Taiwan’s Outlook for 2018: Riding the International Wave

Rising worldwide demand for Taiwan’s export products is injecting more vitality into the economy. Most economists are currently forecasting GDP growth for this year and 2018 in the range of 2-2.5% – not the fast pace that Taiwan was long accustomed to, but still an improvement over recent economic performance. Given Taiwanese companies’ prominent role in the Apple supply chain, the rollout of new iPhone X is expected to provide a boost in the months ahead.

For the first time in a decade, the world’s major economies this year are all experiencing positive growth, signifying that the shockwaves emitted by global financial crises are finally fading.

Consequently, demand for Taiwanese exports in all categories is increasing strongly and Taiwan’s economic growth rates are exceeding expectations. GDP growth is now widely forecast within the 2-2.5% range for both this year and next, a stable if not stellar performance – and a marked improvement over last year’s 1.5%. But in the long-run, economists say, export-dependent Taiwan will need to move up the industrial value chain as its strength in electronics manufacturing is under mounting threat from foreign competition.

“We are in a cyclical upturn,” notes Angela Hsieh, an economist with Barclays, which forecasts GDP growth for Taiwan at 2.3% this year and 2.2% next year.

The government’s Directorate General of Budget, Accounting and Statistics (DGBAS), in a preliminary forecast issued in August, put GDP growth for 2017 at 2.11%, up from an earlier forecast of 1.92% in February. It expects growth in 2018 of 2.27%.

Gordon Sun, director of the economic forecasting center at the Taiwan Institute of Economic Research (TIER), notes that for the first time since 2007, all 45 countries tracked by the Organization for Cooperation and Economic Development (OECD) are forecast to grow this year, easing the burden on the United States to play the role of the world’s economic engine. The International Monetary Fund (IMF) forecasts that global GDP growth will rise from a disappointing 3.2% in 2016 to 3.6% for 2017 and 3.7% in 2018.

Optimism is picking up around the world, causing both businesses and consumers to engage in more spending. The IMF forecasts 2.2% growth this year and 2.3% growth next year for the United States, the world’s largest economy and home to many of Taiwan’s contract electronics manufacturers’ major customers, such as Apple Inc.

China, the world’s second-largest economy and Taiwan’s top export destination, is forecast by the IMF to grow by 6.8% this year and a slightly slower 6.5% next year. In Europe, the economists interviewed for this report see the complications from Brexit as the only substantial risk to stable growth. Potential political turmoil in Spain caused by Catalonia’s independence referendum has generally not been considered a worry by financial markets.

This year Taiwan’s exports grew by a healthy 14.3% from January to September compared with the same period in 2016, according to Ministry of Finance data. In September, the year-on-year growth in exports came to 28.1%, setting an all-time high for that month of US$28.9 billion. (Some economists cautioned, however, that comparisons were skewed by the fact that the Mid-Autumn Festival, which usually falls in September, this year came in October).

Imports were up 14.7% year-on-year for the first nine months, giving Taiwan a favorable trade balance of US$40.6 billion for the period, and by 22.2% in September for a monthly surplus of US$6.7 billion.

Over the first three quarters of 2017, exports increased to all of Taiwan’s main markets, including China/Hong Kong (up by 17.4%), the United States (10.8%), Japan (7.3%), Europe (10.7%), and the ASEAN nations (16.3%).

Export orders, a leading indicator, reveal a similar encouraging trend, with 6.9% growth year-on-year. In September, export orders amounted to US$45.92 billion, another historic high. And in a further sign of increasing economic activity, the industrial production index posted an increase in September of 5.24% year-on-year, the fifth consecutive monthly rise, the Ministry of Economic Affairs (MOEA) reported.

An additional welcome development was that Taiwan’s vaunted tech sector, estimated to account for over 40% of exports, was not alone in contributing to the robust economic growth, as was often the case in recent years. Machinery, which accounts for 8% of exports, saw big gains for the first time in the last few years, posting a whopping rise in September of 56.5% year-on-year in the value of overseas shipments. Describing that degree of growth in demand for Taiwan machinery as “a big surprise,” Gordon Sun attributes it to the recent rapid pickup in global industrial investment.

Increasing export shipments are the main contributor to the resurgent economic growth in Taiwan in recent quarters. Photo: CNA

Other major export industries have also staged a comeback after languishing over the past few years. Exports of chemical products in September rose 46.6% year-on-year, plastics and rubber articles 34%, and base metals and related products 34.2%.

Rick Lo, Senior Vice President at Fubon Financial, cautions that the petrochemical industry, which for decades represented an important source of export revenues for Taiwan, has little room to expand owing to limited available land and environmental constraints. There is also stiff competition from China, which is more able to accommodate large-scale capacity.

