The Taiwan economy is back in positive territory, but the pace of growth is likely to remain slow until global conditions improve substantially.
In the meantime, Taiwan may benefit as a key part of the supply chain for Apple’s iPhone 7, but its tourism sector will need to make up for a sharp drop in visitors from China.
Apple’s recently released iPhone 7 features new colors, state-of-the-art camera systems, and increased water and dust resistance. Can it also serve another function: helping to prop up the Taiwanese economy?
There are currently signs that the recent recession has bottomed out, enabling Taiwan to start undergoing a gradual recovery. At the same time, it is clear that the island’s main economic strengths continue to be concentrated on exports of technology gadgets and components like those associated with the iPhone 7. The question economists are asking is whether such products can give enough of a boost to the economy to provide significant forward momentum.
Last year Taiwan posted the lowest GDP growth rate – 0.75% – since the global financial crisis. Taiwan also suffered three consecutive quarters of negative growth, from the second half of 2015 through the first quarter of 2016. Now, however, the economy is showing definite (if still not robust) improvement. The second quarter this year saw a return to positive territory with growth of 0.7% year-on-year and third-quarter results were even stronger at 2.06%, according to the government’s Directorate General of Budget, Accounting and Statistics. DGBAS is now forecasting growth of between 2% and 2.5% for the second half of this year, with GDP expanding by 1.22% for the year as a whole and 1.88% projected for 2017.
The forecasts of other financial and research institutions vary widely. Barclays, the British bank, puts GDP growth this year at 1.1%, based largely on what it sees as better-than-expected iPhone7 sales. For 2017, it expects GDP growth in Taiwan of 1.7%, helped along by a low baseline effect. The Chung-hua Institution for Economic Research (CIER), a government-sponsored think tank, forecasts GDP growth of 1.08% this year and 1.81% in 2017.
But others are more cautious. Tony Phoo, an economist with Standard Chartered Bank, predicts that Taiwan’s economy will grow by only 0.7% this year and 1.4% in 2017, while Gordon Sun, the chief macroeconomic forecaster at the Taiwan Institute of Economic Research (TIER), says the island will be lucky if its growth this year approaches 1%. The International Monetary Fund (IMF) also puts Taiwan’s GDP growth at just 1% for this year, with 1.7% forecast for next year.
One encouraging sign for the economy was that exports, which are equivalent to about two-thirds of the level of Taiwan’s GDP, showed year-on-year growth in July for the first time in one-and-a-half years. After registering 1.2% growth in July, they went on to expand 1.0% in August before contracting 1.8% in September to US$22.5 billion. Imports in September rose 0.7% to US$18.19 billion, for a favorable trade balance of US$4.37 billion.
Electronics was among the healthiest of the export sectors, showing growth in September of 16.8%. The subsector of communication and audio-visual products grew by 0.6% (better than in previous months), which was considered a sign of success of the sales of devices such as the iPhone 7, benefiting Taiwanese companies such as Largan Technology, which makes smartphone camera lenses for Apple, and Catcher Technology, which makes iPhone7 casings.
The positive picture becomes even clearer when examining export orders – a sign of shipments to come in the next few months – for September. After increasing for the first time in 17 months in August at a surprising rate of 8.3%, they went on to rise 3.9% year-on-year in September at US$42.96 billion. Orders for electronic products climbed 10.1%, with the information and communications technology (ICT) subsector rising 8%.
However, categories such as chemical products and plastics and related materials were down -10.3% and -7.3% respectively. Orders for iPhone7 components were boosted when Apple’s main rival, Samsung, scrapped its flagship Galaxy Note 7 smartphone in October, less than two months after its launch, amid reports of fires in new devices. The safety concerns dealt a huge blow to Samsung’s reputation and sales outlook.
The appetite for Taiwanese exports appears to be concentrated in the advanced economies, with export orders to the United States rising 12.9% in September. Orders from China and Hong Kong, which together take nearly 40% of Taiwan exports, saw a mere 3.7% uptick, while the figure for ASEAN was 1.7%. While this trend augurs well for consumer demand in Western countries, the outlook is grimmer for China and emerging markets.
