The Economic Outlook of Taiwan by Ray Yeutien Chou and Shou-Yung Yin The Institute of Economics, Academia Sinica, Taipei October 2016 Prepared for Project LINK 2016 Fall Meeting, Toronto City, Oct. 19-21, 2016 I. Introduction Taiwan’s economy has suffered contraction for three consecutive quarters since the third quarter of 2015. The reasons for this recession include drop in crude oil price, sluggish global economy and the push to economic reforms in China. In the beginning of 2016 also recovery of the global economy was not significant due to weakness in the U.S. and Japan, though growth in the Eurozone and China exceeded expectations. The latest update of forecasts for 2016 by the International Monetary Fund (IMF) in July revised the growth rate forecast from 1.9% to 1.8% in Advanced Economies while the world trade volume growth expectations have been lowered from 3.1% to 2.7%. These estimates suggest that the outlook for 2016 is worse than what we had expected. The real GDP growth rate in the first quarter of 2016 in Taiwan was -0.29% (year-on-year), largely accounted for by negative annualized growth in investment (-0.25%) and in exports sector (-4.04%). However, some of the high frequency indicators show that Taiwan may have a rebound in the second half of this year. In the following, we briefly discuss recent economic performance and forecasts for each GDP component. II. Recent Economic Performance A. Consumption After solid growth in 2014 (3.33%), private consumption was dampened by weak performance in the second half of 2015. The decline was not offset by a drop in the consumer price index; real private consumption grew only 0.48% and 1.69% (year-on- year) in the third and fourth quarters in 2015 respectively. Although there was some improvement in the first quarter of 2016 (2.53%, year-on-year), it is largely attributable to the subsidy scheme last year that boosted consumption by 5.09 billon NT dollars. The latest figures indicate that that private consumption grew only 1.23% (annualized) in the second quarter, reflecting that domestic demand is still subdued, which is consistent with the negative growth in real wages in the first six months of 2016 (- 1.58%, year-on-year). Real government consumption registered negative growth in 2015 (-0.33%). It grew 5.47% in the first quarter this year, largely because of expansion of the stimulus policy. In the second quarter this year there was only a slight increase (1.96%) in government consumption. B. Investment Gross fixed capital formation grew only 1.76% and 1.23% in 2014 and 2015 respectively. Because debt to GDP ratio was already close to the official upper limit (40%), government investment and government-owned enterprises investment declined by 4.30 and 6.94% in 2014 and 2015 respectively, though private investment did go up 3.17% and 2.75% in the same periods. More specifically, government investment has declined for six consecutive years, from 2010 to 2015, reflecting that there isn’t much room for improvement in our economic performance with fiscal policy (Government investment contributed -0.12% to GDP growth rate in 2015). In 2016, real private investment grew only 0.16% and 1.13% in the first and second quarter respectively although imports of capital equipment were up 5.4% (year-on-year) in the first eight months (22.1% in May). However, the growth in these imports is largely explained by the rise in import prices caused by appreciation of the Yen. Government investment and public utilities investment have continued to follow the pattern of 2015, i.e. growth rate registered was -3.09% and -3.02% in the first quarter and -7.01% and -2.33% in the second quarter, respectively. C. Exports and Imports The weak global demand and China having started building the “red supply chain” which means producing electronic parts in China rather than importing for assembly of finished products are the two factors that have resulted in Taiwan’s exports of goods and services declining 0.16% in 2015 in real terms for the first time since 2009. Meanwhile imports of goods and services grew only 0.92%, reflecting weak domestic demand which includes subdued consumption and investment as mentioned before. While we still have negative growth in export and import sectors of -4.04% and -1.49% in real terms respectively in the first quarter of 2016, there was a pick up in the second quarter (0.63% and 0.21%). This is consistent with the slightly stronger growth in China and recovery of demand in the semiconductor industry. Total volume of exports to China (including Hong Kong) declined for seventeen