2015 did not bring the expected strong performance for the Taiwan economy. Growth for the year is now likely to come in at a disappointing level of under 1%. The outlook for next year seems better – but recent experience has shown that forecasts so far in advance are subject to too many variables to be highly accurate. As usual, Taiwan’s economic conditions will depend heavily on demand for its exports in international markets.
Taiwan began 2015 with every indication that economic growth this year would be robust. In February, the government’s Directorate General of Budget, Accounting and Statistics (DGBAS) announced its expectation that the economy, riding on the success of last year’s GDP growth of 3.77%, would achieve growth this year of around the same level. In line with that prospect, first-quarter growth hummed along at a brisk pace of 3.84%. Then, abruptly, growth plunged to 0.52% in the second quarter, shattering the aura of optimism.
Economists have since adjusted their forecasts for the year to reflect what most anticipate to be rather feeble growth. Of the seven institutions interviewed for this report, the Standard Chartered Bank was the most optimistic, putting the figure for the year at 2%. At the pessimistic end of the spectrum, the Chung-Hua Institution for Economic Research (CIER), a semi-official think tank, projects the rate of growth for the year at 0.9%, though privately some economists note the possibility that even that number will turn out to be beyond Taiwan’s reach.
Next year is likely to be slightly better, however, with most forecasts coming in at two-something percent. Cheng Cheng-mount, president of the Agricultural Bank of Taiwan, and Raymond Yeung, a senior economist with the Australian and New Zealand Banking Group (ANZ), are at the more cautious end, forecasting 2016 GDP growth of 2%. Standard Chartered’s 4% was once again the most optimistic.
Looking back over 2015, the question is what caused the economy to lose steam. While local media reports have chiefly blamed competition from Chinese electronic component makers, dubbed the “red supply chain,” economists tend to have more prosaic explanations. Calling the situation a “bread-and-butter cyclical slowdown,” for example, a UBS Securities Asia report concludes that “the market has simply underestimated the tech product cycle and the weakness in emerging market demand (Chinese market demand especially).”
Provided that global growth does not further weaken significantly, pundits say, trade should bottom out and improve moderately next year, providing a boost for Taiwan, whose exports are equivalent to about 70% of GDP. But experts caution that, longer-term, there may be rocky times ahead unless Taiwan starts making structural reforms, including industrial upgrading, deregulation, and preparations for joining more free trade networks.
The most recent trade figures show a continuation of what has been a steady stream of gloomy news. According to the Ministry of Finance’s customs data, exports in September came to US$22.54 billion, a full 14.6% below the level of a year earlier, while the first nine months of the year saw an overall contraction of 9.9%. September imports of US$17.3 billion were down 24.4% year-on-year, and the nine-month total saw a 34.3% drop. The fall in the price of oil and other commodities was directly responsible for much of the decline in import value and indirectly also affected export prices.
Virtually all industrial sectors and all export markets have been impacted. In September, the biggest drop in the value of exports was to the key markets of China and the ASEAN countries, both roughly 17% below the level of September 2014. Those figures prompted the ANZ Bank to predict that final calculations for the third quarter would show that Taiwan had experienced the first quarterly contraction in GDP since 2009. “Trade performance and investment sentiment have declined beyond our expectations,” the bank said in a report.
Export orders, a leading indicator, tell a similar story, having posted monthly contractions since April. For the month of September, the export orders of US$41.35 billion represented a 4.5% slump year-on-year. Suggesting that the problem is easing, Finance Minister Chang Sheng-ford recently noted that the rate of decline in September had eased from previous months.
Indeed, a mild pickup is anticipated as the United States enters the Christmas buying season. Some boost may also come from the September launch of Apple’s latest smartphone, the iPhone 6s. Many Taiwanese companies supply components to Apple, such as camera lenses and metal casings, and UBS attributes Taiwan’s healthy GDP growth last year to Apple’s launch of the iPhone 6. This year’s lackluster performance may be partly because the iPhone 6s is not significantly different from its predecessor, leading many consumers to wait for the next new model before making another smartphone purchase.