Changing environment

A mainstay of the Taiwanese economy continues to be Information and Communications Technology (ICT) products and related components. Under the traditional supply chain model, Taiwanese companies accept orders from big Western brands for such items as personal computers and mobile phones, perform high-end functions like R&D and design domestically, and then do final assembly and the shipment of goods in China.

In recent years, however, the nature of the economic relationship with China has been shifting from a complementary basis to a competitive one, as China is increasingly able to turn out finished products similar to Taiwan’s in sophistication. Yet many Western technology companies still rely mainly on longtime Taiwanese partners to supply the components. For example, Apple’s supply chain features such inputs from Taiwanese companies as Largan Precision’s iPhone camera lenses and Catcher Technology’s casings.

In September, ICT and audio-visual exports grew by 24.1%, while electronic parts and components increased 20.8% and semiconductors 20.5%. “Taiwan is heavily synchronized with the U.S. tech cycle,” observes Barclay’s Hsieh.

Local manufacturers are pinning their hopes on sales of Apple’s latest smartphone models to sustain momentum into the year-end shopping season. While the release in September of Apple’s iPhone 8 undoubtedly helped drive Taiwan’s economic growth this year, it did not generate as much market excitement and level of sales as anticipated.

Sales of Apple products built with Taiwan-made components have helped provide a significant boost for the local economy. Photo: Matthew Fulco

Some economists expect a boost in sales from the scheduled release in November of the iPhone X, which contains advanced features such as facial recognition and whose launch marks the 10th anniversary of the iPhone. “People are optimistic about the iPhone X,” says Hsieh. Some skeptics, however, caution that the relatively high price tag, which starts at US$999, could suppress demand. Hsieh agrees that it will be a drag on the economy if the new iPhone models fail to be a hit with consumers.

Economists have also been watching the amount of imports of capital goods as an indicator of industrial vitality. They note that such imports, including semiconductor manufacturing equipment, through August experienced three straight months of double-digit decline from the previous year. Most economists, however, attribute the slowdown to cyclical adjustments in inventories, rather than a decrease in business confidence, but they still caution that the coming months could be a time of slower momentum.

Along those lines, Standard Chartered Bank economist Tony Phoo notes that the rapid gains in global DRAM and flat-panel prices that began last year have stalled, possibly indicating a cooling in the technology sector. At the same time, the overall economic outlook is still regarded as moderately robust, barring any unexpected external events such as geopolitical disruptions. Barclay’s Hsieh says she expects the recovery to continue at least until the second half of next year due to the impact of the new iPhones, but after that the situation will depend on whether attractive new tech products are being brought to market.

Aside from the effect on the tourism sector, the cooling in cross-Strait relations that began when Beijing cut off formal communications with the administration of President Tsai Ing-wen in June last year is not expected to make much of a dent in the economy. China and Hong Kong usually take around 40% of Taiwan’s exports, including electronic components for assembly into finished products that are exported to Western markets. China so far has not interfered with cross-Strait ICT supply chains, presumably because of the likely impact on its own tech companies that rely on Taiwanese components.

In addition, China is in the process of shifting its emphasis from production for export to greater focus on domestic consumption. It has also been catching up to Taiwan in many areas of industrial technology. Stephen Su, General Director of the Industrial Economics and Knowledge Center (IEK) at Taiwan’s Industrial Technology Research Institute (ITRI), notes that the only remaining standout industry in Taiwan is semiconductors, and even there China is beginning to challenge Taiwan in IC-chip design. Taiwan needs to upgrade its industries in the longer term, says Su (see the accompanying article).

Further, given the steady rise in labor costs, China is no longer an inexpensive place for Taiwanese companies to operate, especially in lower-end manufacturing sectors such as furniture and textiles. TIER’s Sun notes that even ICT manufacturing is starting to diversify to locations such as the United States and India, while other exporting enterprises are increasingly setting up bases in Southeast Asia, aided by the government’s New Southbound Policy.

China is still a massive market, and its proximity to Taiwan means it cannot be ignored or replaced altogether. But questions are arising about its future pace of growth. In October the IMF warned about a risk of debt build-up on the mainland –the debt ratio is estimated to have ballooned to 234% of GDP last year – and urged the authorities to rein in credit expansion. While acknowledging the risk, Standard Chartered’s Phoo says it is unlikely to seriously damage China’s growth outlook in the near term.

Following China’s recently concluded National Party Congress, China is likely to continue on a path of policy reform, Phoo says. “Therefore growth will slow, but not dramatically. This should lend support to Taiwan in 2018 and 2019.”

