The Economic Outlook of Taiwan

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1 The Economic Outlook of Taiwan by Ray Yeutien Chou and Shou-Yung Yin The Institute of Economics, Academia Sinica, Taipei October 2016 Prepared for Project LINK 2016 Fall Meeting, Toronto City, Oct , 2016

2 I. Introduction Taiwan s economy has suffered contraction for three consecutive quarters since the third quarter of The reasons for this recession include drop in crude oil price, sluggish global economy and the push to economic reforms in China. In the beginning of 2016 also recovery of the global economy was not significant due to weakness in the U.S. and Japan, though growth in the Eurozone and China exceeded expectations. The latest update of forecasts for 2016 by the International Monetary Fund (IMF) in July revised the growth rate forecast from 1.9% to 1.8% in Advanced Economies while the world trade volume growth expectations have been lowered from 3.1% to 2.7%. These estimates suggest that the outlook for 2016 is worse than what we had expected. The real GDP growth rate in the first quarter of 2016 in Taiwan was -0.29% (year-on-year), largely accounted for by negative annualized growth in investment (-0.25%) and in exports sector (-4.04%). However, some of the high frequency indicators show that Taiwan may have a rebound in the second half of this year. In the following, we briefly discuss recent economic performance and forecasts for each GDP component. II. Recent Economic Performance A. Consumption After solid growth in 2014 (3.33%), private consumption was dampened by weak performance in the second half of The decline was not offset by a drop in the consumer price index; real private consumption grew only 0.48% and 1.69% (year-onyear) in the third and fourth quarters in 2015 respectively. Although there was some improvement in the first quarter of 2016 (2.53%, year-on-year), it is largely attributable to the subsidy scheme last year that boosted consumption by 5.09 billon NT dollars. The latest figures indicate that that private consumption grew only 1.23% (annualized) in the second quarter, reflecting that domestic demand is still subdued, which is consistent with the negative growth in real wages in the first six months of 2016 (- 1.58%, year-on-year). Real government consumption registered negative growth in 2015 (-0.33%). It grew 5.47% in the first quarter this year, largely because of expansion of the stimulus policy. In the second quarter this year there was only a slight increase (1.96%) in government consumption. B. Investment Gross fixed capital formation grew only 1.76% and 1.23% in 2014 and 2015 respectively. Because debt to GDP ratio was already close to the official upper limit (40%), government investment and government-owned enterprises investment declined

3 by 4.30 and 6.94% in 2014 and 2015 respectively, though private investment did go up 3.17% and 2.75% in the same periods. More specifically, government investment has declined for six consecutive years, from 2010 to 2015, reflecting that there isn t much room for improvement in our economic performance with fiscal policy (Government investment contributed -0.12% to GDP growth rate in 2015). In 2016, real private investment grew only 0.16% and 1.13% in the first and second quarter respectively although imports of capital equipment were up 5.4% (year-on-year) in the first eight months (22.1% in May). However, the growth in these imports is largely explained by the rise in import prices caused by appreciation of the Yen. Government investment and public utilities investment have continued to follow the pattern of 2015, i.e. growth rate registered was -3.09% and -3.02% in the first quarter and -7.01% and -2.33% in the second quarter, respectively. C. Exports and Imports The weak global demand and China having started building the red supply chain which means producing electronic parts in China rather than importing for assembly of finished products are the two factors that have resulted in Taiwan s exports of goods and services declining 0.16% in 2015 in real terms for the first time since Meanwhile imports of goods and services grew only 0.92%, reflecting weak domestic demand which includes subdued consumption and investment as mentioned before. While we still have negative growth in export and import sectors of -4.04% and -1.49% in real terms respectively in the first quarter of 2016, there was a pick up in the second quarter (0.63% and 0.21%). This is consistent with the slightly stronger growth in China and recovery of demand in the semiconductor industry. Total volume of exports to China (including Hong Kong) declined for seventeen consecutive months (nominal), from February 2015 to June Although signs of rebound in the latest two months have been observed, share of China in total volume of exports fell to 38.8% in the first eight months in 2016, which was the lowest since The second and third largest export destinations were ASEAN countries and the U.S., whose shares remained steady at 18.4% and 12.1% in the same period but exports to ASEAN and the U.S. declined 6.1% and 6.0% respectively in the same period. All of these figures reflect a weak global demand and are consistent with the downward revision of global trade volume forecast by IMF. Nevertheless, exports to Europe registered a positive growth indicating a better outlook.