The China Factor
Wai-ho Leong, an economist with Barclays Investment Bank, cites another contributor to the recent anemic growth: weak demand from China that caused a huge inventory buildup in the electronics sector across Northeast Asia. Consequently, Taiwan’s Industrial Production Index recorded a 5.2% drop in September, and the Taiwan Semiconductor Manufacturing Co. (TSMC) announced that it had slashed capital expenditure for the year by more than 20% to a four-year low. UBS puts gross fixed capital formation at 1.1% this year, with a rise to 1.3% next year.
Much of the steep drop in exports can be attributed to the economic turbulence in China, as the mainland and Hong Kong together receive nearly 40% of Taiwan’s exports. Around one-third to one-half of these shipment are intermediate components and materials to be assembled in China for re-export.
Chinese growth has been sluggish ever since the unexpected devaluation of the yuan and the mainland’s stock market rout in August. To the alarm of Taiwanese exporters, China’s GDP growth rate in October dipped beneath 7% for the first time since the global financial crisis. The People’s Bank of China then cut interest rates for the sixth time in less than a year in an effort to stoke economic activity, and the bank’s vice governor, Yi Gang, sought to reassure any doubters that China would be able to maintain annual economic growth at around 6-7%.
While China’s economy is opaque, there seems to be a consensus among economists that its double-digit GDP growth is a thing of the past. As China attempts to transform into a consumer-driven economy, the main risk for Taiwan, economists say, is whether the transition will go smoothly or instead result in a “hard landing” that could send shockwaves across the island.
In the wake of the economic uncertainty in China, in addition, many emerging markets have been revising their growth forecasts downward. Due to weaker Chinese demand, commodity prices have been falling, exports from other countries are stagnating, and the yuan devaluation is pressing their own currencies downwards, diminishing their purchasing power. Healthy growth in emerging markets is important for Taiwan, especially as Southeast Asian nations buy almost 20% of Taiwanese exports.
There are also significant uncertainties with regard to the United States, which is undergoing a moderate recovery and is now widely viewed as assuming China’s previous role of leading global growth. Standard Chartered Bank economist Tony Phoo notes that volatility in the world’s equity and exchange markets is frequently blamed on China, but the “other half of the story” is that markets are also jittery about the direction of U.S. monetary policy. No one knows when the Federal Reserve will decide to raise interest rates.
Such a rate hike would have pros and cons, economists say. On one hand, it could be a confidence booster, demonstrating the Fed’s optimism about American economic prospects. Leaving interest rates flat, on the other hand, reduces the risk of capital flows out of emerging markets that could cause massive currency depreciation, affecting those nation’s ability to pay off U.S.-dollar denominated debts and generally worsening their economies. The Fed, which needs to be careful, held off on a rate hike in September. Phoo says he now expects the adjustment to take place in December, but Cheng cites market expectations that the move may not take place until March next year.
Besides the modest recovery in the U.S. economy, which is expected to see 2.1% GDP growth this year, economists say that the Eurozone and Japan, also key buyers of Taiwan’s exports, are showing slow but steady improvement.
Another crucial element in Taiwan’s economic picture this year was the low price of oil. The drop in the petroleum market caused prices overall to decline for most of the year, including export valuations, making trade figures appear even more dismal than they would have otherwise. UBS, which reports that international oil prices were down 50% for the first 10-months of this year, forecasts a mild single-digit increase next year, which would bump up Taiwan’s inflation slightly.
Taiwan’s Consumer Price Index was negative for the first eight months of this year, averaging minus 0.62%, before unexpectedly registering an upturn by 0.28% in September due mainly to the effect of typhoons on fruit and vegetable prices. DGBAS is now forecasting inflation of minus 0.19% for this year as a whole, before rising mildly to 0.74% next year.
