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Economics: Taiwan Economics – Markets – Strategy Investment recovery is likely to sustain The negotiations with China on tourism and transportation issues are progressed smoothly Still, growth drivers on the way Despite the downside risks caused by inflation, we maintain our 2008 GDP forecast unchanged at 5.0%, as we think the new government’s policy stimulus will bode well for a sustained investment recovery in 2H08. The blueprint planned by the new government centers on strengthening economic ties with China and promoting infrastructure investment in the island. The new president Ma Ying-jeou has pledged to establish weekend direct charter flights and allow the direct entry of tourists from China starting from July. As we pointed out previously, these two are relatively mature proposals reflecting improving cross-strait economic relations, as the negotiations on related technical details have already moved forward over the last two years. Since the ending of presidential elections in March, interactions between Taiwan’s new leaders and China’s top government officials have been warm. The bilateral dialogue between the semiofficial Straits Exchange Foundation (Taiwan) and the Association for Relations across the Taiwan Strait (China), which has been suspended for almost a decade, is now scheduled to resume on June 11-14. The weekend charter flights and tourism issues will be the focus of this meeting, and a formal official agreement is likely to be formulated successfully according to newswire reports. We stay optimistic in this regard. Tourism revenue alone (brought by 3000 China tourists per day) is estimated to add annual GDP growth by 0.4ppt (Chart 5). The positive effect on investment, employment and income growth in related industries would be even more significant. Chart 5: Tourism revenue to grow % 2.0 1.5 1.0 0.5 Visitors Arrivals (RHS) Tourism revenue/GDP mn, persons 6 5 4 3 2 1 Chart 6: Saving-investment gap widening % 31 29 27 25 23 21 19 17 Saving / GDP Investment / GDP 0.0 1991 1994 1997 2000 2003 2006 2009F 0 15 1997 1999 2001 2003 2005 2007 Infrastructure investment could be funded through the private sector The new president also promised to promote the “I-Taiwan 12 infrastructure projects” over the next eight years, which amount to a total of TWD 4trn (3% of GDP per year). We concur that investment is a much-needed driver for Taiwan’s economy. The external-internal imbalance has widened for years - trade surplus stayed persistently strong, but investment has been massively relocated overseas due to sluggish confidence on domestic politics and the long-term trend of globalization. As a result, the saving-to-investment gap has widened sharply, from 2.8% (of GDP) in 2000 to 9.5% in 2007 (Chart 6). It is true that the infrastructure investment plan targeted by the government appears somewhat ambitious in light of its still-weak fiscal position (-0.2% of GDP in 2007) and rising fiscal burden resulting from fuel subsidies this year. Nevertheless, we think the official proposal of raising 1/3 funds from the private sector (via the BOT model) is feasible. Moreover, the leading role played by the government in increasing 84
Economics – Markets – Strategy Economics: Taiwan investment should be valued, in terms of helping restore investor confidence in the island. Taking into account the above positive factors, we expect the revival in investment especially private investment to sustain into 2H08 and 2009. Combined with the downside risks on private consumption, the overall GDP growth is likely to slow moderately towards 4% in 2Q-3Q08 and then bounce back to 5% from 4Q08. Monetary policy: the CBC takes a long-term perspective Taiwan’s central bank (CBC) maintained monetary tightening over the past three quarters, in contrast to the aggressive Fed rate cuts and the wait-and-see approach adopted by most Asian central banks. We think the CBC is taking a long-term perspective. At the 1Q monetary policy committee meeting in March, the CBC remained comfortable with growth outlook this year, saying that the 4.3% growth projected by the government think-tank National Statistics is “close to the 10- year growth average”. By contrast, the CBC cited inflationary pressures as the key reason for rate hikes, which is no surprise given that the current inflation rates of 3-4% are far above the 10-year average of less than 1%. Compared to one quarter ago, the National Statistics has upgraded their 2008 growth forecast to 4.8% from 4.3% after the release of 1Q GDP report, and lifted inflation forecast to 3.3% from 2.0%. Clearly, this means the official view is that inflation risks have further risen and growth risks are lower than they previously feared. Consequently, chances are high that the CBC will place inflation as the top policy concern and extend the rate hike cycle. Apart from the 12.5bps rate hike projected for June, we have added two more 12.5bps hikes into our policy forecast for 2H08, which will lift the benchmark rediscount rate to 3.875% by the year-end. The short-term money market rates, deposit rates and new loan rates are currently below inflation and also policy rate, at merely 2-3% (Chart 7). Even after further hikes of 37.5bps, real rates would only get closer to the zero level. Moreover, capital inflows is unlikely to fade substantially going forward. Taiwan should remain attractive to foreign investors and domestic investors staying offshore as they bet on increasing integration with the mainland over the medium term. Consequently, market interest rates should continue to edge upward at a more gradual and moderate pace than policy rate in the coming quarters. In sum, liquidity conditions should remain supportive to economic growth, despite the possibility of more rate hikes. The official forecasts of inflation and GDP growth have both been lifted Expect more rate hikes ahead, but liquidity conditions should remain supportive to economic growth Chart 7: Real rates still negative % YoY, % pa 10 8 6 4 2 0 -2 CPI Rediscount Rate New Loans Rate Deposit Rate: 1 Yr May-98 May-00 May-02 May-04 May-06 May-08 Chart 8: External position strengthening USD bn 15 10 5 0 -5 -10 -15 Current Account Financial Account Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 85
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