4 Total volume of imports from all major suppliers (China, the U.S., European and ASEAN) declined in the first eight months of 2016, except Japan. On the other hand, exports of industrial products, which accounted for 98.6% of total exports, declined continually in However, the decline has been moderate compared with the numbers for 2015 (from -10.9% to -6.6%). Imports of agricultural and industrial materials declined in the first eight months and their share in total imports plunged from 77.8% in August of 2014 to 66.9% this year. Another reason for the depressed growth of imports was a weak domestic demand which can be observed from the drop of imports of consumption goods (-3.9% year-on-year in the first eight months of 2016). D. Money, Prices and Exchange rates In 2015 M1B expansion was lower than M2 for the first time since 2011, reflecting weak demand for funds. This is in sync with lower growth of loans at all banks. In the first half of 2016, growth of M1B was similar to 2015, ranging from 6.11% to 6.92% while growth of M2 decelerated in the same period, ranging from 4.14% to 5.63% but it has been below 5% since March. The latest numbers are 6.24% and 4.70% for M1B and M2 respectively (August 2015). Since crude oil price has stopped declining, consumer price index (CPI) was up 1.38% in the first eight months, mainly because of higher food prices, which rose by 5.77%. But the other components including fuel related prices offset the effect of the rise in food prices. In the same period, the core price index was up 0.81%. In addition, since international commodities prices are still weak, the wholesale price index (WPI) declined 3.93% in the first eight months of Due to hot money flowing into Taiwan s financial market, the demand of NT dollars has risen and has led to exchange rate appreciating by 2.2% since July. The latest number is as on 9/9. III. Future Prospects: In the coming two years, we expect external pressures to ease due to recovery of the world economy. According to the latest forecast released by IMF, the world trade volume will grow at 3.9% in both advanced economies and emerging markets and developing economies in 2017, which is much better than numbers for 2015 and In addition, while the sluggish imports of China are the main concern, the new policy adopted by the Taiwanese government is likely to mitigate the impacts of the New

5 Southward Policy and stimulate investment at the same time. By considering these positive factors, according to the macroeconomic model of Academia Sinica, real GDP is forecast to grow only 0.91% in 2016, 1.38% in 2017 and 2.90% in In the following, we discuss the major components of GDP. A. Consumption It is difficult and complex to estimate private consumption, the major component of GDP. The latest high-frequency data show that sales of food and beverages grew 3.7% in July but imports of consumer goods declined 3.9% in August. Moreover, Taiwan consumer confidence index (CCI) has also showed a downward trend, reflecting a weak outlook in this sector. More specifically, in August, CCI dropped 6.59 points year-onyear. As a result, we believe that growth of private consumption will be small in 2016 (2.16%), lower than the simple average of the past three years (2.67%). However, even the minimum wage will rise 5% from 2017, rising prices are expected to offset the wealth effects. We expect growth of private consumption to decelerate from 2.16% to 1.05% in 2017 and accelerate to 3.12% in According to the government budget document, government consumption is projected to grow by 1.91% in 2016 and increase nominally by 0.10% in B. Investment The two consecutive quarters of contraction in gross fixed capital formation can be largely attributed to the sharp decline in investment by the government and government-owned enterprises. While private investment too seems to have lost momentum, the latest indicators show signs of reversal. For example, PMI (Purchasing Managers' Index) has been in expansion territory for six consecutive months, especially the indices of new orders and expectations of the next six months economic situation. All these factors suggest that investment should revert to its normal pattern in the near future. We expect real private investment to grow 0.61% in Furthermore, the Asian Silicon Valley plan to be implemented from 2016 to 2023 has an outlay of 11.3 billion NT dollars and is likely to improve Taiwan s overall economic structure for enhanced internet infrastructure, mobile broadband services, e-commerce, smart applications, test beds, industry-university collaboration, digital talent and regulatory adjustments. This is expected to stimulate investment in 2017 and Government investment has declined for six consecutive years since 2010, mainly due to budget constraints. However, to retain competitiveness, real government investment is expected to be increased by 7.39% and 10.27% in the third and fourth quarter this year respectively. Additionally, after a negative growth of investment by government-

6 owned enterprises in 2015, a positive growth of 0.52% is projected for Overall, we expect that the average annual growth of gross fixed capital formation will remain weak in 2016, with a growth of only 0.77% year-on-year and shall accelerate in 2017 and 2018 at an average rate of 2.14%. C. Exports and Imports Though external trade has been a matter of growing concern since 2015, the latest data for August show that nominal growth of exports was encouraging. For example, exports to China grew 3.5% year-on-year, exports to US were up 5.7% and growth in exports to Europe and ASEAN was 2.1% and 0.8%, respectively. This is in line with economic recovery of Eurozone and ASEAN as well as the fiscal boosts in China. Imports of equipment for the semiconductor industry grew 8.0% in August. The upward trends in both exports and imports are clear and suggest that the momentum is likely to continue in the coming years. After considering price effects, based on our model, real goods and services exports are projected to grow by -0.38% and 5.51% in 2016 and 2017, respectively. We also expect imports of goods and services to rise 0.65% and 5.88% in 2016 and 2017, respectively. D. Money, Prices and Exchange rates In August, inflation was only 0.57%, mainly due to the drop of oil prices. However, we expect oil prices to be more stable in the second half of the year and, therefore, inflation is likely to maintain its positive pattern. We expect CPI to rise by 0.89% in 2016 and 0.13% in 2017, which is higher than in In addition, since international commodities prices are still weak, wholesale price index (WPI) is expected to decline 2.35% in 2016 and rise by 1.54% in Money supply is expected to expand modestly, with M1B and M2 growing 5.70% and 5.48%, respectively, in IV. Policy Issues and Uncertainty A. The impacts from China The sluggishness in Chinese economy cannot be wished away. Since 2015, China s imports from South Korea have registered growth in the range of 24.35% to 5.31%, the figure for July this year being %. In the same period, the change in Chinese imports from Taiwan ranged from % to 1.81%, the latest number being -8.83%. The numbers for the U.S. ranged from % to 10.88%, the latest number being %. Similarly, Chinese imports from Japan too have registered change in the range of -19.3% to 4.01% and the latest number was -4.59%. In general, we can observe that exports to China have declined for all its major trade partners.

