The Economic Outlook of Taiwan

by Ray Yeutien Chou The Institute of Economics, Academia Sinica, Taipei

October 2011

Prepared for Project LINK 2011 Fall Meeting, New York City, Oct. 24-26, 2011

I.

Introduction

Taiwans economy in the first half of 2011 expanded steadily, thanks to the continued momentum of last years strong growth in domestic and foreign demand. These include strong growth of domestic consumption and investment, rapid growth of emerging economies in Asia-Pacific, expanded cross-strait trade, and order transfer effect resulted from Japans earthquake. The growth of economy reached 6.16% year-on-year in the first quarter and 5.12% during the second quarter. However, new developments in the international arena have created headwinds to further growth in foreign demand for Taiwan exports: e.g., the unsettled and worsening European debt crisis, weak US job market, earthquake impact on March 11 in Japan, Mainland Chinas tightening economic policy against inflation. Being an economy heavily dependent on export, Taiwans economic prospect for the second half of 2011 is deemed to be weaker. We have adjusted the 2011 real GDP growth rate from the estimated 5.52% in July to 4.7%. The current uncertainty in international economy is expected to be resolved at least partially, and the annual growth rate for GDP is expected to reach a mild 5.12% in 2012. II. Recent Economic Performance

A. Consumption With the recovery of the world economy, Taiwans economy showed a strong performance in 2010 which GDP growth rates reached 10.88%. Meanwhile, Taiwans economy has continued to revive through the resilient domestic demand led by China and other emerging countries, the economy's exports and private investment rose significantly in the first quarter of 2011. In terms of private consumption, moderate growth of the economy helped restore consumer confidence and the improvement of the labor market facilitated consumer spending. The private consumption experienced growth rates of 4.38% and 3.12% in the first and second quarters of 2011. Consequently, the growth rate of nominal private consumption in the first and second quarters of 2011 was 4.87% and 4.21%. B. Investment Total gross fixed capital formation grew substantially last year especially for private investment. According to the Directorate-General of Budget, Accounting and Statistics (DGBAS), total gross fixed capital formation and private investment had enjoyed the double-digit growth, the growth rate was 23.44% and 32.51%, respectively. Besides, domestic companies continued to expand production capacity during the first quarter of 2011, the growth rate was 11.4% but plunged to 5.66% in
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the second quarter due to external uncertainties. As for other investment components, public investment grew at annual rates of -0.46% and 7.19% in the third and fourth quarters of 2010. Its annual growth rate then fell to -12.01% in the first quarter of 2011 and is expected further to -17.8% in the second quarter. Meanwhile, the growth of government investment has declined gradually, the growth rate of government investment rose 0.1% and -6.09% in the first and second quarter of 2011. Private investment has recently become the major momentum to support Taiwanese economy consequently. C. Exports and Imports Strong economic impetus in Asian emerging economies supported regional trade, further encouraged Taiwans exports. And the demand for high-tech products from advanced economies helped boost Taiwans exports and imports. For example, the total volume of exports from January to August of 2011 was 208.04 billion US dollars, which represents a 15.7% year-on-year increase. Similarly, the volume of imports (192 billion US dollars) increased by 17.6%. The trade surplus is expected to increase 25.8 billion US dollars in 2011, representing a slightly improvement from 2010. China (including Hong Kong) was still the major export market for Taiwan, its share in the total volume of exports reached 40.5%. Exports to China rose at the growth rate of 10.4% year-on-year. The second and third larger export destinations were the US and Japan, which shares in the total volume of exports were 11.9% and 5.9% from January to August of 2011. Exports to the US increased by 22.4% year-on-year, but exports to Japan increased merely by 3.5% because of Japans disaster. Industrial products were still the major exporting goods, accounting for 98.9% of total export volume from January to August of 2011. Their total export volume increased by 15.6% compared with the same period in 2010. As for total volume of imports, agricultural and industrial material accounts for the largest share (77.3%) from January to August of 2011, with an increase by 19.4% year-on-year. D. Money, Prices and Exchange Rates Owing to increases in bank loans and investment, the money supply (broad monetary aggregate) M2 in August of 2011 rose 6.16% from a year earlier. Comparing with the first eight months of the year, M2 grew an average annual growth rate at 6.01%. The interest rate was still low relative to normal level, providing abundant liquidity in the market. Inflation, held at a modest 1.34 percent in August, about the same as a month earlier, following a drop in Taipei home prices and slowing orders from abroad for Taiwanese manufactured goods. The annual growth rate of
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Taiwans Consumer Price Index in 2011 is expected to grow slightly from 0.96% in 2010 to 1.69%. Also, the annual growth rate of Wholesale Price Index in 2011 is expected to drop from 5.46% in 2010 to 3.84%. Moreover, due to the weak recovery of United States, the Taiwanese Dollar exchange rate have steadily appreciated against the US Dollar for more than 12 months, from a level of 32.17 in July last year to 29.0 in August this year. The recent turmoil created by the European sovereign debt crisis, however, has caused the NT$ to depreciate significantly. III. Future Prospects: 2011-2013 A. Consumption Recent economic data indicates the downside risks in the US and European Union (EU) economies are worsening. And the economic uncertainties in the US and EU would dampen the confidence for consumer and business sectors. Taiwans economy is certain to be affected by global market turmoil. But, despite the weakening global economic outlook, domestic demand in Taiwan remains resilient. According to the DGBAS, real GDP is forecasted to grow 4.81% in 2011, and domestic demand become more important as a contributor to GDP growth in the second half of 2011. Owing to the improvement of the job market and relaxation of tourism restrictions from China, private consumption is expected to grow 3.09% and 3.61% year-on-year in the third and fourth quarter of 2011. Its annual growth rate is projected to slightly decrease from 3.65% in 2010 to 3.48% in 2011. The average growth rate of private consumption from 2012 to 2013 will be 3.67% in real terms. B. Investment The economic crisis in the US and EU is expected to harm the demand for consumer electronics. So the decision of Taiwanese business spending becomes slower and more cautious amid a gloomy global economy. According to the DGBAS, private investment is expected to decline 9.91% and 6.76% in the third and fourth quarter of 2011, respectively. We forecast the annual growth rate of private investment for 2011 will plunge substantially from 32.51% in 2010 to 2.6%. At the same time, government and public investment are expected to be negative growth this year mainly due to the end of public construction, the annual growth rate of government and public investment is projected to -1.72% and -12.75%. Overall, the annual growth rate of gross fixed capital formation for 2011 is forecasted to hugely drop from 23.44% in 2010 to 0.68%, and the average annual growth of gross fixed capital formation from 2012 to 2013 will be around 4.21%. C. Exports and Imports
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Recent global economic turmoil is caused by worsening debt crisis in EU and slowing growth momentum in the US. Meanwhile, the economic crisis in EU and the US has negative effects on export-oriented economies like Taiwan. The latest economic data showed Taiwans export orders revealed a moderation in demand from major export markets. This is a warning sign for Taiwan because it exhibited that worsening conditions in EU and the US have not only hit the nations local tech sector, but would also have an influence on labor market in coming months. Nevertheless, the implementation of the Economic Cooperation Framework Agreement with China has established closer economic and trade links with Taiwan. And strong economic momentum in Asian emerging economies would support regional trade continuously, further pushing Taiwans exports. The 2011 annual growth rate of exports is projected to decelerate from 25.65% in 2010 to 5.96%. For 2012 and 2013, Taiwans exports of goods and services are anticipated to keep growing mildly. Moreover, the demand for electronic and production machinery products, boosted by the industrial upgrading in China, may further enhance Taiwans exports in the future. The average annual growth rate of exports from 2012 to 2013 is expected to be 9.86%. In addition, the 2011 annual growth rate of imports is forecasted to fall from 28.2% in 2010 to 1.86%. The average annual growth rate of the import volume is expected to be 8.73% from 2012 to 2013. D. Prices and Money Supply In terms of price, as governments around the world are beginning to adopt austerity policies, the soaring international crude oil and raw material prices trend has eased; therefore, the expected inflation remains within reasonable limits. Looking ahead, the inflationary pressure of consumer price in Taiwan is expected to remain under control at a moderate level. CPI will increase mildly at the rate of 1.45% and 2.00% for 2012 and 2013. Moreover, with global hot money flowed around, the prices of agricultural and industrial raw materials have experienced great volatility. But the inflation pressure will not become serious until global economy returns to solid growth. WPI is projected to rise by 2.93% in 2012. As for exchange rate, with the recoverable uncertainty of industrialized countries, NT dollar is expected to fluctuate persistently. Thus, NT dollar would depreciate modestly from 29.4 per US Dollar in 2012 to 29.82 per US Dollar in 2013. IV. Policy Issues and Uncertainty

