The opposition Chinese Nationalist Party (Kuomintang, KMT) won an overwhelming victory in the Legislative Yuan election held on 12 January, winning more than two-thirds of the total seats. In the run-up to the presidential election (22 March), KMT candidate Ma Ying-jeou appears to be ahead of the ruling Democratic Progressive Party (DPP) candidate, Frank Hsieh. Nevertheless, we think the result is a difficult one to call, given floating voters and the possibility of a backlash against the wide margin of the KMT’s Legislative Yuan victory. Regardless of the winning candidate, the newly elected president is likely to tailor policies to suit the KMT, given the party’s
overwhelming majority in the parliament. Incumbent Chen Shui-bian has had
numerous stand-offs in the legislature with the KMT-led majority coalition, resulting in deadlock over economic and other measures. We thus expect the relationship between the administration and the legislature to improve under the new president.
The main focus of the presidential election is Taiwan’s policy toward mainland China.
Based on the political views expressed by presidential candidates Ma and Hsieh, we expect cross-strait relations to improve, whichever candidate is successful. The specific policy measures proposed include: 1) the start of regular, direct flights across the Taiwan Strait; 2) the reception of mainland Chinese tourists in Taiwan; 3) the lifting of upper limits on direct investment in China; and 4) the easing of restrictions on investment from China. The targeted number of tourist arrivals from China in the initial stage of proposed deregulation is 1,000/day, which is around the same number of tourist arrivals Taiwan sees from the US.
The KMT plans to rapidly and comprehensively liberalise Taiwan’s interaction with China, whereas the DPP intends liberalisation to be more gradual and cautious. If liberalisation measures result in greater cross-strait exchange, we think Taiwan would benefit more from China’s economic growth. However, cooperation from mainland China would be essential for such measures to be implemented, and we think it will be some time before the two sides can reach an agreement.
Executive-legislative relations likely to improve with a KMT victory in the Legislative Yuan
Warming cross-strait relations should increase the benefits for Taiwan from China’s rapid growth
Economics | Taiwan Kota Hirayama
Our view now versus three months ago
We have cut our 2008F export forecast to reflect increased concerns over an
economic slowdown overseas; accordingly, we have also cut our projections for private capital investment and private consumption in Taiwan. For 2009F, however, we expect overseas economies to pick up and thus leave our export and private investment estimates broadly unchanged. Given the KMT’s overwhelming majority in the legislature and its pledge to expand public sector investment, we have lifted our projections for public spending in 2008-09F.
Summary
GDP growth reached 6.9% y-y in 3Q07, driven by private consumption and exports.
Robust growth also appears to have continued in 4Q07. We think external demand trends will be an important factor in 2008F and beyond. The slowing in Taiwanese exports should be relatively mild, despite the increasing uncertainty over prospects for the US economy, since Taiwanese exports are supported by robust growth in other Asian economies. Turning to domestic demand, we project an acceleration in private consumption and public spending. The easing card loan problem and an improved employment and income environment should underpin private consumption.
The KMT has pledged to greatly expand public investment, and we expect budgets to be framed accordingly. Taiwan’s economy is likely to continue to expand, despite losing some momentum. The central bank has continued to hike rates, against a backdrop of growing concern over inflation. However, interest rates have hardly risen in real terms, and the effects of monetary tightening have thus been limited. As such, we expect the central bank to continue hiking interest rates.
Real economy developments and directions
GDP growth accelerated from 5.2% y-y in 2Q07 to 6.9% y-y in 3Q07, backed by private consumption and exports. We think that a structural factor, in the form of the disappearing card loan problem, and a cyclical factor, namely an improved
employment and income environment, have underpinned private consumption. While exports to the US have declined, exports to China and other parts of Asia are growing by more than enough to compensate for the decline, and are clearly starting to drive Taiwan’s exports. Customs-based statistics show export growth accelerating from 9.7% y-y in 3Q07 to 15.3% in 4Q07. Even allowing for growth in imports, it appears external demand gave real GDP growth a substantial boost in 4Q07. We estimate that the real GDP growth rate reached its highest level since 2004 at 5.9% y-y in 2007.
External demand trends are an important factor for assessing Taiwan’s economic outlook, in our view. Financial market turmoil triggered by the sub-prime mortgage crisis has dampened the outlook for the US real economy. We believe that this will have a negative impact on Taiwanese exports. Although exports to the US and Europe have slowed recently, overall export growth has accelerated, owing mainly to
expanding exports to Asia. We look for export growth to the Asia region to remain robust in 2008F and beyond, which should mitigate the impact on Taiwan from any economic slowdown in the US. We project a relatively mild slowing in Taiwanese exports, and expect growth to accelerate again in 2009F, as the US economy picks up.
Private consumption and public spending are likely to drive domestic demand. We expect the structural and cyclical factors seen in 3Q07 GDP statistics to continue to underpin private consumption. In terms of public spending, the KMT has pledged to expand public investment by 10% annually; thus we would expect budgets to be drawn up in deference to the KMT’s targets. Since the 2008 budget has already been passed, however, we do not expect public investment to expand in earnest before 2009F.
