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Global Economic Outlook
Taiwan: Q3 2010 Outlook
By Adam Wolfe
- The Taiwanese economy will expand at its fastest pace in more than a decade due to strong investment and export growth.
- Personal consumption will grow only modestly in 2010, despite an improving labor market, as asset price inflation ceases to supplement income growth.
- With muted consumption but strong investment and credit demand, the central bank will only slowly normalize its monetary policy in 2010.
Outlook Update: The View From the Top
Taiwan’s recovery from the trough of Q2 2009 has been remarkable, prompting us to again revise our forecast for its GDP growth: to 6.8% in 2010, up from 5.5% in our previous Outlook. The revision is largely due to a swing in our expectations for Taiwan’s net exports and restocking. Though we previously believed net exports' contribution to GDP would contract slightly in 2010 from 14% in 2009, weak private consumption has kept Taiwan’s domestic demand muted, despite strong investment demand, and should result in a slight expansion of net exports that may continue into 2011. Demand from China, the U.S and EU will wane over the course of 2010, however, tempering GDP growth. Weaker-than-expected private consumption and a slowdown in capital inflows have led us to reduce our forecast for inflation this year. We now expect the CPI to average 1.2% in 2010, though we maintain our forecast for two additional 12.5 basis point (bp) rate hikes this year, following the hike in Q2.
Growth Dynamics: Strong Investment, Weak Consumption
For several months in Q1 2010, Taiwan’s economy was on the verge of overheating as manufacturers operated at or above capacity. This sparked some sharp upward revisions from other forecasters, but the leading indicators already are pointing to a slowdown, and we are slightly less optimistic than consensus about Taiwanese consumption growth. Despite a large upward revision, our 6.8% growth forecast is now about half a percentage point below consensus, whereas we previously were on the high end of the spectrum.
Figure 1: Less Vroom Vroom in the V-Shaped Recovery
Source: Ministry of Economic Affairs
Private consumption was surprisingly weak in Q1 2010, expanding only 3% from a low base. An improving labor market (unemployment fell to 5.2% in May from 5.8% at the end of 2009) should lift private consumption slightly in Q2, but RGE now expects private consumption to increase only 2.5% in real terms in 2010 as base effects ease the growth rate in H2 and support from buoyant asset prices wanes.
Although investment surged 26% y/y in Q1, it was a massive restocking that provided the largest contribution to growth. After a year of destocking, the rebuilding of inventories added about 4.5 percentage points to growth in Q1, according to RGE’s calculations. The restocking cycle is likely to continue into 2011, but the contribution to GDP will decline as base effects shift. RGE expects investment to remain elevated, up about 13% this year, amid capacity expansions after two years of double-digit contractions. In H1 2010, manufacturers reported a large increase in back orders, and factories were operating at full capacity. Although the global economy is expected to slow in H2 2010, a new trade agreement with China will help ensure the new capacity is utilized.
Figure 2: Composition of GDP, Billions TWD (2006 prices)
Source: Directorate-General of Budget, Accounting and Statistics
Risks: Open for Trouble
Taiwan’s small and open economy has become more vulnerable to global swings, which RGE believes will slow in H2 2010. Because net exports now account for 14% of Taiwan’s GDP, up from 2% in 2005, slower global growth will weigh on Taiwan in H2 2010 and 2011. We no longer expect a contraction in net exports in 2010 or 2011 because the TWD remains competitive, thanks to USD strength. Also, an economic cooperation framework agreement (ECFA) signed in June will boost Taiwanese exports to China in 2011, and private consumption will remain muted from the hollowing out of Taiwan’s manufacturing sector to only research and marketing since 2000. Still, Taiwan cannot maintain this large trade surplus indefinitely, and when it contracts, growth will slow sharply.
Luxury property prices in Taiwan still look overvalued, but as capital inflows have waned the risk of asset bubbles has deflated somewhat. However, another flight-to-safety episode, whether due to growth concerns in China or debt problems in the EU, would strain Taiwan’s financial sector and consumption growth.
Additionally, mayoral elections in November 2010 in five key municipalities representing about 60% of the electorate have the potential to disrupt the gradual cross-strait economic integration underway. The ruling Chinese Nationalist Party (KMT) may suffer losses as the opposition Democratic Progressive Party (DPP) benefits from skepticism of the ECFA within its ranks, which should bolster the turnout for the DPP and its Pan-Green supporters at the polls.
Policy Implications: A Slow Drift Bank to Normal
As RGE had expected, Taiwan’s central bank hiked interest rates by 12.5 bps at its Q2 2010 monetary policy meeting on June 24. Although inflationary pressures remain muted due to a relatively weak revival of domestic consumption, Taiwan’s overall recovery has been stronger than anticipated. With unemployment falling and Taiwanese manufacturing operating near potential, monetary policy normalization will continue in 2010, despite the less impressive external environment. RGE expects the central bank to continue hiking interest rates by 12.5 bps at each of the next two policy meetings, with a year-end target of 1.625% for the benchmark rate.
Figure 3: Easing Inflationary Pressures, Slow Normalization
Source: Directorate-General of Budget, Accounting and Statistics; Central Bank of China
Taiwan will undertake some fiscal consolidation, and the deficit should narrow from about 6% of GDP in 2009 to around 4% in 2010. Although stimulus spending will continue to put stress on Taiwan’s fiscal sustainability and credit ratings, the risks of a problematic fiscal deficit or downgrade seem minimal given the government’s strong asset position (over US$360 billion in reserves).