TIER’s Gordon Sun notes that roughly one-third of Taiwan’s total exports relate to ICT, while another third involves commodities such as petrochemicals and metals, and a final third consists of machinery and equipment. The latter two categories are mainly purchased by China and emerging markets. “If we depend only on ICT, it is not enough of a driving force to grow,” he worries.
Impact of oil prices
Sales of petrochemical products have been hurt by the slowdown in China, excess capacity in Chinese refineries, and a sharp drop in global commodity prices since the middle of 2014. Phoo estimates that a recovery in oil prices should provide some support for these kinds of Taiwanese exports going into 2017. He says Standard Chartered expects crude oil prices to rebound to US$60 per barrel next year, roughly US$10 dollars higher than current prices.
Angela Hsieh, an economist at Barclays, takes a more cautious view, saying demand for petrochemicals will probably stay low, with relatively low oil prices discouraging producers from expanding their output. She notes that while crude oil prices may rise US$60, that price level is still modest compared with the more than US$100 of a few years ago.
Along with the pick-up in exports, the government’s business monitoring system in July rebounded to flash a “green” light, the first time since February 2015. The government’s National Development Council (NDC) uses a five-color spectrum to categorize the state of Taiwan’s economy, with green signifying healthy growth. Phoo says the green light reflects improved manufacturing confidence, which bodes well for capital expenditure and hiring in 2016.
The Industrial Production Index, another measurement of manufacturing activity, also turned positive in August. In September, it grew 5.02% year-on-year.
Nevertheless, economists remain cautious about the recovery because of the mediocre outlook for global trade and the fact that demand for Taiwan’s exports could weaken once the Christmas shopping season ends. The IMF in October lowered its projections for global growth in 2016 to 3.1%, down 0.1 percentage point from an April forecast, and predicts it will recover to 3.4% in 2017. “This reflects a more subdued outlook for advanced economies following the June U.K vote in favor of leaving the European Union (Brexit) and weaker-than-expected growth from the United States,” the IMF said in a statement.
The United States, the recipient of a little over 10% of Taiwan’s exports, is projected by the IMF to have economic growth of 1.1% this year and 2.2% next year. Other economic forecasters are less optimistic about sustained strong growth in the United States. “No one has a conviction that the data will stay strong next year in the U.S,” says Hsieh of Barclays. Standard Chartered’s Phoo considers that U.S. growth is poised to be “feeble.”
Another factor being watched is the prospect of a U.S. interest rate hike in December. Bloomberg rated the chance of the Federal Reserve raising rates at 70%, but Hsieh and other economists say that expectations of a rate hike are fading. A U.S. rate increase could heighten market volatility and cause global “hot money” to flow from emerging markets’ stock markets, including Taiwan’s, to those of the United States.
While Brexit may cause global uncertainties and market volatility that could indirectly affect Taiwan, Britain’s vote to leave the European Union is seen as unlikely to have much impact on Taiwan directly as trade between the UK and Taiwan has been stagnating. Michael Reilly, a former director of the British Office in Taipei, writing in the Global Taiwan Brief notes that when the UK decided to leave the EU, the pound fell to a 31-year low and a worried Korea immediately considered adopting a US$17 billion stimulus package.
In contrast, some Taiwanese officials even suggested the vote could be good for Taiwan out of belief that the UK might now be more open to trade deals with diplomatically isolated Taiwan. This view was encouraged by a rare visit to Taiwan from the UK’s Minister for International Trade, Greg Hands.
Liu Meng-chun, a division director at CIER, says there is no need for concern over the global impact of Brexit, as the process will be drawn-out, giving financial markets time to absorb the shock and prepare.
Fewer Chinese tourists
China, whose GDP growth the IMF forecasts at 6.6% this year and 6.2% next year, is another major influence on Taiwan’s economic performance. One area of recent heated media attention has been the steep drop in the number of Chinese tourists after newly inaugurated President Tsai Ing-wen irked Beijing by refraining from accepting a “One China” position. TIER’s Sun notes that China was the largest source of tourists last year, with over 4 million visitors who spent around NT$180 billion (about US$5.7 billion). If the number of mainland tourists decline by half, he says, Taiwan could faces losses of NT$90 billion. Hsieh of Barclays estimates that if current trends continue, 12 basis points could be shaved off the GDP growth rate, with the effects magnified if GDP growth is relatively low.
