the four parties had agreed would take place over a twelve-year period in return for Singapore's making a substantial development loan to Sabah and Sarawak. Each side accused the other of delaying on carrying out the terms of the agreement. In December 1964, Kuala Lumpur demanded a higher percentage of Singapore's revenue in order to meet defense expenditures incurred fighting Confrontation and also threatened to close the Singapore branch of the Bank of China, which handled the financial arrangements for trade between Singapore and China as well as remittances.

Political tensions between Singapore and Kuala Lumpur also escalated as each began getting involved in the politics of the other. UMNO ran candidates in Singapore's September 1963 elections, and PAP challenged MCA Alliance candidates in the Malaysian general election in April 1964. UMNO was unable to win any seats in the Singapore election, and PAP won only one seat on the peninsula. The main result was increased suspicion and animosity between UMNO and PAP and their respective leaders. In April 1965, the four Alliance parties of Malaya, Singapore, Sabah, and Sarawak merged to form a Malaysian National Alliance Party. The following month, the PAP and four opposition parties from Malaya and Sarawak formed the Malaysian Solidarity Convention, most of whose members were ethnic Chinese. Although the Malaysian Solidarity Convention claimed to be noncommunal, right-wing UMNO leaders saw it as a Chinese plot to take over control of Malaysia. In the following months, the situation worsened increasingly, with abusive speeches and writings on both sides. Faced with demands for the arrest of Lee Kuan Yew and other PAP leaders by UMNO extremists, and fearing further outbreaks of communal violence, Tengku Abdul Rahman decided to separate Singapore from Malaysia. Informed of his decision on August 6, Lee tried to work out some sort of compromise, without success. On August 9, with the Singapore delegates not attending, the Malaysian parliament passed a bill favoring separation 126 to 0. That afternoon, in a televised press conference, Lee declared Singapore a sovereign, democratic, and independent state. In tears he told his audience, "For me, it is a moment of anguish. All my life, my whole adult life, I have believed in merger and unity of the two territories."

Data as of December 1989