Darson Chiu, an associate research fellow at TIER, notes that economists at first expected cheaper oil prices to help to boost Taiwan’s economy, but the actual results turned out to be the reverse. “The fear of deflation has been haunting Taiwan’s economy for the entire year,” he says, though the fear in fact seems unfounded, as core inflation has been rising, supported by solid domestic demand. Phoo notes that while monthly export figures expressed in monetary terms have declined sharply year-on-year, the change is much less substantial in terms of the volume of units shipped. The low oil prices have particularly affected petrochemical exports, and falling commodity prices have had a similar effect on exports of metal products and other items.
The Monetary Side
With regard to monetary policy, the Central Bank in September adjusted interest rates for the first time in four years, lowering the discount rate from 1.875% to 1.75%. The move was largely viewed as a symbolic confidence booster, rather than one that could bring substantial change. Barclay’s Leong notes that Taiwan’s banking system is already flush with liquidity. “It’s not a question of the availability of credit, it’s a question of demand for credit,” he says. “There’s only so much monetary policy can do, and whatever can be done, the Central Bank has already done it.”
Economists generally expect the Central Bank to leave rates unchanged when its board meets again in December. An ANZ report says the rate is now likely to stay flat at 1.75% throughout next year, and Cheng agrees – unless the economy is really troubled, for example by cross-Strait tensions. UBS sees the possibility of a rate rise in December if the U.S. Fed also increases rates, but says that most likely Taiwan’s rates will be left alone.
In other signs of easing, the Central Bank in recent months has gradually guided the overnight interbank rate – the rate from which banks can borrow from one another on a short-term basis – downward. To stimulate domestic demand and the housing market, it has also relaxed some previous measures designed to cool property prices. For example, it has raised mortgage limits on luxury housing and an individual’s third property from 50% to 60% of the property’s value.
As for the New Taiwan Dollar, UBS expects the currency, which closed at NT$32.505 against the greenback on October 16, to weaken further against the U.S. dollar in 2016. The greenback has been gaining strength on expectations of a U.S. rate hike, while the depreciation of the Chinese yuan has been putting downward pressure on the Taiwan dollar. UBS is forecasting an exchange rate of NT$34 against the dollar by the end of 2016, with an average of NT$33.5 throughout next year. “The NT dollar should nevertheless remain one of the more stable Asian currencies, supported by Taiwan’s huge current account surplus and slightly stronger economic fundamentals next year,” UBS says.
A striking aspect of Taiwan’s economic performance this year was that unemployment remained low, unlike the situation in many other nations. Unemployment hovered between 3.5% and 4% throughout 2014 and most of this year, standing at 3.89% in September. (Seasonally adjusted, the DGBAS says, it stood at 3.79%). One of the reasons for the stable employment conditions, Leong says, is the growth of the services sector fueled by a Chinese tourist boom that has offset potential job losses in manufacturing. Wage levels in Taiwan have stagnated for two decades and still remain subdued, with DGBAS estimating that wages in the industrial and service sectors rose by 3.53% in the first seven months of the year.
UBS is projecting growth of 3% in private consumption this year, supported by cheap fuel costs and feelings of job security.
Going forward, economists say it is more urgent than ever for Taiwan to forge free trade agreements and join free trade networks if it is to avoid economic marginalization. TIER’s Chiu notes that Taiwan has signed FTA-style agreements only with Singapore, New Zealand, and a handful of allies in Central America, while Korea, Taiwan’s main competitor, has signed FTAs with the United States, European Union, China, and ASEAN.
Economists note the trend of Taiwanese entrepreneurs leaving China to set up shop in Southeast Asia to escape relatively high Chinese labor costs and growing competition. Phoo notes that while Taiwanese investment in Southeast Asia remains relatively small compared to the estimated accumulated investment in China of over US$150 billion, it is growing rapidly. (Cheng, for his part, is skeptical about Southeast Asia’s potential, pointing to issues such as under-developed infrastructure in Vietnam and unstable electricity supply in the Philippines.)