Challenge for tourism

In the tourism sector, the number of Chinese arrivals has dropped dramatically. While last year Taiwan was still able to increase total visitors by 2.2% by attracting tourists from other Asian nations, the outlook for this year is less promising. At 5.96 million foreign arrivals from January to July, the total was down 5.2 % from the same period last year – even though the number of tourists from all parts of the world except China showed an increase. The 1.5 million Chinese visitors during that period represented a 37.7% drop from the same period in the previous year.

While the economic impact on Taiwan of the decline in Chinese tourism has not been nearly as great as many had feared, some businesses, especially in the service sector, have suffered. TIER’s Sun notes that while domestic consumption has increased, retail sales as monitored by the MOEA fell by 0.1% from January to August. He estimates that the shortfall of 1 million Chinese tourists this year will amount to lost revenue for Taiwan of about US$1.4 billion. Adding to the problems this year for the hospitality industry, Sun says, has been the rise in personnel costs due to the government’s new five-day workweek policies.

The first individual Chinese tourists several years ago received special gift bags from the Tourism Bureau. Photo: AP/Wally Santana

Taiwan’s probable exclusion from a planned free-trade grouping, the China-backed Regional Economic Comprehensive Partnership (RCEP), may also be detrimental to the economy at some point, as the prospective member countries cover about 70% of Taiwan’s trade. Some observers see a risk of entire supply chains moving out of Taiwan if RCEP is concluded. As other Asian nations can now match Taiwan’s strengths in many areas of manufacturing, international companies may want to take advantage of tariff breaks offered under RCEP in locations other than Taiwan.

For the moment, however, RCEP’s momentum seems to have stalled. Barclay’s Hsieh notes that escalating tensions on the Korean Peninsula have caused an increased focus in the region on security issues. The idea of negotiating new free-trade regimes “will come back to life, but isn’t imminent,” says Hsieh. “Meanwhile no news is good news for Taiwan.”

Lately considerable market attention has been focused on Taiwan’s Central Bank – not because of speculation about the possibility of a rate hike but rather due to uncertainty over who will succeed Governor Perng Fai-nan who is set to retire in February 2018 after 20 years in the post. Perng has been named one of the world’s top central bankers for several years running by New York-based Global Finance magazine, and is considered a hard act to follow.

After 20 years in the post, retiring Central Bank Governor Perng Fai-nan is considered hard to replace. Photo: CNA

One likely successor is Perng’s protégé, the current Deputy Governor, Yang Chin-long, who has spent his entire career at the Central Bank. Another name mentioned by the local media is Lyu Jye-cherng, chairman of Taiwan Financial Holdings and the Bank of Taiwan. President Tsai is considered likely to announce the new appointment at the end of this year.

If the Central Bank does hike interest rates, Barclay’s Hsieh says the earliest it is likely to happen would be the bank’s board meeting next June after the new governor has settled into the position. The discount rate, the rate on accommodations with collateral, and the rate on accommodations without collateral have been kept unchanged at 1.375%, 1.75% and  3.625% respectively for five quarters and currently there is no strong economic reason to raise them.

Inflationary pressure has remained low, with the Central Bank predicting a rise in the Consumer Price Index (CPI) of 0.8% this year and 1.12% next year. Steady food prices have been a principal cause of the low inflation, as this year saw relatively little typhoon damage to crops and livestock. Another factor has been the stronger Taiwan dollar. In October the U.S. Treasury Department removed Taiwan from its currency watch list, a move that Deputy Governor Yang attributed to the Central Bank’s efforts to reduce intervention in currency markets, according to Taiwanese media reports.

Whereas the average exchange rate for 2016 came to NT$32.33 per U.S. dollar, the Chung-Hua Institution for Economic Research (CIER) projects a rate of NT$30.59 to the dollar this year and NT$30.79 for 2018. Observers believe the Central Bank will be reluctant to allow the currency to rise any higher because of the potential impact on export prices.

The United States is facing a similar transition in central bank leadership as Federal Reserve Chair Janet Yellen’s term expires in February. There seems to be no clear consensus among Taiwanese economists as to when the Fed is likely to raise interest rates, but they agree that financial markets do not viewer higher rates in the U.S. as potentially disruptive “There is a risk of policy tightening, but not to the extent where it will derail the economy,” says Phoo.

Assessing unemployment

Unemployment rates have remained moderate, in August registering 3.89% or a seasonally adjusted 3.76%. But Peng Su-ling, CIER’s Director of Economic Forecasting, notes that these relatively low unemployment figures can be misleading, as Taiwan has chronic structural unemployment. Since wages have barely risen in over a decade, many Taiwanese professionals, especially young people, choose to work overseas in the West or in China where wages are higher. She also notes that part-time work and contract work in Taiwan have increased.