All in, our economic growth forecast for 2008F falls to 4.0%, from 4.6%. For 2009F, however, we have raised our growth forecast to 4.9%, from 4.5%.
Projections down for 2008F on slowing external demand, and up for 2009F in anticipation of expanding public investment
Continued economic expansion, but with slower momentum
Rapid growth in 2H07 backed by private consumption and exports
Robust growth in exports to Asia should offset weaker exports to US
Private consumption and public spending to drive domestic demand
We forecast real GDP growth of 4.0% for 2008F and 4.9% for 2009F
Economics | Taiwan Kota Hirayama
Fiscal policy
On 20 December, 2007, the Legislative Yuan passed the central government’s 2008F budget. Expenditure in areas including the military and personnel was cut during discussions in the Legislative Yuan, and the final budget was 0.8% smaller than the Executive Yuan’s (cabinet) original proposal. As a result, year-on-year growth in the 2008F budget slowed to 3.5%, from 6.4% in the 2007 budget. We thus think that the public sector is unlikely to drive Taiwan’s economy in 2008F. Nevertheless, we note that major fiscal measures could be introduced if economic slowing overseas is more severe than expected.
Looking ahead to fiscal measures in 2009F, we expect major expansion in public investment given the KMT’s overwhelming victory in the Legislative Yuan. The DPP administration has consistently reduced public spending in real terms since 2000, which has curbed Taiwan’s economic growth rate. The KMT’s policy outline drawn up in June 2007 includes measures to expand public investment and improve Taiwan’s infrastructure. KMT presidential hopeful Ma followed this up by announcing that he would increase public investment by at least 10% pa. Although the outcome of the presidential election is difficult to call, we expect the victor to increase public spending, in deference to the KMT’s dominant position in the legislature.
Monetary policy and interest rates
Concerns over inflation are growing in Taiwan. The CPI growth rate accelerated from 1.5% y-y in 3Q07 to 4.5% in 4Q07. Although this mainly reflects a spike in fresh food prices owing to typhoon disruption and persistently high international prices for commodities such as crude oil and grain, the core inflation rate excluding food and energy prices is also on the rise. Concerns are abound that inflation will worsen, as inflation expectations rise in response to inflationary pressure from the supply side.
The central bank continues to gradually raise interest rates, lifting its policy rate (the rediscount rate) in December 2007 by 12.5bps to 3.375%. However, real interest rates have hardly risen, since the impact of hikes in the policy rate has been offset by rising inflation. Despite the heightened uncertainty over economic prospects overseas, we expect Taiwan’s central bank to continue to hike interest rates in response to domestic economic and price conditions. Assuming further hikes of 12.5bps each quarter, we project a policy interest rate of 3.875% at end-2008F and 4.375% at end-2009F.
Forex policy and outlook
The NT dollar appreciated against the greenback between late September 2007 and early November, in response to a movement away from the US dollar on a global scale.
The local unit has subsequently settled back to roughly NT$32.4:US$1. The US has been cutting interest rates, while Taiwan is likely to continue to hike rates. As the interest rate gap between Taiwan and the US reverses, the downward pressure on the NT dollar should ease. Nevertheless, we think the NT dollar will stay close to its current level, for three reasons: 1) the central bank likely wants to keep the local currency stable against the yen; 2) the NT dollar has been trading near its three-year historical average; and 3) the yen is unlikely to continue appreciating unabated against the US dollar, following its appreciation in 2H07.
Based on the above, we expect the NT dollar to remain stable at around its current level against the US dollar, save for bouts of temporary appreciation. Given the recent trends, we now forecast a forex range of NT$31.0-34.0:US$1 for 2008F and end-2009F, versus our previous forecast range of NT$31.5-34.5:US$1. However, our fundamental view of the NT dollar’s outlook is unchanged.
Economic boost from public sector unlikely in 2008F
The KMT victory in the Legislative Yuan points to a major increase in public spending in 2009F
Increased concern over inflation due to supply-side pressure
We expect the central bank to keep hiking interest rates
The local unit should remain at around the current level against the US dollar
We forecast a forex rate of NT$31.0-34.0:US$1 for end-2008F and end-2009F
Economics | Taiwan Kota Hirayama
Risks
We identify three main risk factors for the Taiwanese economy. The first and largest risk, in our view, is a more severe economic slowdown overseas than we have anticipated. Economic slowing overseas could depress exports and have a serious impact on Taiwan’s economy. The second risk is further stagnation in private consumption should inflationary pressure persist despite repeated interest rate hikes and government measures to rein in prices. The third risk we identify is potential deadlock in the KMT-dominated Legislative Yuan in the event that the DPP candidate wins the presidential election and adopts an uncooperative approach.
Risks include a worse-than-expected economic slowdown overseas, stalled consumption due to inflation, and political deadlock
Economics | Taiwan Kota Hirayama