Exclusion from the U.S.-backed Trans-Pacific Partnership (TPP) could be a serious economic hindrance for Taiwan, while joining the TPP could help Taiwan’s economy flourish by ensuring its continued linkage to regional supply chains. TIER’s Chiu says the prospect of tariff-free treatment could cause Japanese automakers to choose to import parts from TPP member Malaysia rather than Taiwan.
Excluding most information and communications technology products, which are covered by an existing World Trade Organization agreement, Taiwan’s exports face tariffs from TPP member nations averaging 4.4%. Lack of TPP membership would mainly affect such industries as petrochemicals, auto parts, and machinery. For the Chinese-backed Regional Comprehensive Economic Partnership (RCEP), involving the 10 ASEAN nations plus China, India, Japan, South Korea, Australia, and New Zealand, tariff levels for Taiwan are even higher, averaging 7.8%, TIER data shows. Chiu suggests that Taiwan complete its planned FTA with China under the Economic Cooperation Framework Agreement (ECFA), and then through that channel seek to join RCEP.
In urging Taiwan to do its best to join the TPP, AmCham Taipei notes that at US$5.8 billion in foreign direct investment in 2014, Taiwan ranked last among 12 leading Asian investment destinations, according to a recent survey. One likely reason for this lag is the trouble Taiwan faces in forging FTAs in the face of Chinese diplomatic pressure on other nations.
Deregulation and Stimulus
Inadequate regulatory coherence was also cited by AmCham as a reason for Taiwan’s relatively low FDI. Economists generally agree that the government could help boost the economy by streamlining regulations and ensuring that regulatory practices adhere to international norms. As one example, Liu Meng-chun, director of CIER’s center for economic forecasting, notes that due to restrictions on universities’ ability to raise faculty salary and tuition levels, many professors have accepted more lucrative positions overseas.
Another area in which economists would encourage the government to be more proactive is in adopting measures designed to provide fiscal stimulus. In July the government unveiled a stimulus package aimed at long-term industrial upgrading, including more inducements for R&D spending and greater financing for SMEs. Barclays’ Leong suggests that the program be extended to include needed infrastructure projects, such as improving roads on the east coast.
But the government’s strained finances, with public sector debt approaching the legal limit of 50% of GDP, leave little room to undertake much fiscal stimulus. Another constraint is uncertainty about the prospects for policy continuity following the combined presidential and legislative elections set for January 16 next year. In addition, the current administration is undoubtedly unwilling to introduce any potentially controversial economic measures before the election. Economists also point to the period between the January elections and the new president’s inauguration next May, effectively amounting to a four-month leadership vacuum (see the accompanying report).
Taiwan’s opening up to Chinese tourists in 2008 has brought a significant structural change to the economy, making the island a significant exporter of services for the first time and creating new service-sector job opportunities. Inbound tourism revenues rose to NT$437 billion (about US$13.6 billion) last year from just NT$187.1 billion six years ago. This year the number of international arrivals is due to pass the 10 million mark for the first time, due in large part to increased visitors from across the Strait. But some political observers wonder whether the flow of Chinese tourists next year would be affected by a Democratic Progressive Party victory in Taiwan’s elections in January.
The burgeoning services sector could ultimately help ease Taiwan’s dependence on electronics exports, Barclay’s Leong says – but only if the sector is upgraded. While the service industries have been successful at creating employment, the jobs tend to be less skilled and lower paid than those in manufacturing. He adds that an impediment to the development of Taiwan’s service sector has been the Legislative Yuan’s withholding of ratification of the controversial cross-Strait Trade in Services Agreement signed with China in June 2013.
ANZ’s Yeung recommends that public policy focus on ways to make Taiwan’s services more internationalized to enhance their competitiveness against services in other parts of Asia. The result could also be a boost for Taiwan’s stagnating wage levels. Yeung notes, for example, that while Hong Kong and Singapore are the regional leaders in financial services, Taiwan has the advantage of having a larger manufacturing base. “Many Taiwanese companies use Hong Kong and Singapore to service their financial needs,” he says, but much of this business could be brought back to Taiwan if local financial services companies succeed in upgrading to a more sophisticated international level. This evolution will require improving the Taiwan workforce’s “soft skills,” including English-language capability, Yeung says.
