Summary

The 1.1% yoy growth for Q1 2001 was the weakest since Q1 1975. The downturn in the global technology cycle has hit the Taiwanese economy hard. Both fiscal and monetary measures have been adopted to prevent the economy from sliding into recession. Nevertheless, their effectiveness may be limited. It seems that recovery in Taiwan depends much on the resurgence of the global technology sector, which is not expected until late this year or early next year. Real GDP growth is expected to slow to 1.2% for 2001, compared to the 6.0% growth last year.

Hi-tech downturn hit exports hard

Although the US economic downturn has not degenerated into a recession, the technology downturn is dramatic and has hit Taiwan exports hard. With electronics and IT exports plunging 22.8% yoy, total exports were down 17.0% yoy in Q2. Disappointing exports have prompted the authorities to let the currency depreciate to around 34.5 per USD. Unfortunately, the worst is not yet over. Sharp decline in exports is to continue in Q3. First, there is a high base for comparison as Q3 last year was the peak in exports. Second, the earlier-anticipated V-shaped rebound in the US economy in H2 is unlikely to happen. Besides, the adjustment in global hi-tech capital investment is still going on and is not expected to complete in 1-2 quarters' time. All these suggest that a turnaround in Taiwan exports is not to be seen until Q4 2001 or Q1 2002. This is confirmed by the 10.4% yoy decline in export orders (17.2% yoy decline for electronics and IT goods) for the April-May period, presaging further weakness in exports. Imports saw a steeper decline of 15.2% yoy in the January-May period. This reflected not only falling exports, but also subdued domestic demand, which is evident in the 18.2% yoy decline in capital goods imports. As imports dropped more than exports, the trade balance for the January-May period went up by 166% to US$ 4.9 billion.

Production and investment declined

Industrial production dropped sharply with declining exports. Manufacturing production was down 8.1% yoy in the April-May period, following the 4.8% yoy reduction in the first quarter. The worst performing sectors were metal and machinery, and electronics and IT, dropping 12% yoy and 11% yoy respectively in April-May. Capacity utilization is in the trough. Nevertheless, production has not yet reached the bottom. Shipments are still declining while inventories are rising. A recovery in industrial production is not expected until late Q4 this year.

Fixed capital investment has not fared well amid deteriorating economic condition. In Q1, private fixed capital plunged 7.5% yoy. In May's business sentiment survey, the share of manufacturers expecting the economy to get worse in 3 months' time increased from 34% to 39%, while only 13% expected the economy to improve. Negative sentiment should continue to have an adverse impact on fixed capital investment.

Unemployment rising

Weak economic activity has led to deteriorating labour conditions. The unemployment rate shot up to 4.2% in May, a high in more than 20 years. Unemployed persons broke the 400,000 level in May. In fact, had it not been for the slower labour force growth in the past few months, the unemployment rate should have been higher. Employment growth has dropped for 5 consecutive months. While some 70,000 jobs were created over the past year in the service sector, this was more than offset by the 150,000 job cuts in the industrial sector. This reflects not only the cyclical weakness in industrial production, but also the more fundamental restructuring of the economy. The fact that there are increasing FDI by Taiwanese manufacturers in mainland China has resulted in less investment in the domestic industrial sector and hence less employment opportunities. Looking forward, the headline unemployment rate is expected to climb higher in Q3, when fresh graduates enter the labour market. As the economic outlook remains bleak, improvement in the labour market is unlikely until next year.

Private consumption remains subdued

Consumer spending remains sluggish. Real private consumption expenditure grew a mere 2.0% in Q1, compared to the 3.8% growth in Q4 last year. The outlook for private consumption is not very optimistic. Spending is dragged by the worsening labour market. Consumer confidence is also hurt by deteriorating employment prospects associated with the hollowing out of the industrial sector. As to the stock market, while further downside of equities prices may be limited, a substantial rebound is unlikely. Resurgence in the global technology sector is still not in sight, thus capping any upside for Taiwan's tech-heavy stock market. This means that the negative wealth effect will continue to dampen consumer sentiment. Consequently, consumer spending is not expected to recover for the rest of the year.

No threat of inflation

There is no threat of inflation because of weak domestic demand and lower food prices. The CPI rose a mere 0.2% yoy in the first half of the year. Stripping off volatile fresh food and energy prices, the core CPI was up 0.5% yoy. Despite a weakened currency and higher energy prices, imported inflation should not be a concern in the short term. Import prices (in local currency terms) have only risen 1.1% yoy so far this year. Yet the domestic WPI was down 0.7%, indicating that sluggish consumer demand is still the dominant force dragging price increases. Even if the currency continues to depreciate, any impact on prices would not surface until next year. Inflation for 2001 is expected to be 0.6% only.

Stimulus measures

To prevent the economy from sliding into recession, both fiscal and monetary policies were adopted to boost demand. First, a TWD111.5 billion supplementary budget was put forward to the legislature for approval. Second, the CBC has cut interest rates 6 times since last December, bringing down the re-discount rate by 100 basis points to 3.75%. Besides, the currency has also been allowed to depreciate, aiming at boosting external demand.

As far as monetary policy is concerned, it appears that it has not been very effective in boosting demand as both loan growth and money supply growth have been decelerating. The reasons are twofold. First, banks are quite cautious in their lending attitude for fear of rising non-performing loans. This is so despite the government's urge that banks should be more lenient in extending credit to enterprises in difficulties. Second, loan demand is dampened by subdued domestic demand and the pessimistic economic outlook.

Since mid-May, the TWD has depreciated by about 5% to around 34.5 per USD. It was widely regarded as the CBC's willingness to let go the currency to arrest the declining trend in exports. Arguably, the TWD depreciation in May could be a mere response to the fall of the JPY and the KRW earlier this year. This implies that the TWD will closely follow the JPY and the KRW. Yet the risk of capital flight may put the CBC into a dilemma. BOP figures for Q1 show that despite the declining stock market, there was net equities portfolio inflow in Taiwan. Should the currency continue to weaken, capital outflow may be triggered, which may be disastrous to the stock market and hence further weaken domestic demand.

Political development

While the political environment in Taiwan is much more stable than in SE Asia, there are growing uncertainties which warrant more attention. Domestically, the legislature election is coming in December. It remains to be seen whether the pro-independence faction in the KMT is to form an alliance with the DPP. If yes, it will intensify the confrontation between the locals (the ethnic Taiwanese) and the non-locals. This may mean that the political agenda will be occupied by ethnic issues, instead of the more pressing economic ones. Externally, the recent pro-independence gestures made by president Chen has renewed cross-strait tensions. So far, the reaction from mainland China has been much more restrained than expected. But the lack of progress in the political front between Taipei and Beijing will mean more economic challenges for president Chen.