consecutive months (nominal), from February 2015 to June 2016. Although signs of rebound in the latest two months have been observed, share of China in total volume of exports fell to 38.8% in the first eight months in 2016, which was the lowest since 2006. The second and third largest export destinations were ASEAN countries and the U.S., whose shares remained steady at 18.4% and 12.1% in the same period but exports to ASEAN and the U.S. declined 6.1% and 6.0% respectively in the same period. All of these figures reflect a weak global demand and are consistent with the downward revision of global trade volume forecast by IMF. Nevertheless, exports to Europe registered a positive growth indicating a better outlook. Total volume of imports from all major suppliers (China, the U.S., European and ASEAN) declined in the first eight months of 2016, except Japan. On the other hand, exports of industrial products, which accounted for 98.6% of total exports, declined continually in 2016. However, the decline has been moderate compared with the numbers for 2015 (from -10.9% to -6.6%). Imports of agricultural and industrial materials declined in the first eight months and their share in total imports plunged from 77.8% in August of 2014 to 66.9% this year. Another reason for the depressed growth of imports was a weak domestic demand which can be observed from the drop of imports of consumption goods (-3.9% year-on-year in the first eight months of 2016). D. Money, Prices and Exchange rates In 2015 M1B expansion was lower than M2 for the first time since 2011, reflecting weak demand for funds. This is in sync with lower growth of loans at all banks. In the first half of 2016, growth of M1B was similar to 2015, ranging from 6.11% to 6.92% while growth of M2 decelerated in the same period, ranging from 4.14% to 5.63% but it has been below 5% since March. The latest numbers are 6.24% and 4.70% for M1B and M2 respectively (August 2015). Since crude oil price has stopped declining, consumer price index (CPI) was up 1.38% in the first eight months, mainly because of higher food prices, which rose by 5.77%. But the other components including fuel related prices offset the effect of the rise in food prices. In the same period, the core price index was up 0.81%. In addition, since international commodities prices are still weak, the wholesale price index (WPI) declined 3.93% in the first eight months of 2016. Due to hot money flowing into Taiwan’s financial market, the demand of NT dollars has risen and has led to exchange rate appreciating by 2.2% since July. The latest number is 31.51 as on 9/9. III. Future Prospects: 2016-2018 In the coming two years, we expect external pressures to ease due to recovery of the world economy. According to the latest forecast released by IMF, the world trade volume will grow at 3.9% in both advanced economies and emerging markets and developing economies in 2017, which is much better than numbers for 2015 and 2016. In addition, while the sluggish imports of China are the main concern, the new policy adopted by the Taiwanese government is likely to mitigate the impacts of the “New Southward Policy” and stimulate investment at the same time. By considering these positive factors, according to the macroeconomic model of Academia Sinica, real GDP is forecast to grow only 0.91% in 2016, 1.38% in 2017 and 2.90% in 2018. In the following, we discuss the major components of GDP. A. Consumption It is difficult and complex to estimate private consumption, the major component of GDP. The latest high-frequency data show that sales of food and beverages grew 3.7% in July but imports of consumer goods declined 3.9% in August. Moreover, Taiwan consumer confidence index (CCI) has also showed a downward trend, reflecting a weak outlook in this sector. More specifically, in August, CCI dropped 6.59 points year-on- year. As a result, we believe that growth of private consumption will be small in 2016 (2.16%), lower than the simple average of the past three years (2.67%). However, even the minimum wage will rise 5% from 2017, rising prices are expected to offset the wealth effects. We expect growth of private consumption to decelerate from 2.16% to 1.05% in 2017 and accelerate to 3.12% in 2018. According to the government budget document, government consumption is projected to grow by 1.91% in 2016 and increase nominally by 0.10% in 2017. B. Investment The two consecutive quarters of contraction in gross fixed capital formation can be largely attributed to the sharp decline in investment by the government and government-owned enterprises.