Sinclaire Prowse, writing for the Global Taiwan Brief in January, notes that Taiwan loses about 20,000 to 30,000 white-collar workers each year and that the working population aged 15-65 started to shrink in 2016 by 180,000 annually, a problem compounded by Taiwan’s aging society.

Despite the uptick in exports and economic growth, most Taiwanese are still cautious about their spending. In its August forecast, DGBAS said that private consumption is expected to grow by a mere 1.89% this year. Hsieh of Barclays notes that most Taiwanese are rather pessimistic after years of slow growth, though consumer confidence has been improving slowly, in August reaching its highest level since July last year.

Wage levels are also improving gradually, economists say, and will be boosted by a government plan to raise the salaries of civil servants by 3% next year. In addition, the Ministry of Labor has proposed a 5.3% increase next year in the minimum hourly wage and a 4.7% rise in the minimum monthly salary to NT$22,000.

For its part, the stock market has delivered a standout performance this year, though without significantly boosting overall domestic consumer confidence. In late October, the Taiex stood at over 10,700, the highest point in 27 years, and foreign investors have pumped a net US$7 billion into Taiwan equities so far during 2017, Bloomberg reported, the most among the 10 Asian markets tracked by the news agency.

According to CIER’s analysis, overall capital investment this year will grow by 2.13%, with private investment up 1.7%, public (state enterprise) investment 4.93%, and government investment 3.74%. Hsieh notes that at a time when the cyclical upswing is causing private investment to increase markedly across Asia, it is not happening in Taiwan.

Factors that may be discouraging such investment include a shortage of available land, concern about the future stability of the power and water supply, and a regulatory environment that is perceived to be unfavorable in some sectors. Bucking the trend, however, Taiwan Semiconductor Manufacturing Co. (TSMC) recently announced plans to invest as much as US$20 billion to build a three-nanometer fab in the Tainan Science Park.

Various government policies are expected to impact on the economy this year and in the future. Some got a thumbs up from the economists interviewed, while others were less well received. On the positive side, the above-mentioned plan to raise salaries by 3% for civil servants, public school teachers, and military personnel from January 2018 was broadly welcomed as it would encourage the private sector to follow suit, spurring private consumption.

Another policy that should boost consumption is a tax-reform package announced in mid-September, which is expected to clear the legislature by the end of the year. Among its initiatives, it will lower that maximum individual income tax rate from 45% to 40%, increasing disposable income and helping to keep high earners in Taiwan.

Special legislation to support the Forward Looking Infrastructure Development Program by allowing the Executive Yuan to spend up to NT$420 billion (US$14 billion) over the next four years on national infrastructure projects passed the Legislative Yuan in July. This step also won the economists’ approval. “It’s a change for the better,” says Hsieh, while noting that this spending is relatively moderate by international standards.

In addition, a draft bill aimed at drawing more foreign white-collar workers to Taiwan by easing visa and residency requirements was just enacted by the legislature in late October [the December issue of TOPICS will contain more details].

On the negative side, the government’s five-day work-week policy was criticized by some economists for being too rigid with regard to permissible working hours, overtime pay, and other conditions. “Businesses feel they have lost all flexibility,” the CIER’s Peng says. The new Premier, William Lai, has instructed the Ministry of Labor to draft new amendments to the labor law to ease objections from employers and many knowledge workers. The bill is expected to be sent to the Legislative Yuan this fall.

Peng also points to the clash between the government’s plans to make Taiwan nuclear-free and slash carbon emissions by 2025 and its need to ensure sufficient power supply for Taiwan’s vital high-tech industries. Massive blackouts occurred across the island for up to five hours in mid-August, owing in part to unprecedentedly low power reserve margins.

More fundamentally, says ITRI’s Stephen Su, Taiwan needs to transform its industrial structure, moving more rapidly into new cutting-edge areas such as artificial intelligence and the Internet of Things (IoT), in order to foster higher growth. “For Taiwan to achieve higher GDP growth of 3% or 4%, it will have to rely on industrial transformation and not the global market,” Su says.

The bright side, according to many economists, is that Taiwan already excels in making high-tech products at low cost, a strength it can build on.

“In the past, Taiwan hasn’t displayed the creativity of Apple or Google, but we are extremely good at making products at low cost,” says Fubon’s Rick Lo. “Taiwan will play an important role in future technology developments, such as IoT and driverless buses.” As of now, these industries are not well enough developed nor is there enough global demand for them to be an economic driver.