Taiwans government signed a Cross-Straits Economic Cooperation Framework Agreement (ECFA) with China in June 2010 and the policy took effect in September. More than 500 Taiwanese products exported to China enjoy preferential tariffs
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following the implementation of ECFA. This agreement not only benefits to Taiwan in economic trades with China, but also helps Taiwan to sign free trade agreements with other trade partners in the future. The ECFA serves to show Taiwans trade partners that the political tension across the Taiwan Strait has been reduced. It should enhance Taiwan to play a more important role in the global economy. Following the signing of the ECFA with China, Taiwan has signed an investment protection arrangement with Japan in September this year. Minister of Economic Affairs Shih Yen-hsiang described the investment protection arrangement as a comprehensive and forward-looking pact covering three crucial areas: investment protection, furthering investment and the spirit of free trade. This new trade arrangement with Japan is a major breakthrough in bilateral ties over the past three decades. Taiwans government continues to push for Taiwans participation in regional economic integration and hopes to negotiate economic agreements with its other major trading partners in the future. V. Conclusion

Taiwan's economy in 2011 is expected to retain steady growth mainly on the back of substantial growth in exports and private consumption. However, the economic weakness in Europe and the US has affected Taiwans exports in the second half of the year. In order to ease the impact of the recent debt crisis facing Europe and the US on Taiwans economy, the government attempts to speed up further expansion of exports to Asia and emerging markets. The implementation of the ECFA and the signing of the Taiwan-Japan investment protection arrangement are major accomplishments in this direction. On balance, we expect the annual growth rate of real GDP of Taiwan will be around 5.10% from 2011 to 2013.