But Cheng Cheng-mount, president of the Agricultural Bank of Taiwan, along with Phoo and Liu, are less worried, arguing that visitors from other nations could make up much of the loss. Tourism Bureau statistics show that although drops in Chinese tourists have been quite dramatic in recent months – for example during the period of October 1-18, traditionally a high season for Chinese tourism, mainland tourist arrivals were down 48% from the same period last year – the number of higher-spending visitors from other countries is increasing. Taiwan has now waived visa requirements for Thailand and Brunei, which should further help boost Southeast Asian visitors.
Liu notes that Japanese and Korean tourists tend to spend more on luxury items such as high-quality ceramics, while Chinese tourists, especially those in tour groups, generally travel on the cheap. An indication that the situation is not as grim as the media makes out, Phoo says, is that retail sales are still holding up and restaurant business continues to grow. According to the Ministry of Economic Affairs (MOEA), Taiwan’s food service revenues rose 2.5% to a record high of NT$293.7 billion in the first eight months of the year. Then, in September, retail trade increased by 2.2% and food and beverage services by 5.3%. Even though around 10,000 tourism-industry workers staged mid-September demonstrations with placards saying “No job, no life,” Cheng views the protest as relatively small by Taiwanese standards, “showing the Chinese tourism problem has been exaggerated.”
Still, uncertainties remain about the impact on Taiwan of the Chinese economy more generally, as the mainland seeks to rebalance and move towards a consumption-based services economy. China’s overheated property market and debt expansion are among the causes for concern. Phoo, however, says China’s economy can be expected to stabilize, and while Barclays predicts a moderate slowdown in China, it does not foresee a hard landing.
Economists also worry about China’s so-called “red supply chain” – an import-substitution strategy adopted by Beijing that makes it difficult for Taiwanese exporters to stay competitive in that market. TIER’s Sun says that China has largely caught up with Taiwan in the supply of petrochemicals and machinery, a main reason for sliding export numbers for Taiwan in those sectors, and only Taiwan’s ICT products are still global standouts. Taiwanese and Chinese companies once had a complementary relationship, with Taiwan taking orders from Western branded companies and doing the high-end manufacturing, while outsourcing the lower-end production to China. But now many Taiwanese and Chinese companies have become competitors.
Stephen Su, general director for the Industrial Economics and Knowledge Center (IEK) at the Industrial Technology Research Institute (ITRI), regards the rise of Chinese companies as a reason why Taiwan’s economic growth seems to be lagging compared with the other Asian tigers – Hong Kong, Singapore, and South Korea. He says that while Taiwan’s semiconductor sector, including its foundries and chip design houses, are holding up well, lower-end technology products and components such as printed circuit boards and downstream solar panel modules are now dominated by Chinese companies.
CIER’s Liu predicts that Taiwan enterprises in future will be unable to compete in areas requiring mass production and will need to look for niche markets, focusing on custom-design technology products by using the internet and e-commerce to find customers.
However, a bright spot for Taiwan internationally could be Southeast Asia. Standard Chartered notes that ASEAN is poised to be the world’s next big manufacturing hub, given the abundance of land and relatively cheap labor. The ASEAN countries are already luring labor-intensive Taiwanese industries, such as footwear and furniture makers, to leave China and set up shop there. According to Standard Chartered, Taiwan and South Korea are the biggest source of foreign direct investment in Vietnam, accounting for almost 50% of all inflows.
“As more and more Taiwanese integrate into the Southeast Asian market, at some point we will see a spillover into the local” economy, says Phoo. As an early sign of that trend, Phoo says Financial Supervisory Commission data shows a significant gain in offshore revenues by Taiwanese banks derived from servicing clients operating in Southeast Asia. He is also optimistic that exports of electrical equipment and machinery exports will pick up once Taiwanese companies expand their operations further in Southeast Asia and require more capital equipment.