7 Taiwan s external trade is heavily dependent on China s domestic demand (the share of exports to China in total exports is around 39%). Besides exports to all our major partners are declining and yet share of exports to China has been declining. Taking these two facts into account, we should be aware of the risk emanating from the close bond between Taiwan and China. The sluggishness in the Chinese economy is obvious from the fact that real total fixed investment in China fell to 6.92% and 5.95% in the first and second quarters of this year from an average of 7.48% for the whole year in While it is doubtful whether the fiscal policy (expansionary infrastructure spending) and the monetary policy (five cuts in lending rate) can really maintain the pace of China s economic growth, the Caixin PMI has been in expansion territory for the last two months (50.6 and 50), after contraction for fifteen consecutive months, from March 2015 to June 2016, revealing a sign of recovery. In addition, consumer spending in China is still robust and is growing at a rate of around 8%. However, notwithstanding expectations of the Chinese economy not heading for a hard landing, uncertainties still exist. One is whether the increase in investment can continue to gain momentum and another is that spillover effects from Brexit (even the trade between China and the U.K. is not high) may become more relevant. These will probably drag down China s economy as well as Taiwan s exports % 10.00% 5.00% 0.00% -5.00% % % % % % -4.59% -8.01% -8.83% % % EuroZone Japan SouthKorea Taiwan U.S. Figure 1. The change of exports to China from major trade partners

8 B. Asian Silicon Valley It is crucial for Taiwan to upgrade drivers of its economic growth. In the last decade, while we have been successful in being the leading semiconductor manufacturer, we have lost our competitiveness recently. Therefore, the new government s plan is to improve Taiwan s overall economic structure by the Asian Silicon Valley plan in Taoyuan City, home to many industrial clusters and a large pool of high-tech talent. According to the National Development Council (NDC), the Asian Silicon Valley plan contains one ecosystem, two objectives, three links and four strategies. The ecosystem will be built around innovative startups with a heavy focus on research and development (R&D). The two objectives are to foster that ecosystem and promote innovative R&D for internet of things (IoT) industries. The three links will join local industries together, connect Taiwan to the world and build links to the future. The four strategies will tie Taiwan to Silicon Valley and other global tech clusters, turning the island into an innovative startup destination for young Asians and creating new industries for the next generation. The plan s implementation period will run from 2016 to A budget of 11.3 billion NT dollars has already been allocated for 2017 for internet infrastructure, mobile broadband services, e-commerce, smart applications, test beds, industry-university collaboration, digital talent and regulatory adjustment. Taiwan s share in the global IoT market will rise to 4.2% in 2020 and to 5% in 2025 and shall contribute 0.9% to 1.7% to GDP. V. Conclusion In sum, we believe that economic growth is likely to remain weak in the developed world and growth in emerging markets too may continue to lose momentum this year. But the most important thing is that domestic exports are highly dependent upon demand from China. In the short-run, external trade cannot recover. The recent increase in financial volatility has been caused not by the divergence of monetary policies but by Brexit. However, even after taking these into account, long-term growth prospects for Taiwan are not strong, grow by 1.38% in 2017 and 2.90% in 2018, because of a notso-strong recovery of global economy and world trade and weak growth in China.

9 Taiwan 2012 %chg 2013 %chg 2014 %chg 2015 %chg 2016 %chg 2017 %chg 2018 %chg Aggregate Demand (Billions of NT$, Current Prices) Exports gds+serv Imports gds+serv Gross dom prod Aggregate Demand (Billions of NT$, 2011 Prices) Priv consumption Pub consumption Fixed invest Exports gds+serv Imports gds+serv Gross dom prod Key Economic Indicators (Index and Billions of NT$) CPI Whole sale pr Exports deflator Import deflator GDP deflator Exchange Rates Oil Price Money Supply,M

The Economic Outlook of Taiwan

The Economic Outlook of Taiwan by Ray Yeutien Chou and An-Chi Wu The Institute of Economics, Academia Sinica, Taipei October 2017 1 Prepared for Project LINK 2017 Fall Meeting, Geneva, Oct. 3-5, 2017 2