In manufacturing, economists say, Taiwan also needs to replace its over-reliance on OEM electronics production with more diverse value-added and branded products.
UBS notes that Taiwan’s non-tech exports have long been losing competitiveness, partially a result of China’s over-capacity in traditional industries such as steel and chemicals.
And while most economists say the threat from the so-called “red supply chain” has been exaggerated in Taiwan, China is still giving Taiwan intense competition when it comes to relatively low-end technology, such as liquid crystal display flat panels, solar panels, and printed circuit boards. But even for these items, the risk is long term. “Taiwanese companies will see their market share eroded gradually, but this will not happen overnight,” says Raymond Hsu, an analyst with Taiwan Ratings who follows Chinese competition in the tech sector.
There is much less risk of Chinese competition when it comes to more sophisticated technology products, Hsu says. Taiwan’s world-class semiconductor industry would be particularly hard to topple. The Chinese government is actively promoting “indigenous innovation,” but Hsu notes that while China can easily hire talented people by offering high salaries, acquiring new technology in the form of foreign patents or through M&A activity can run into major hurdles. He cites the stated interest of a Chinese state-owned company, Tsing-hua Unigroup, to buy U.S. memory chip maker Micron Technology. Most sources have concluded that such a deal would be blocked by the American authorities due to national security considerations.
Regardless of the degree of risk from the “red supply chain,” however, Hsu urges Taiwanese companies to abandon their traditional focus on cost-cutting in favor of making innovation the key to their competitiveness. Otherwise, “if it isn’t China, it will be Japan, Korea, or someone else pushing Taiwan out,” he says.
In recent years, the Taiwan economy has benefited enormously from its companies’ undertaking of contract manufacturing of components for PC computers and smartphones, economists say. But as these markets mature, bringing slower growth, Taiwan needs to focus on new technologies and a new generation of tech products.
Cloud computing products and services, the Internet of Things, and 3D printing are among the new potential areas Taiwan is exploring, but can they develop into as big a market as smartphones and laptops? “Whether the use of such tech means that every household would consider buying one is a big question mark,” says Phoo of Standard Chartered.
For at least the short term, concludes Chiu of TIER, Taiwan’s best hope of regaining strong economic momentum is to carry out serious structural reform.
The Difficulties of Accurate Forecasting
Despite the benefit of their economic models, predicting the future is a risky undertaking even for economists. Nevertheless, the surprises this year were much more numerous than usual. “The downward revisions have been non-stop and very unconventional,” says Darson Chiu of the Taiwan Institute of Economic Research (TIER).
Why didn’t anyone foresee the huge drop in second quarter GDP growth? The main culprit was the opacity of the Chinese economy, which prevented many from anticipating turbulence ahead. The difficulties across the Strait caused a huge drop in demand for Taiwanese exports.
Another factor may have been economists’ underestimation of the degree of influence China has on emerging markets – and emerging markets on Taiwan, as they now buy over 30% of the island’s exports. In addition, many institutions base their GDP forecasts partly on the activities of Taiwan’s exporters, who also failed to see the China shock coming and were optimistically accumulating inventory. Standard Chartered Bank economist Tony Phoo notes that Taiwan’s domestic economy was not to blame, as it was flourishing during this period. “Net trade activity was the main drag,” he concludes.
Liu Meng-chun, director of the center for economic forecasting at the Chunga-Hua Institution for Economic Research, notes that in China even official statistics can be incorrect and thus serve as unreliable economic indicators. He cites a State Department memo from 2007 released by Wikileaks that quoted Chinese Premier Li Keqiang as telling the U.S. ambassador to China that GDP figures in Liaoning, where he was then party chief, were “man-made.” Li said he preferred to track Liao-ning’s economy by looking at other indicators: the cargo volume on the province’s railways, electricity consumption, and the volume of bank loans. CIER’s Liu agrees that Li’s comments are good advice when trying to assess the real conditions in China.