TIER’s Sun also notes the increased attention that Taiwanese ICT companies are paying to India. Chip designer MediaTek, for example, recently said it would triple its workforce in India within three years from 500 to 1,500 as it expands research and software development. Foxconn, the world’s largest contract manufacturer, also signed an MOU last year with India’s Maharashtra state to invest US$5 billion over five years in new electronics manufacturing facilities.
The Tsai Ing-wen administration is hoping to spur economic relations with South and Southeast Asia through the “New Southbound Policy,” but political scientists question the likelihood of success, given that few nations with diplomatic ties with China are willing to buck pressure from Beijing to sign free trade agreements with Taiwan. Although China gave the nod to Singapore to enter into an FTA with Taiwan in 2013, the chilly cross-Strait relations at present would make a similar case unlikely.
Taiwan’s best hope for entering such a network is considered to be through second-round membership in the U.S.-backed Trans-Pacific Partnership. The TPP has been signed by all 12 negotiating parties, but still needs to be ratified by their respective parliaments, which may be difficult as both U.S. presidential candidates have backed away from the idea.
Even without FTAs, Phoo remains bullish about Taiwan’s potential in ASEAN markets. FTAs are helpful but not essential, he says, noting that Taiwan’s trade with other countries has grown over the years without them.
In another sign of economic recovery, the Central Bank of the Republic of China (CBC) in September left the discount rate unchanged at 1.375% after four consecutive reductions, marking the end of an easing cycle.
“Compared with other major economies, the domestic short-term and long-term interest rates have both stayed at relatively low levels,” the CBC said in a statement. “The Board judged that a policy rate hold is conducive to price and financial stability and an accommodative monetary policy helps foster economic growth.”
The consensus among economists is that the CBC does not want to ease any further at this time in order to leave room for further rate cuts should the global or local economy unexpectedly deteriorate. In addition, although deflationary risks have subsided due to gradual gains in oil and commodity prices, the Bank is considered unlikely to adopt tightening measures, viewing GDP growth as not strong enough to inspire demand for credit. Phoo says interest rates are likely to remain flat into 2017.
Regarding price levels, DGBAS forecasts modest inflation, with the Consumer Price Index (CPI) rising by 1.12% for the year as a whole, compared with minus 0.3% for 2015. The recent agricultural damage from typhoons has increased the cost of fruit and vegetables, but the impact is expected to be only short-term. A proposal to raise the tobacco tax by NT$20 per pack, if passed by the legislature, could push up core inflation next year.
Unemployment has remained rather steady, registering an average of 3.93% for the first eight months of this year and 3.99% in September (seasonally adjusted it stood at 3.93%). “We believe that unemployment will hover around 4% or lower until 2017, unless there are global risks,” Phoo says. Meanwhile, wages have remained stagnant for around two decades, due partially to the hollowing out of manufacturing as businesses relocated to regions with cheaper labor, and partially to the introduction of robotics and automation. Cheng estimates that automation has caused Foxconn’s workforce to shrink by 10-20% in recent years.
Private consumption is also expected to experience only mild growth – 1.47% this year and 1.59% in 2017, according to CIER projections. Phoo points out that the state of the housing market is linked to consumption, as people are more willing to spend money if they feel the value of their property is increasing. He sees the property as market stabilizing, noting that registered property transactions rose 6.9% in July in six major Taiwanese cities.
Standard Chartered still regards Taiwan’s property market as weak. Despite government efforts to relax some of the measures it previously adopted to cool down the housing market, average home prices have declined in Taipei this year, correcting by more than 8% after peaking in the middle of 2014. In March, Central Bank Governor Perng Fai-nan announced that he saw no need to continue various mortgage restrictions introduced in June 2010 – such as subjecting houses in Taipei and parts of New Taipei City to a mortgage ceiling of 60% – as the measures had achieved the goal of curbing property speculation. Phoo says he sees little room for property transactions to decline any further after dropping for two years.
On the investment side, CIER forecasts growth in total fixed investment of 1.27% for 2016 before rising to 1.85% in 2017, while it puts the outlook for private investment at increases of 1.06% this year and 2.06% next year. Private investment largely follows the trade cycle, Phoo says so it is likely to increase moderately, but not substantially, in the year ahead.
The economists interviewed lamented that Taiwan continues to attract relatively little direct foreign investment compared with other countries in the region. Sun attributes the problem in part to Taiwan’s exclusion from most free-trade networks. “Two-thirds of Taiwanese export products are subjected to tariffs,” he observes.
Investing in infrastructure
As for public-sector spending, the Executive Yuan has called for 3.4% increase in expenditures on public works, bringing the amount to NT$186.9 billion, as part of an overall 1.1% increase in the budget for 2017. Barclays, in a report, described the plan as “uninspiring.” Given that core inflation will come to around 0.8%, says Angela Hsieh of the bank, a 1.1% increase on a nominal basis is not a meaningful increase in real terms. Barclays considers the budget as a reflection of the new government’s caution, noting that the debt-to-GDP ratio is set to fall from 34.1% to 33.9% (well beneath the statutory ceiling of 40.6%).
The Executive Yuan has also proposed other initiatives to boost short-term growth. For example, the NDC plans to establish a NT$100 billion equity fund under the National Development Fund, as well as a trading company to help companies expand, innovate, and upgrade. The fund would invest in the shares of promising firms, but would not vie for management rights, and would exit once it achieves its goal. Economists welcome the general intent of this policy, but express concern about how well the public-private partnerships will work out in practice.
Another striking feature of Taiwan’s economy this year has been the stock market rally. According to Bloomberg data, the Taiwan bourse attracted US$14.3 billion in overseas funds as of October, the most among nine Asian markets. According to Hsieh of Barclays, after Brexit a flood of foreign portfolio money poured into emerging markets, and investors have been especially attracted to Taiwan, considering the dividend yields on the TAIEX at an appealing average of 4%.
“The foreign portfolio inflow has pushed foreign ownership in the TAIEX to around 40%,” Hsieh says. “However, the low volumes in the TAIEX suggests little participation by local investors.” In addition to the subdued attitude of domestic players, another reason for reservations about the rally is that a future U.S. rate hike could cause “hot money” to flow out.
In terms of exchange rates, Barclays predicts that the New Taiwan dollar, which stood at NT$31.47 to the dollar in October, will reach 32.5 by the end of this year. CIER expects the NT to average 32.29 for 2016 and 31.68 in 2017.
Structural factors, such as the rapid aging of the society, persist in hindering growth in the Taiwan economy. The current birth rate is insufficient to reach replacement levels, and from next year the island’s workforce will start to shrink. This labor shortage is exacerbated by a brain drain as talented people seek better-paid opportunities abroad than what they can find in Taiwan.
Surprisingly, most economists conclude that frostier relations with China are not a significant factor in slowing economic growth. Aside from the need for innovation and industrial upgrading (see sidebar), the major factors they cited as impeding growth are regulatory barriers, a lack of effective policy coordination among ministries, and a lack of policy continuity. Unclear and outdated regulations make it difficult for businesses to plan ahead and risk embarking on long-term investments.
“The government needs to relax a lot of regulations, such as financial-sector regulations,” says the CIER’s Liu, noting that the government needs innovative financial-sector policies to support initiatives such as seed funding and angel funding for start-ups. “We need to open new sectors,” says Liu, but efforts to innovate are too often stymied by government regulations, including requirements for permits.
Pointing to the example of the car-booking app Uber, which was heavily fined for violating regulations, as it was registered as a software company rather than a taxi service, TIER’s Sun says that middle-level officials under both the Tsai administration and the former Ma administration are too controlling over business operations in a free market. Their conservatism obstructs leaders such as President Tsai from getting things done, he complains.
Another problem is the Legislative Yuan, where intervention by lawmakers on behalf of particular interests can delay or skew projects and policy implementation. Su of ITRI says while Taiwan is ahead of other Asian countries in terms of its democratic development, its political immaturity compared with Western democracies impedes economic development. “Every minority voice has to be taken care of and that often compromises decisions and strategies,” he says. “The only way Taiwan can move forward is having consistent policies and a united direction.”